Over the past few months, there’s been a clarion call—mainly from companies with skin in the game—for employers to start filling their 401(k) plans with non-traditional investment options like cryptocurrency and alternative investments.
These companies are standing in line with insurance companies that have been trying to convince plan sponsors to add annuities to their plans ever since the SECURE Act gave them the green light to offer these and other lifetime income options.
But, given the huge level of fiduciary risk plan sponsors will be taking on if they offer these complex, opaque and often pricey investment options, is there really a great need for them to bow to the pressure from recordkeepers, brokers and wholesalers who keep knocking on their doors?
Perhaps not.
Manufacturing demand
Oh, the industry is trying hard to build a case that there’s a huge demand for these options.
The insurance industry in particular has been particularly relentless, publishing their own surveys (like this one) that claim that a majority of plan participants want annuities and other so-called lifetime income options.
Another survey from a recordkeeper planning to roll out alternatives indicates (what a surprise) that 76% of plan participants want private equity and private credit investment options to be added to their plans.
Yet, in spite of this apparent “pent-up demand,” very few plans now offer annuities and alternative investments.
Why?
Because more than 60% of plan sponsors don’t truly understand how annuities work or how to position them with participants.
Plan sponsors are even more hesitant about adding alternative investments. Less than 2% of all DC plan assets are invested in private equity or private credit funds.
Due diligence is challenging
Unlike mutual funds, which are relatively easy to understand and evaluate, there’s no easy way for plan sponsors to conduct fiduciary-level due diligence of these complex, opaque and often costly products.
Some argue that, for annuities at least, these complexities are no longer an issue, because the SECURE Act offers safe harbor protections for employers who add annuities to their plans.
But if you read it closely, the SECURE Act only protects against liabilities if, after conducting appropriate due diligence, the plan sponsor chooses annuity providers that fail to meet their financial obligations to annuitants.
There’s nothing in the Act that protects plan sponsors who select annuities that carry unreasonable costs or whose features are incompatible with the retirement income needs of plan participants.
And even though the Trump administration has directed the Department of Labor to encourage the inclusion of cryptocurrency and private investments in 401(k) plans, it has provided no guidance on how plan sponsors can meet their ERISA fiduciary obligations when conducting due diligence on these options.
Researching and selecting annuities and non-traditional investments are beyond the capabilities of nearly all plan sponsors. Their ERISA 3(21) and 3(38) fiduciary advisors may not be able to help either, since many of them don’t use annuities or private investments with their retail clients.
Furthermore, there are no third-party research tools available to help plan fiduciaries evaluate these products, let alone determine which are most appropriate for their plans, given participants’ varied demographics, life expectancies, investment goals, risk profiles and retirement income needs.
Even if these tools become available, employers still face the daunting task of providing the educational resources participants will need to determine if using a chunk of their retirement nest egg to buy an annuity or invest in crypto or private equity and credit funds makes sense.
Plan sponsors can’t possibly handle these responsibilities on their own. So, they’ll need to outsource them.
Since most plans’ incumbent fiduciary advisors won’t be qualified to take on this responsibility, employers will have to hire independent fee-only consultants (i.e., not commissioned brokers or insurance agents). Since these professionals will bill the plan directly, their fees could significantly increase overall plan expenses.
Given this hornet’s nest of complications, plan sponsors should consider asking, “Do we need to offer these non-traditional investments, period?”
The short answer is “No.”
ERISA doesn’t require plans to offer them. Nor does ERISA require employers to ensure that employees save enough for retirement or have access to non-traditional investment or lifetime income options.
But do plan sponsors really want to maintain annuity contracts for retired employees that may pay out for decades?
And what happens if employers want to switch plan service providers or recordkeepers? The SECURE Act requires plan sponsors to move annuity contracts intact from one plan provider to another—adding even more complexity to an already arduous process.
And what happens to accounts with investments in illiquid private equity and credit funds if the new recordkeeper doesn’t offer these same options? Would these funds have to be liquidated, with huge potential losses for participants?
For many plan sponsors, the hassles and risks of offering non-traditional investments aren’t worth their questionable benefits.
However, just because an employer chooses not to offer these options in-plan doesn’t mean they have to completely ignore the wishes of employees who want them.
Because there are two relatively simple ways plan sponsors can let qualified active participants withdraw money from their 401(k) accounts tax and penalty free to purchase these products on their own.
Those with Roth 401(k) accounts can do this anytime after they turn age 59½, since all Roth withdrawals are tax-free as long as certain conditions are met.
It’s a bit trickier for participants with pre-tax accounts. Plans would need to allow for in-service withdrawals that let active participants over age 59½ withdraw money from these accounts and roll it over into a brokerage IRA that offers access to annuities and private investment options.
When done correctly, participants won’t have to pay taxes or penalties on these in-service withdrawals.
This approach offers benefits for everyone.
Plan participants will have the freedom to take money out of their 401(k) accounts to purchase any kind of product they want, rather than be limited to in-plan options. And they can keep the remaining money in their account invested to grow in value over time.
Plan sponsors won’t have to deal with fiduciary and administrative complexities and risks of offering these non-traditional investments.
Many participants may benefit from buying annuities or investing in private equity or credit funds. But employers should not feel obligated to include them in their plans. Modifying plan documents to offer in-service withdrawals will enable participants to choose their own non-traditional products, freeing plan sponsors of the administrative burdens and fiduciary risks of selecting and managing in-plan options.
EDITOR’S NOTE: This op-ed was submitted prior to the news that President Donald Trump is expected to sign an executive order Aug. 7 directing the DOL and SEC to provide employers guidance regarding alternative investments including private equity in 401(k) plans.