A proposed rule from the Department of Labor would make it easier for company retirement plan sponsors to add alternative-type assets, such as private credit and private equity, to company retirement plans like 401(k)s. As long as the 401(k) plan’s fiduciaries can demonstrate that they followed a due diligence process incorporating criteria like fees and liquidity, the proposed regulation would give them “safe harbor,” thereby damping the possibility of lawsuits from participants in those plans.
The proposal, if enacted, would make it easier for plans to offer workers access to a broad swath of “alternative” asset types, everything from cryptocurrency to private securities to infrastructure-type investments. These industries have lobbied hard to get their securities into company retirement plans, often touting their return advantages or risk-reduction capabilities relative to the plain-vanilla stock and bond investments that dominate the menus of most 401(k) plans today.
Of course, 401(k) plans are unlikely to become the wild west overnight. This is still in a proposal phase, and safe harbor notwithstanding, 401(k) plan sponsors are usually circumspect with respect to adding new asset types. And never say never, but most of these types of investments, especially private equity and private credit, are unlikely to pop up as stand-alone investment options on 401(k) plan menus. Rather, they would probably appear inside target-date funds or managed retirement accounts that are overseen by investment professionals rather than participants themselves.
Reversing Progress
That said, getting alternative investments inside of 401(k)s feels very much like a solution in search of a problem, a distraction at best, and a payday for high-fee asset managers at worst. In terms of their underlying investment options, 401(k) plans have been headed in the right direction over the past few decades. That owes to fee pressure in the asset management industry writ large, the rapid uptake of index-fund-based target-date funds, and an increased awareness of idiosyncratic risks like employer stock and extreme asset allocations. Today, most 401(k) plan menus are dominated by boring, low-cost index funds and collective investment trusts (or such funds held inside target-date funds), and the benefits of that emphasis far outweigh any drawbacks. That’s because Morningstar’s research has consistently demonstrated a close connection between fund performance and expenses: The cheaper the fund, the better the odds it will outperform its peers, and in turn, the better the participant outcome. Allowing alternative investments, which are usually expensive and opaque relative to core fund types, would be a step backward for 401(k) menus.
Instead, the biggest problems with 401(k) plans relate to usability, accessibility, and helping 401(k) investors at key life stages, such as when they switch jobs or retire. Addressing the following issues would likely have a much bigger positive impact on workers’ retirement outcomes than adding alternative-type investment options.
Pain Point 1: Plans Not Universally Available
Saving for retirement through automatic payroll deductions, as 401(k)s and other company retirement plans allow workers to do, helps simplify retirement investing. Today’s company retirement plans typically include nudges into age-appropriate target-date funds, which help harness busy workers’ natural tendency toward inertia. (Average participants make no changes to their accounts in a given year, which gives them a better shot at benefiting from the market’s compounding effect.)
The elephant in the retirement savings room is that roughly half of workers don’t have access to a workplace-savings plan for retirement. This issue has gotten more attention over the past decade, and innovations like state-facilitated IRAs have aimed to address it. Nonetheless, it’s a yawning problem in a time when pensions have all but disappeared. Standing up an analog to the Thrift Savings Plan for government workers, but opening it to anyone with earned income, would go a long way toward addressing that gap.
Pain Point 2: Bifurcation in Plan Quality
A related issue is that 401(k) plans vary widely in quality and especially expenses, and company size largely explains that variation. Larger employers often field gold-rated plans with low fees and stellar investment options—not surprising, given that they have more assets and leverage to negotiate—whereas 401(k) participants at smaller firms are often saddled with high-cost plans and weak investment choices. The typical 401(k) plan charged 0.74% in all-in fees in 2023, according to data from BrightScope. But fees are neatly correlated with plan size: Plans with between $1 million and $10 million charged 0.97%, on average, whereas plans with more than $1 billion had all-in expenses of just 0.25%. Smaller plans were also much more likely than large ones to use the recordkeeper’s proprietary funds rather than selecting investment choices at arm’s length.
The bifurcation in plan quality begs for a turnkey solution, like the aforementioned “Thrift Savings Plan for the Masses,” that smaller employers could use instead of setting up their own plans. Giant employers could still employ people and hire consultants to craft bespoke plans with all of the bells and whistles, but smaller companies should be able to turn to a low-cost, “good enough” option to facilitate retirement savings for their workers.
Pain Point 3: Switching Costs for Job Changers
An additional challenge in the 401(k) space is that workers change jobs frequently. Tethering retirement savings to employers creates administrative headaches, contribution forfeitures, 401(k) plan “leakage,” and missed compounding opportunities. Vanguard research has shown that even though workers typically pick up a 10% increase in income when they change jobs, retirement savings rates actually decline, often because the prior employer’s default contribution rate was higher than the new employer’s. That’s because many employers automatically increase employees’ contributions when they get a raise, but the contribution rate snaps back to a starting level when the employee takes a new job.
One way to address these challenges would be to extend smart “nudges” and defaults to the rollover process. For example, if a worker rolled over 401(k) assets to a new employer’s plan, the plan could employ the same contribution percentage in place at the previous employer. Additionally, because an IRA rollover is typically a two-step process—funding the new account and then investing the funds—rollover IRA dollars often lie fallow in cash for many years. This “procrastination penalty” costs retirement savers billions of dollars in missed compounding opportunities, with the youngest workers paying the biggest opportunity-cost toll. Allowing IRA providers to default workers into an age-appropriate investment vehicle, such as a target-date fund, just as 401(k)s do, would help circumvent this hurdle.
Pain Point 4: Not Enough Help With Retirement Decumulation/Income
Finally, adding alternatives to 401(k)s is a distraction from the key spot where workers need help: figuring out how to position their assets and spend from their accounts in retirement. 401(k) plans have wonderful guardrails for workers in the accumulation phase, including sensible defaults and often minimalist, low-cost investment menus. But retiring participants have no such safeguards; there is no guidance on sensible asset allocations or safe spending rates, for example. Affluent retirees may be able to turn to a good-quality advisor for their decision-making, but those with smaller portfolios will have fewer options.
Nascent initiatives like target-date funds that allow the participant to buy into an annuity are a starting point to help workers simplify income generation in retirement, but they’re a baby step. Smart defaults for 401(k) to IRA rollovers could work in this context, too, as could putting some oomph behind fiduciary requirements for financial advisors assisting retirees. If policymakers and 401(k) plan sponsors are serious about wanting to improve retirement outcomes, they would concentrate their energies on strategies that assist retiring employees at a life stage when they most need the help. Allowing 401(k) plans to add complicated, higher-cost investments to their menus is a step backward, and it detracts from what really matters.