I've never had a requirement for a money-market fund in any of the 6 different 401(k) plans I've had, and this is the first time I've ever heard of one. Maybe you and matchewed work at the same company? :-)
But I'm confused. First you say:
If I use one of their templates, I automatically have 2% in a MMF. If I pick my own funds, majority of them Schwab products, they still require 1% in a MMF.
But then you say:
Or I have the option of choosing everything myself directly from Schwab and I could eliminate that 1% in an MMF.
Which one is it? Are there two different ways of "picking your own funds"? Maybe the second way, that avoids the MMF, is through a "brokerage window"? If so, is there any fee for that privilege? If not, I'd just go that way.
Since the MMF seems like it's something that's part of these pre-selected templates, yeah, it seems like it's their way of charging a fee for that "service" (especially if the templates are a Schwab thing, since they've already shown through their Intelligent Portfolios that that's a method they use to generate income for themselves).
Either way, you shouldn't stress too much about it, at least if the ERs on the funds are reasonable. Lots of 401(k)s have shitty things about them, and 1% in a MMF is fairly low on the shitty-things scale. If you have an expected return of 8% on your non-MMF investments, that 1% in a MMF will be equivalent to the drag of a 0.08% expense ratio.