Charles Schwab has launched a new retirement plan service using index mutual funds—a move that had been in the works for more than a year and that could cut the cost of defined contribution retirement plans by as much as 25 percent compared with pricier actively managed mutual funds.

Schwab first announced its plans to introduce passive investing into the 401(k) market last March, and hoped to roll out ETF-only 401(k) portfolios this year. But that timetable has now been pushed back about a year, with the ETF portion of the “Schwab Index Advantage” program now not expected until 2013.

While Valley Forge, Pa.-based Vanguard Group already offers its index mutual funds in some 401(k) plans, Schwab appears to be alone in seeking to integrate ETFs into defined contribution benefit plans. Schwab would leave the decision of whether to choose ETFs or index mutual funds to 401(k) plan participants.

Schwab’s plan could shake up the $3 trillion-plus 401(k) market, especially if the ETF piece takes off.  It would blaze a trail for ETFs to tap into the retirement market, which is roughly three times as big as the total U.S. ETF market. Total ETF assets are now at a record $1.164 trillion, according to data compiled by IndexUniverse.

Many are looking at the 401(k) market as the next major frontier for ETFs. Slowly but surely, ETFs have been chipping away at the dominance of mutual funds offering lower cost, transparency and trading benefits that active mutual funds lack. In 2011, ETFs pulled in twice as much new money as mutual funds did.

Shaving $100,000 In Fees

Schwab will initially serve up a combination of index fund-based portfolios with an independent investment advisory service for the all-in cost of 0.65 percent to 0.70 percent of assets under management—about 25 percent less than what an average mutual-fund-based 401(k) plan costs, according to data provided by the company.

“It’s time to rethink the 401(k) plan and pay close attention to workers who, now more than ever, are worried about their retirement savings, are often confused by their plan’s complexity and may be missing out on the help they need to save and invest for retirement,” Schwab’s Jim McCool, executive vice president and head of institutional services, said in a press release earlier this year.

Schwab’s Retirement Plan Services currently provides 401(k)s to about 1.5 million workers, and it has around $90 billion of assets under management.

Saying that nine out of 10 workers worry they don’t have enough money for retirement, McCool argued that the industry as a whole needs to reassess the way 401(k)s are managed because they are the main savings tool for most Americans.

“Through such low-cost investments, fund operating expenses could be cut significantly,” Schwab’s head of retirement plan services Steve Anderson said. “For the average worker in a 401(k), that can mean nearly $115,000 more at retirement,” Anderson argued, using Schwab calculations.

Schwab officials argue that benefits of its index-only retirement plans go beyond cost reduction, saying it doesn’t take as much time to select an index fund compared with an actively managed fund.

Investment Advice For Those Who Want It

Schwab said it is also planning a low-cost investment-advice service for those employers who lack time or expertise, or both, in managing 401(k) accounts.

The cost of the investment advice alone is pegged at 0.45 percent—and that’s included in the all-in cost estimate of 0.65-0.70 percent a year.

“Employees who prefer to manage their account themselves can do so at any time using either the index funds provided under the plan, or by opening a self-directed brokerage account if their employer offers this feature through their 401(k) plan,” the company said.

Schwab says it is still working on the platform to support ETFs, including supporting intraday trading and, as noted, that piece of the puzzle is now expected to be completed in 2013.