Are ETFs a Good Fit for 401(k) Plans?

Exchange-traded funds (ETFs) have become a staple in many investors’ portfolios thanks to their low costs, tax efficiency, and broad diversification. But are they a smart addition to a retirement account like a 401(k)? The answer depends on how the plan is structured, your goals, and the flexibility of employer-sponsored plans.

It’s also important to keep in mind that although ETFs have gained traction in individual retirement accounts (IRAs) and brokerage accounts, their integration into 401(k)s has been slower and more complex. Here’s what to know before relying on ETFs in a retirement savings strategy.

Understanding ETFs

Exchange-traded funds (ETFs) are pooled investment vehicles or baskets of stocks that trade on exchanges just like individual stocks. They often aim to track the performance of an index, sector, or asset class and can include a wide range of securities—from domestic and international equities to commodities, currencies, and bonds.

Types of ETFs

There are over 12,000 ETFs on the market, and they vary by type. Here are some of the most common:

This variety allows investors to build highly diversified portfolios tailored to their risk tolerance and investment horizon.

Management Styles

ETFs are often passively managed and meant to track a benchmark index. However, some are actively managed and attempt to outperform the market.

“When evaluating ETFs for a 401(k), it’s important to consider cost, liquidity, and administrative ease,” says Christopher Stroup, founder of California-based Silicon Beach Financial. “ETFs often have lower expense ratios than mutual funds, but they trade like stocks, which can complicate implementation in a retirement plan.”

Advantages of Including ETFs in 401(k) Plans

Cost Efficiency

One of the key selling points of ETFs is their low cost. According to data from the Investment Company Institute, the average expense ratio for actively managed equity ETFs is significantly lower than that of comparable mutual funds. “ETFs typically have lower expense ratios than mutual funds, which helps reduce long-term costs,” says Stroup.

These lower fees can be particularly important for retirement planning as they can have a compounding effect over time, especially in a tax-deferred environment where savings remain invested for decades.

Diverse Investment Options

ETFs give 401(k) investors access to a broad range of asset classes and strategies, from U.S. large caps to emerging markets and niche sectors—all of which can help ensure strong portfolio diversification. In some cases, ETFs are also used as building blocks to create custom portfolios or in ETF-based target-date funds, which automatically adjust asset allocations as retirement approaches.

Disadvantages of Including ETFs in 401(k) Plans

Intraday Trading Concerns

Unlike mutual funds, which are priced at the end of the trading day, ETFs can be bought and sold throughout the day at market prices. While this affords investors some flexibility, it can be a double-edged sword for retirement savers, says Stroup. “While ETFs can be bought and sold throughout the day, long-term investors don’t need this flexibility. It may also encourage unnecessary trading,” he says.

In the same vein, it’s important to remember that 401(k) plans are designed for long-term, automated investing—and frequent trading is generally discouraged. By design, the intraday nature of ETFs may conflict with the generally hands-off philosophy of retirement planning.

Tax Efficiency in Tax-Deferred Accounts

ETFs are often lauded for their tax efficiency—particularly their ability to avoid capital gains distributions through in-kind redemptions. But this advantage matters less in a 401(k), where investments grow tax deferred.

“ETFs use an in-kind redemption process, minimizing capital gains distributions,” Stroup says. “401(k) participants should know that this matters more in taxable accounts.”

In other words, the tax benefits of ETFs are largely neutralized inside a 401(k), where taxes aren’t due until distributions are made in retirement.

Plan Integration

One of the biggest hurdles to wider ETF use in 401(k)s is operational. Many 401(k) providers still lack the infrastructure to support ETFs as seamlessly as mutual funds, limiting their availability in standard plan menus.

“Some 401(k) providers don’t support ETFs efficiently, which makes them less accessible than traditional mutual funds,” says Stroup. Mutual funds, by contrast, are deeply embedded in the 401(k) ecosystem. They allow for easy automation of contributions, dollar-cost averaging, and rebalancing—features that aren’t always available with ETFs.

Current Trends and Adoption

ETF Adoption in 401(k) Plans

Although mutual funds still dominate the 401(k) landscape, ETFs are beginning to gain ground—particularly in plans that offer greater investment flexibility. “More 401(k) plans are starting to offer ETFs, especially in self-directed brokerage accounts where participants can select ETFs alongside traditional funds,” says Stroup.

These brokerage windows, offered by major providers like Fidelity and Schwab, allow retirement savers to build more customized portfolios that include ETFs targeting specific sectors, regions, or strategies. Additionally, some plan sponsors are exploring ways to reduce fees by incorporating ETFs into their core investment menus, Stroup says.

Innovative 401(k) Plans Using ETFs

Some forward-looking employers are taking a more progressive approach by integrating ETFs directly into their 401(k) offerings. One notable trend is the development of ETF-based target-date funds—portfolios that automatically shift asset allocations as participants near retirement, using low-cost ETFs instead of mutual funds, Stroup says.

These ETF-based solutions aim to deliver the same hands-off investing experience as traditional target-date funds but at a potentially lower cost. They’re also being used by robo-advisors and managed account platforms embedded within 401(k) plans.

The Bottom Line

ETFs offer compelling benefits for retirement planning (and investing)—low costs, diversification, and transparency—but they aren’t always a perfect fit for 401(k) plans. Their intraday tradability and tax efficiency matter less in a retirement account, and plan integration remains a key barrier.

Still, with the rise of adoption—including through self-directed brokerage windows and ETF-based target-date funds—more retirement savers will likely gain access to ETFs over time. As always, the best option depends on your specific plan and your long-term goals.