Do ETFs Have a Place in 401(k) Plans?

While the global exchange-traded fund industry will turn 35 years old on March 9, and investors continue to flock to the low-cost investments, it remains to be seen whether ETFs will establish more of a presence in defined contribution retirement plans.

Largely due to the structure of ETFs and how they can be  traded intraday, some believe that ETFs are not built for 401(k) plans. Meanwhile, a handful of retirement plan service providers and recordkeepers are looking to incorporate ETFs into their retirement plan portfolios.

There is $15.4 trillion invested in about 14,000 ETFs with 23,000 listings, according to Deborah Fuhr, managing partner and founder of ETFGI, an independent research and consulting firm she launched in 2012 in London. She says ETFs are traded on 81 exchanges in 63 countries.

One of the reasons why ETFs are not often in the 401(k) market is because one of the main benefits of ETFs for U.S.-based investors is the redemption process, which makes ETFs more tax efficient than mutual funds.

“You don’t really need tax efficiency in the 401(k) wrapper because it’s already tax efficient,” Fuhr says.

Another challenge Fuhr points out is that with the 401(k) market, the overall movement of funds between plan administrators and mutual fund companies has been in place for a long time, so there is little incentive to change this architecture.

“Everyone’s quite happy to be paid how they’re paid, as opposed to sticking ETFs in that don’t pay the same kind of fees that you might get using mutual funds,” Fuhr explains.

She also argues that when an investor buys an ETF, it’s like buying a share in a company. For example, if someone buys an IBM share and the price is $100, they need to have $100 to invest. However, with mutual funds, Fuhr says investors are able to buy units in a fund, valued at the amount that is available to invest, which has historically worked well in 401(k) plans.

Betterment’s All-ETF 401(k)

But some brokers and recordkeeping platforms, such as Betterment, allow investors to buy fractional shares of ETFs. In fact, Betterment is one of several providers that has built its own recordkeeping and custody platforms for an all-ETF 401(k).

Mindy Yu, director of investing at Betterment, says many recordkeeping platforms were built with mutual funds in mind decades ago with an inability to adopt funds that can trade throughout the day as ETFs do.

Yu says there has been a lot of growth in ETFs over the past few years, and many mutual funds are converting to ETFs. According to data from the Federal Reserve Bank of St. Louis, mutual funds had around $22 trillion in total assets as of the third quarter of 2024.

Betterment offers diversified managed portfolios using ETFs, and Yu says these portfolios operate similar to how a target-date fund would.

“Essentially, [the portfolio] will have a glidepath depending on when the plan participant wants to retire, and we’ll derisk them, and it’s all through the usage of ETFs,” Yu says. “Building a portfolio using ETFs is very flexible, and it allows us to be more customized.”

Yu argues that mutual funds tend to be more rigid in that within target-date funds, the glidepaths are designed within five-year parameters, and if someone decides to retire sooner than their target-date, they have to sell out the mutual fund and think about which new fund applies to them.

“With the efficiency and the automation of how Betterment builds solutions through ETFs, you simply change the year and essentially will be managing that customized managed portfolio to that specific retirement year,” Yu says.

Betterment has more than $17 billion in retirement assets on its all-ETF 401(k) platform.

How ETFs Benefit Investors

Fuhr notes that another fruitful area for ETFs may be in the decumulation phase of retirement. As participants retire and take money out of their defined contribution plans, Fuhr says many look to ETF strategies.

“As people move out of 401(k)s and [are thinking] about directly managing their own money, they look at ETFs as a very easy tool to understand,” she says.

Fuhr says ETFs also can often easily fit into a 401(k) plan’s self-directed brokerage window where investors are able to pick from a variety of investments beyond the standard investment options provided by the plan.

Several other firms have taken steps to allow for more ETFs in 401(k) plans. State Street Global Advisors filed for permission with the Securities and Exchange Commission in October 2024 to create mutual funds as a share class of its ETFs, which would be “specifically designed for, and only available to, investors purchasing through a retirement plan.” Schwab also applied for the same structure last June, following others like Morgan Stanley, Dimensional Fund Advisors and Fidelity.

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