Schwab Joins the 401(k) Wars

The discount broker jumps in with an index-only retirement plan.

Dan Caplinger
Dan Caplinger
May 19, 2011 at 12:00AM

When the bottom fell out of the stock market in 2008 and 2009, a lot of workers got fed up with their retirement savings plans. But with nearly $3 trillion in assets at stake, 401(k) money represents a huge pool of prospective managed money, and financial services companies are going after them aggressively as Baby Boomers start to near retirement age.

Earlier this year, three big banks -- Wells Fargo (NYSE: WFC), Bank of America (NYSE: BAC), and JPMorgan Chase (NYSE: JPM) -- started beefing up their employee ranks to try to improve their competitive position in the 401(k) management department. TD AMERITRADE (Nasdaq: AMTD) answered last month with a 401(k) plan offering that includes exchange-traded funds as investment options for plan participants.

But Charles Schwab (NYSE: SCHW) is going with a different approach. If it's successful, it could dramatically change the way that workers invest for retirement.

All indexes, all the time
Schwab announced that it plans to offer employers a 401(k) package that includes only index funds as investment options. It also plans to give companies a choice to pick a different package with an all-ETF portfolio.

The index-fund product won't come out until later this year, and ETF-based 401(k) platform probably won't be available until 2012. But the move couldn't come at a better time. In one fell swoop, an index-only 401(k) will address several problems that led policymakers a few years back to consider massive changes to the entire structure of retirement savings.

First and foremost, one of the primary complaints of 401(k) plans is that they force workers into high-fee, actively traded funds. In particular, the small businesses that Schwab intends to target with its new offerings, those with between $20 million and $1 billion in plan assets, are often susceptible to choosing 401(k) providers that give the business a no-cost plan at the expense of workers having to pay more.

In contrast, an index-only plan would replace high-fee active funds with the rock-bottom expenses that index funds have. That, in turn, should help strengthen dismal performance for many plans. As a Schwab representative noted, the lower fees on an index-only platform for 401(k)s could give some accounts an additional $100,000 or more in extra retirement savings.

Keep it simple
But even beyond fee savings, index funds and ETFs could potentially make it much simpler for even novice investors to understand exactly what they're investing in. Actively traded mutual funds often have names that obscure exactly what they invest in. On the other hand, index funds tend to have boring, descriptive names that make it very clear what types of securities they hold. For instance, "Schwab S&P 500 Index Fund" may not be as exciting a name as "Schwab Premier Equity Fund," but with the former, you know pretty much exactly what you're getting.

Of course, Schwab has self-interest in mind as well. A stronger set of 401(k) offerings will help it build market share. When the ETF platform rolls out next year, it will provide another source of inflows for its relatively new ETF offerings, which Schwab is trying to build up in defiance of industry leaders BlackRock's (NYSE: BLK) iShares, State Street's (NYSE: STT) SPDRs, and Vanguard.

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The next shoe to drop?
With companies throughout the industry staking their claim to trillions in retirement funds, the interesting question is who will come out with a competitive proposal next. So far, 401(k) industry leaders, including Vanguard, Fidelity, and Aon's (NYSE: AON) Aon Hewitt division haven't made waves in enhancing their offerings. But if up-and-coming 401(k) managers show signs of success with initiatives like the one Schwab is making, then they'll likely have no choice but to respond with moves of their own. In the end, workers should benefit from better selection and lower cost.

Picking a broker for your personal account is just as important as having a good 401(k) plan. Find the right broker now in the Fool's Broker Center.