What Is A Self Directed Brokerage Account In A 401k?

A self directed brokerage account is a provision included in some 401k plans that allows you to have more control over your investments within your 401k. The majority of 401k accounts offer a small selection of mutual funds to invest in.

For lots of investors, this small selection of funds is adequate to help them save for their retirement. However, other more experienced or knowledgeable investors (i.e. self directed) want the opportunity to have greater control over their investment selection.

This is where a self directed brokerage account or SDBA comes into play. An SDBA allows you to access a broader range of investments beyond the small selection curated by your specific plan. For this reason SDBAs are often referred to as a brokerage window.

The exact investments you can buy through an SDBA will vary by plan but may include individual stocks, bonds, and ETFs. It is important to note that not all 401k plans offer a SDBA as a benefit of the plan and there is not a rule or law requiring them to do so.

Since a self directed brokerage account is offered as part of a 401k plan, the rules that apply to the 401k plan also apply to the self directed brokerage account.

For 2024, the maximum amount you can contribute to a 401k (including the SDBA portion if offered) is $23,000 or $30,500 if you are 50 or older. Your employer may offer a match that increases these numbers but you as the plan participant cannot contribute more than the limits listed above.

If you were to over contribute, it is your responsibility to notify your plan administrator so the excess contributions can be returned to you. Most investors will not run into this problem as the contribution limits for 401(k)s are fairly high and are adjusted for inflation annually. However, it is important to be aware of the rule.

Once you are 59 and a half years old, you can start to take withdrawals from your 401k penalty free. Note the words "penalty free." If you have a traditional 401k, you will still be required to pay the applicable income taxes from any withdrawal taken.

If you take a withdrawal before you are 59 and half years old you may incur an additional 10% IRS penalty on top of the applicable income taxes. There are some exceptions that may allow you to avoid this 10% penalty on early withdrawals, but in general it is best to wait until you reach 59 and a half to avoid the penalty.

The rollover rules that are applicable to standard 401k plans are also applicable to SDBA 401k plans. You are allowed to rollover your money to an IRA, such as a Traditional IRA, or a new 401k plan. This is typically done through a direct rollover in which a check is made payable to the new financial institution for the benefit of (FBO) your name.

An indirect rollover on the other hand is where a check is made payable to you and it is your responsibility to get it to the new financial institution within 60 days. Your plan record keeper can advise you on the specifics of how to process a rollover so reach out to them for help.  

The first advantage to a SBDA 401k is that you have greater control and more flexibility over your investments. For example, say that the core funds offered in your 401k plan are only focused on US stocks and US bonds.

However, you may want the ability to invest in international or emerging market stocks and bonds. If your employer offers a self directed brokerage window, you may be able to buy these investments through the brokerage account of the plan.

It has already been touched on, but arguably the biggest advantage to a SBDA 401k is the increased investment selection. You may be able to access hundreds of investment funds, stocks, bonds, and ETFs through a self directed brokerage account that are not offered in your plan.

Additionally, some self directed brokerage accounts may allow you to access alternative investments such as precious metals, private placements, energy investments, tax liens, and more depending upon the specific rules of your plan.

Depending upon the fees of your normal 401k plan, it may end up being cheaper to invest through the self directed brokerage 401k. Keep in mind that this may be a rare occurrence, but for some investors that have a 401k with above average fees, it is something to consider.

If you are considering a SDBA 401k, compare what your fees would be in this account to the fees in the standard 401k by reviewing your plan fee disclosure document.

Although an SDBA 401k offers some benefits, many investors do not have the knowledge or experience necessary to successfully pick and manage their own investments offered outside of the core funds of the plan. Many investors who opt to try to build their own portfolio often end up in a worse place than if they would have just bought something like an index fund that is likely offered as a core fund in most plans.

To further prove this point we can look at some data that shows the difference between actively managed funds and passively managed funds. Actively managed funds are managed by professional fund managers that try to beat the average returns of markets by actively buying and selling investments.

Passively managed funds on the other hand simply try to capture the average returns of the market and usually do not have a fund manager. According to data from SPIVA, only 12% of actively managed funds were able to beat passively managed funds over a 15 year period.

What this literally shows is that 88% of professional fund managers fail to successfully beat the return of the market. If a professional can struggle to pick the right investments, it is likely that you will also struggle if you opt to invest in a SDBA 401k account.  

As mentioned previously, your employer has to opt to offer an SDBA as an option within your 401k. The number of employers offering this as an option is increasing, but there is no guarantee that your current or future employer will.

Employers are primarily concerned that their employees may make poor investment decisions through an SDBA. Employers do not want to be held liable for poor investment decisions made by their employees if they offer an SDBA through their 401k plan.\

If a SDBA is not offered through your 401k plan, you may be able to get an increased investment selection through an IRA, such as a Roth IRA. You can also open up a taxable brokerage account if you want to trade more frequently, but it is important to understand the capital gains tax rules and risks applicable to taxable brokerage accounts before using one.  

The words "self directed" can be a little misleading in regards to an SDBA 401k. You as the plan participant have discretion over the investments you buy and sell through the brokerage window as well as when you want to buy and sell.

However, your employer may limit the investments offered through the brokerage window. For example, some employers will simply offer a greater selection of mutual funds through the brokerage window. If your normal 401k offered 15 mutual funds, the brokerage window may offer an additional 50.

Some employers will give you more freedom and offer individual stocks, bonds and alternative investments. If you are considering an SDBA 401k for a broader investment selection, check the specific rules of your plan to see what will actually be available to you.

Just like it may be cheaper to use a SDBA 401k, it can also be more expensive. It all comes down to the specific rules of your plan. Some plans will attach higher costs to SDBAs and the investments offered in the SDBA could also be higher than those in the normal 401k for similar types of investments.

Like most financial questions, it depends. A self directed brokerage through a 401k can be a viable option if you are not happy with the investment selection in your normal 401k plan. However, it is also important to understand the risks that come with SDBAs.

The benefit of an increased investment selection can also be a downfall for some investors. With an increased investment selection, you need the skills and knowledge to select the appropriate investments that align with your risk tolerance and financial goals.

Picking your own investments can bring emotions to the front of the table which can lead to the possibility of making unwise financial decisions - especially during the times that your selected investments do not perform well.

Before diving head first into a self directed brokerage account, there are a few things you can do. First, you can try your hand at paper trading. Paper trading is a process in which you can buy and sell investments under real market conditions with "fake money" through some online brokers.

In other words, you are not risking any real money. Paper trading can be a way to test if you would be able to successfully pick and manage your own investments through a self directed brokerage account without risking any financial loss.

Secondly, you may consider hiring an independent financial advisor to help you with your SDBA if it is allowed by your plan. Although this will come with an increased cost, it can be beneficial to you if you want access to additional investments beyond your plan's core funds, but lack the knowledge and experience to pick them yourself.

Finally, start by allocating a small percentage of your investments towards your SDBA if you decide to use one. You do not have to place your entire contribution into your SDBA. You can still place a majority of your contributions into the core funds of your plan.

If you allocate a small percentage of your portfolio towards the SDBA portion, such as 5%, you will get to see if you should actually use the SDBA without risking a large sum of your retirement savings. You can always increase the amount later on, but start small.

The bottom line is that a self directed brokerage account, or brokerage window, is an option offered by some 401k plans that will allow you to access a greater investment selection giving you more flexibility and control over your retirement savings.

An SDBA may be a viable option for you depending upon your needs and goals, but make sure to be careful when using one. SDBAs may increase your risk as your emotions can get involved with picking from a larger investment selection.