Some 401(k) plans open a window to broad investment opportunities.
They let you invest in stocks, bonds, or funds of your choosing, as well as the investments and company stock that are part of the plan’s menu. Using this option, you trade through a designated brokerage account, just as you would using a broker outside the plan.
Self-directed brokerage account
Investing your 401(k) money through a brokerage account, or window, has advocates as well as detractors.
Those in favor argue that having the greatest possible choice is a boon for 401(k) participants with investment experience who prefer to select their own investments and have the skill and experience to do it.
But others believe that having unlimited choice may be confusing or intimidating. They point out that it’s impossible for plan sponsors to evaluate the nearly infinite array of investments that are available through brokerage accounts. They also worry that employees may not have enough information to make smart choices.
Some employers fear that they might be held legally liable for losses if plan participants are disappointed with their returns, since any investments made through the plan might appear to have been sanctioned by the employer.
A tax plus
From the employee’s perspective, one of the greatest appeals of a 401(k) brokerage account is that dividends and capital gains aren’t subject to current taxes. For example, if a stock in your portfolio hit a new high in a period of market exuberance, you could sell it and realize the profit. You could then use the entire amount to make more stock investments, or earmark some of the gain for a more conservative account as insurance against a market downturn or a bad investment decision.
Of course, there’s also the possibility with a 401(k) brokerage account that you could lose large amounts of money if the markets falter or you make poor choices. In that case, you can’t write off any of those capital losses to offset gains.
While you defer tax on any earnings in a 401(k) brokerage account, remember that you do pay income tax when you start withdrawing from your account at the same rate you pay on your ordinary income.
You should consult your tax adviser about the tax implications of withdrawing from a 401(k) brokerage account in comparison to taking money out of a brokerage account outside a 401(k) plan.
Pros and cons of having 401k brokerage account
Maintaining a brokerage account in your 401(k) carries a modest annual fee — in the range of $25 to $175, depending on the firm. Further, you may pay transaction costs and commissions on each trade you make. Most people who are enthusiastic about the chance to invest their 401(k) money as they please consider those charges worth the price.
Similarly, mutual funds you purchase through a brokerage account may have higher fees than those provided by your employer, in part because your employer may subsidize part of the cost of investing or because the choices offered through the plan are institutional funds, which typically have lower fees. Any transaction costs, as well as annual fees, are deducted from your account value.
|• Greatest possible investment choices||• May not have all the information needed to make good choices|
|• Capital gains aren’t subject to current taxes||• Short-term trading can jeopardize long-term retirement goals|
Is day trading good for 401k?
Some financial professionals object to brokerage accounts in 401(k) plans because they worry that some investors might be tempted to try short-term trading, also known as day trading. Day traders attempt to make money on rapid, short-term price changes in a number of different stocks. But they face the increased risk of substantial losses by trying to time their trades. Further, the critics say, stressing short-term gains is at odds with the goal of retirement savings, which is long-term growth.
Similarly, these same critics fear that being able to trade regularly in a 401(k) brokerage account might encourage less experienced investors to sell off stocks during a market downturn and buy them again when the markets have recovered.
They argue that this approach — which they sometimes describe as a knee jerk reaction to market fluctuations — is a bad idea. It means you pay higher prices when you repurchase shares, on top of sustaining losses, if you sell when prices have declined dramatically — precisely the point at which panic tends to set in.
There is statistical evidence to show that past investors who stayed in the market through thick and thin came out ahead of investors who moved in and out — but there are no guarantees that will be the case in the future.
Pros And Cons Of Self-directed 401k Brokerage Accounts by Inna Rosputnia
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