Brokerage Window

A brokerage window is a plan arrangement, offered in some 401(k), 403(b) and other participant-directed retirement plans, that lets a participant move part of their balance into a brokerage account inside the plan and choose investments beyond those the plan has designated. The Department of Labor's participant-fee disclosure rule names the arrangement in the same breath as its common synonym: "'brokerage windows,' 'self-directed brokerage accounts,' or similar plan arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan." The money stays inside the plan and keeps the plan's tax treatment; what changes is who picks the investments.

How it differs from the core menu. A plan's designated investment alternatives are the funds its fiduciaries select and monitor, such as target-date, index and actively managed funds, including the plan's default fund. A brokerage window sits beside that menu. The regulation states that the term "designated investment alternative" does not include brokerage windows or self-directed brokerage accounts, and the Department's guidance adds that neither the window nor anything bought through it is a designated alternative unless the plan specifically identifies it as one.

What participants are told. Because the window is not a designated alternative, the investment-specific disclosures in paragraph (d) of the rule, the performance history, benchmarks and expense ratios for each fund, do not apply to it or to what is bought inside it. The plan-level disclosures in paragraph (c) do. Field Assistance Bulletin 2012-02R says the plan administrator must give a general description detailed enough for participants to understand how the window works: how and to whom to give investment instructions, any account balance requirements, any trading restrictions, how it differs from the designated alternatives, and whom to contact. The plan must also explain any fees charged to an individual account for the window, such as start-up, closing, annual, inactivity or minimum-balance fees and per-trade commissions, and report each quarter the dollar amount actually charged. That annual fee explanation goes to every participant, not only those using the window, so that people can decide whether to use it.

What the fiduciaries still owe. Offering a window does not end the plan fiduciaries' responsibilities. The same bulletin states that fiduciaries of plans with brokerage windows remain bound by ERISA section 404(a)'s duties of prudence and loyalty to the participants who use them, including taking into account the nature and quality of the services provided. It also warns that a fiduciary who avoided designating investment alternatives in order to avoid the disclosures would raise questions under those same duties. What the fiduciaries do not do is pick or monitor the individual securities a participant buys through the window.

What it can and cannot hold. The plan and its provider decide what the window can hold. A window may be limited to mutual funds, or may exclude categories such as options, margin trading or particular asset types. A window cannot do what the plan itself cannot do, so withdrawals, loans and distributions still follow the plan's own rules. Questions about holding cryptocurrency or other alternatives through a plan are covered on the pages for those subjects, because the rules there have been changing.

Why a participant might use one. It serves participants who want something the core menu lacks, such as a specific index fund, a particular bond ladder or a broader range of low-cost funds. The trade-off is that the participant takes on the job a fiduciary does for the menu: choosing, diversifying and monitoring, with trading costs and fund expenses that can exceed those of the plan's own options.

The mechanics vary by plan, but the outline is common.

1. Read the plan's description and fee disclosure for the window, which the plan must provide to every participant.
2. Open the window through the plan's recordkeeper, which sets up a brokerage account held inside the plan.
3. Move money in from the core funds, subject to any minimum the plan sets to stay in the core menu or limits on how much can go to the window.
4. Choose and trade investments yourself, paying any commissions and the expenses of the funds you buy.
5. Monitor it. The quarterly statement must show the fees actually charged to your account for the window.

Consider an example: Ana has $200,000 in her 401(k) and moves $50,000 into the plan's brokerage window to hold a fund with a 0.05% expense ratio, replacing a menu fund charging 0.60%. Her fund costs fall from 0.60% x $50,000 = $300 a year to 0.05% x $50,000 = $25, a saving of $275. The window charges a $50 annual fee and she makes four trades a year at $10 each, $40, so her net saving is $275 - $50 - $40 = $185 a year. Had she traded every week at $10 a trade, 52 x $10 = $520 in commissions alone would have turned the saving into a loss.

Pros

• Gives access to investments the plan menu does not offer, sometimes at lower cost.
• Keeps the money in the plan, with the plan's tax treatment and the creditor protection the plan carries.
• Lets an experienced investor build a portfolio that fits the rest of their holdings.

Cons

• No fund-by-fund performance and expense disclosures for what you buy inside it.
• Account fees and trading costs can wipe out any expense saving.
• The participant carries the investment choices alone, including the risk of concentration or frequent trading.
• Availability, permitted investments and limits differ widely between plans.