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A New Direction For Your 401(k)?

Does your company provide a 401(k) plan for its employees? If it does, you may defer part of your salary via payroll deductions, up to annual limits, and have the funds in your account accumulate on a tax-deferred basis. For 2017, the maximum deferral is $18,000 or $24,000 if you're age 50 or over. In addition, your company may kick in matching contributions up to a stated percentage of your compensation. And there's no tax on earnings within your account until you make withdrawals.

How is the money invested? Typically, a plan will offer a variety of choices, usually composed of different mutual funds. Many plans feature "target date funds" geared toward a specific time in the future, such as when you expect to retire. But some experts believe target date funds can be difficult to evaluate and don't take personal needs into account adequately.

One possible alternative is a self-directed brokerage account. Only about one out of five 401(k) plans offers this option. But should the opportunity present itself, it might be right up your alley.

As the name implies, a self-directed brokerage account inside a 401(k) gives the participant a chance to trade investments—including stocks, bonds, and mutual funds—that aren't included on the 401(k)'s normal menu. That way, you have more choices and more of a say about how your 401(k) assets are invested. While this option is not for investing novices, it gives experienced investors a better opportunity to control their own financial destiny.

In most ways, a self-directed account operates just like any other 401(k). You still can benefit from payroll deductions and tax deferral, and your assets can compound free of current taxes.

Perhaps the biggest difference with a self-directed account is that you're charged fees for your brokerage transactions. You also might rely on third-party professional money managers who can manage investments on your behalf. Although you're paying for these services, you'll also pay fees for target date mutual funds and other investments in a regular 401(k). You just need to compare costs carefully, because paying excess fees can undercut your long-term results.

We can't emphasize enough that this 401(k) option is not for everyone. However, depending on your circumstances, it might be right for you.