Charles Schwab plans to lower 401(k) costs by steering assets, for the first time, toward lower-priced passive index funds and ETFs, beginning this year. Should Schwab’s plan gain traction, it could seriously upset the world of defined-contribution retirement plans that’s dominated by actively managed mutual funds.

The San Francisco-based company, which has a long-standing reputation as a discount broker and purveyor of low-cost funds, plans to begin rolling out the index mutual fund piece of its plan later this year, while the ETF portion will come to market sometime in 2012, Greg Gable, the company’s top public relations officer, told IndexUniverse. It also already runs about $200 billion in retirement assets.

Schwab Chief Executive Officer Walt Bettinger first laid out the plan in a presentation to analysts last month. Given Schwab’s big footprint in the money management industry, the initiative could be a game changer in the ETF asset-gathering game. Total money in U.S.-listed exchange-traded products crossed $1 trillion in December, a quarter of the more than $4 trillion in mutual fund assets in 401(k)s and individual retirement accounts.

“This will be, to the best of our knowledge, the first instance of a major provider doing an all-index offering,” Gable said in a telephone interview. “Historically, it has been dominated by active mutual funds. There has been somewhat of a trend of index options into (retirement) plans over the last few years, and it's been on the increase.”

Schwab’s entire push is based on a study it published in September 2010 called “The New Rules of Engagement for 401(k) Success” that found that high costs and a lack of investor education have together conspired to limit the amount people save for their retirements, a shortfall that is beginning to rear its head as the so-called baby boom generation (born between 1946 and 1964) starts to retire.

“In looking at this over the years, it’s clear to us that the two most important factors in looking at success for investors are the cost of the investment and the advice that they get, with advice being paramount in that,” Gable said.

“You’ve got to find a way to take costs out of the equation. Index funds are a great way to do that now—the costs on those are so low relative to active management. And now there are ETFs, which also are a super-effective way to invest,” Gable added.

Lower costs should encourage investors to put more money into their retirement accounts as well as increase the returns they enjoy from that pool of assets, Gable said.

U.S. retirement assets totaled about $16.6 trillion in September 2010, according to the Investment Company Institute, the mutual fund industry’s trade group. Over half of those assets were invested in individual retirement accounts (IRAs), 401(k) plans, or other employer-based defined-contribution retirement plans. And about 52 percent of that money was in 401(k)s and IRAs, or about $4.4 trillion was in mutual funds, the ICI said.

Gable called a widespread move to cheaper index funds and ETFs a “game changer,” advising skeptics to “follow the money.” As Dave Nadig blogged on Dec. 21, mutual funds are expensive and often underperform the market, a factor behind the move that's already going on of some assets flows out of mutual funds and into ETFs.

Advice Matters

Professional advice has a markedly positive impact on retirement savings accounts, according to the Schwab report. Survey participants who received advice tended to almost double the rate they saved for retirement.

They also diversify their portfolios to a greater degree and more consistently stick to their investment objectives, the report found.

Schwab hasn’t decided how much it might charge for advice, but Gable said it could be in the range of 0.40 to 0.50 percent of assets under management per year. That compares with industry standards of at least 0.65 percent. Coupled with the lower investment costs, Schwab’s new retirement initiative may truly be a game changer.

Schwab has 1.4 million corporate retirement plan participants with over $200 billion in assets, placing the firm within the top 20 in the industry by plan assets.