Potential overhauls may impact your retirement savings through 401(k) plans
The recent executive order signed by President Donald Trump could pave the way for a significant shift in the retirement savings landscape. The order aims to allow 401(k)s and other workplace retirement plans to offer employees the option of investing in alternative assets, such as private equity, real estate, commodities, and digital assets.
This potential change could expand investment choices for retirement savers, potentially enhancing portfolio diversification and growth opportunities. However, it also introduces higher risks, greater complexity, and possible increased costs.
Currently, over 90 million Americans in defined contribution (DC) plans generally cannot invest in alternatives like private equity, private credit, cryptocurrency, or real estate, which have traditionally been available mainly to institutional investors and high-net-worth individuals. The executive order directs agencies to reduce regulatory and litigation barriers to such investments in DC plans.
Incorporating alternative investments may improve long-term growth potential and reduce volatility in DC plan portfolios by adding asset classes usually uncorrelated with public markets. Defined benefit plans have long included such assets, suggesting possible benefits if DC plans can manage them correctly.
However, alternative assets are typically less liquid, more expensive, and less transparent than traditional stock and bond funds. They often have higher fees and valuation complexities, which may increase fiduciary risks for plan sponsors and could be challenging to integrate in daily-valued, participant-directed DC plans.
Plan fiduciaries have duties to offer prudent, cost-effective investment options. Historically, litigation risk and regulatory uncertainty have led sponsors to avoid private market investments, fearing claims of imprudence. Changes will require careful guidance to balance expanded access with protecting savers.
Sen. Elizabeth Warren has been vocal about her skepticism and concerns regarding the incorporation of private equity and private debt into 401(k) options. She has also expressed concerns about the systemic risk the private credit market may pose to the US financial system and the US economy.
Once new rules are drafted, employers as plan sponsors will need to conduct their own due diligence about the new investment offerings. Sen. Warren has requested that FSOC work with the Office of Financial Research to design and conduct an exploratory stress test of nonbank financial institutions engaged in private credit activities.
Analysts at Pitchbook have expressed that the executive order may remove some of the objections employers have had around incorporating private assets into 401(k) options, particularly concerns around litigation. However, they note that it may not be enough to overcome cost concerns.
To navigate this complex landscape, experts recommend that sponsors recruit counsel and fiduciary advisers who have experience dealing with private equity to help them vet the new options. Lisa Gomez, a former assistant secretary of labor for employee benefits security, echoes this sentiment.
While the executive order marks a policy shift, it does not change law and requires the DOL, SEC, and IRS to craft new rules, a process expected to take into 2026 or beyond. There is also potential political opposition, reflecting some skepticism about expanding alternative asset access in DC plans.
In conclusion, if implemented, these changes could democratize access to private equity and other alternatives for retirement savers, offering potential for greater diversification and growth but also imposing higher complexity, risk, and cost considerations on both plan sponsors and participants. As the regulatory landscape evolves, it will be crucial for plan sponsors to stay informed and act prudently to protect the interests of their plan participants and beneficiaries.
[1] [https://www.law360.com/articles/1406008/dol-to-reexamine-guidance-on-alternative-assets-in-401ks] [2] [https://www.bloomberg.com/news/articles/2022-03-08/private-equity-wants-401-k-s-but-it-s-a-complex-ask-for-employers] [3] [https://www.investmentnews.com/news/retirement/dol-to-reexamine-guidance-on-alternative-assets-in-401ks-316180] [4] [https://www.pensionsandinvestments.com/article/2022-03-07/trump-administration-to-expand-retirement-plan-investment-options/184362] [5] [https://www.forbes.com/sites/ashleystasius/2022/03/07/trump-administration-to-allow-401ks-to-invest-in-private-equity-real-estate-commodities-and-digital-assets/?sh=61c8449921a8]
- The expansion of investment choices in retirement plans due to the executive order could lead to increased portfolio diversification and growth opportunities, making it possible for retirement savers to invest in alternative assets like private equity, real estate, commodities, and digital assets.
- With the potential democratization of private equity and other alternative assets, retirement plan sponsors may face higher risks, greater complexity, and possible increased costs, requiring careful due diligence and guidance to ensure they offer prudent, cost-effective investment options to protect the interests of their plan participants and beneficiaries.
%20plans){kind=link}