Department of Labor Gives Americans More Freedom to Plan for Future

Every day, millions of Americans anxiously check their retirement accounts to see the impact of the latest gyrations in the stock market on their financial fortunes. Millions of workers on the cusp of retirement have spent decades contributing to their accounts, but all kinds of uncertainty—ranging from the ongoing conflict in the Middle East to artificial intelligence chicken little-ism—are prompting Americans to check their pension plans and 401(k) plans multiple times a day.

Fortunately, recently announced rulemaking by the Department of Labor (DOL) to expand the scope of permitted 401(k) investments will give workers the flexibility they need to plan for their retirements. By giving savers access to alternative investments, the Trump administration is affording peace of mind to countless employees worried that their hard-earned dollars won’t be enough for retirement.

For decades, managers of traditional, “defined benefit” pension plans have been allowed to invest in private equity funds to increase returns for workers. While there’s no explicit legal prohibition on companies including private equity as part of a set of diverse investment options for their employees’ 401(k)s, previous lawsuits have placed a “chilling effect” on such behavior.

Chris Cumming, a reporter with The Wall Street Journal, notes that, “In 2015, a former employee of Intel Corp. sued the company for including private equity and hedge funds in its defined-contribution plan, saying the company violated its fiduciary duty.” The Supreme Court proved open to this line of argument, recently agreeing to hear the case. In the resulting Wild West legal environment, companies dare not expose their workers’ savings to private equity for fear of an avalanche of lawsuits.

Until now, the executive branch hasn’t exactly cleared things up.

As law firm Shulman Rogers notes, “In the first Trump administration, the DOL issued [a non-binding] information letter in June 2020 confirming that 401(k) plan fiduciaries could prudently select and monitor private equity exposure within diversified investment options. … In December 2021, however, the DOL under the Biden Administration issued a supplemental statement to the 2020 Letter … cautioning that plan fiduciaries may not be able to prudently evaluate private capital investment options, as required by ERISA, without third-party advisors. This chilled the enthusiasm generated by the 2020 Letter.”

And that’s a shame, because private equity investments tend to outperform other financial instruments.

Over the past thirty years, equity-backed buyouts have netted average annual returns of more than 13 percent, compared to around 8 percent for broad-based indices such as the S&P 500. Traditional, defined-benefit pension plans have been permitted to invest in private equity, but, because of high costs unrelated to private equity, these plans have largely gone the way of the dodo. Defined-benefit plans promise workers fixed amounts of money upon retirement, regardless of how investments have fared. And low interest rates (albeit elevated for the past few years) that have fueled economic expansion over the past couple of decades have made defined benefit promises unsustainable, resulting in companies phasing out these plans for more flexible defined contribution arrangements. Less than 5 percent of workers rely on traditional, defined pension plans, compared to around sixty percent forty years ago.

Defined contribution plans rose in popularity with account types such as 401(k)s allowing workers some flexibility in determining the investments right for them. But companies switching to defined contribution systems are being put in a no-win situation given the liability concerns of investing 401(k) dollars in private equity funds.

Fortunately, the DOL is easing these legal concerns with new rulemaking blessing 401(k) investments into private equity. This laudable change gives workers more options than ever to save for the future. The Trump administration and DOL deserve praise for giving Americans the freedom and flexibility they need during uncertain times.