Mutual funds dominate the 401(k) landscape, but an investor can opt for exchange traded funds in their 401(k)s if the employer includes a brokerage window, or self-directed 401(k), option.
The brokerage window basically acts like a brokerage account embedded within the retirement plan, writes Adam Zoll for Morningstar. [Build a Diversified 401(k) Portfolio with Six ETFs]
Around 17% of 401(k) plans offered a brokerage window option as of 2012. Potential investors, though, should be aware that plans may vary, with some options only allowing for mutual funds while others include stocks and ETFs. [How Low-Cost ETFs Can Help Boost Your 401(k) Returns]
Before diving in head first, there are some considerations. Investors should look into a brokerage window if it makes sense. Many 401(k)s offer a diverse range of asset classes, but some investors may want more options, such as dedicated emerging market, high-yield, real estate or small-cap exposure to name a few. With ETFs, investors can track a wider range of options.
A 401(k) investors should not utilize the brokerage window as a means for trading or timing the market. The option is not an invitation to begin dabbling in gut instincts. A well-designed 401(k) provides the right mix of equity, fixed-income and alternative assets that suit an investor’s time horizon.
With a brokerage window, investors will have to pay a commission on trades, so costs on regular, paycheck-to-paycheck contributions may add up. Investors should make contributions periodically or look into commission-free funds available on the brokerage platform. [Six Popular Commission-Free ETF Trading Platforms]
Alternatively, savers may also redirect a portion of the money into an IRA instead. The adjusted gross income limits to contribute to a traditional, tax deductible IRA for taxpayers who take part in a workplace retirement plan are $70,000 for singles and $116,000 for married couples who file jointly. For Roth IRAs, income limits are $129,000 for singles and $191,000 for joint filings.
For more information on ETFs in 401(k)s, visit our 401(k) category.
Max Chen contributed to this article.