401(k)s can take advantage of alternative investments: Department of Labor proposal

The Department of Labor proposed rules Monday that would allow 401(k) plans to more easily include alternative assets such as virtual currencies, real estate and private market assets.

The proposal is in response to President Donald Trump’s executive order issued in August, which directed the Department of Labor and the Securities and Exchange Commission to facilitate expanded access to alternative 401(k) assets.

“This proposed rule will demonstrate how plans can consider products that better reflect the current investment environment,” Labor Secretary Lori Chavez-DeRemer said in a statement.

Proponents argue that including alternative investments in a 401(k) can provide retirement savers with greater diversification away from the public markets and potentially higher returns. But some financial advisors have expressed concern that many 401(k) investors lack the knowledge and experience to incorporate these more sophisticated investments, which can result in higher risks and costs.

The Labor Department’s proposal comes as private credit markets are under stress from investor redemptions and concerns about overexposure to software investments due to disruptions in artificial intelligence.

Labor Department officials said at a press conference Monday morning that while the inclusion of alternatives in 401(k) plans is no longer prohibited, concerns about lawsuits challenging investment decisions have kept most plan sponsors on the sidelines.

The Department of Labor’s regulations create so-called safe harbors that help protect plan sponsors from lawsuits. It identifies six factors that plan fiduciaries should “objectively, thoroughly, and analytically consider” when selecting alternative investments. The six factors are performance, fees, liquidity, valuation, performance benchmarks, and complexity.

The rule will be subject to further review, including a 60-day public comment period, before being finalized.

Even if finalized, the rule’s adoption will likely be delayed, experts say.

“Until a court agrees that this language protects advisors from litigation, we remain skeptical that it will encourage fiduciaries to include alternatives in their 401K plans,” Jarrett Seiburg, financial services and housing policy analyst at TD Cowen, said in a research note on Monday. “That means it could be several years before we see the real impact of this proposal.”

Erin Cho, a partner at the Mayer Brown law firm in Washington, D.C., said the proposed rule would not change how alternatives are included in 401(k) options. He said investors have “limited exposure” through vehicles such as target-date funds.

“Under this proposed rule, plan participants will not wake up one day to find that their 401(k) plan menu includes a large number of independent private equity funds, private credit funds, and virtual currency funds,” Cho said.

Andrew Olinger, a partner and general counsel in Wagner Law Group’s New York City office, said the Labor Department’s proposal would not rescind existing rules regarding the need for investors to be “certified” to access stand-alone private equity and other alternative funds.

Similarly, employers need to figure out how to provide alternative funding without running afoul of the 401(k) plan’s “nondiscrimination” rules, Olinger said. These rules are intended to prevent high-income employees from accessing benefits that are not available to lower-income employees.

Altfunds are also relatively illiquid and may not be structurally equipped to easily process withdrawals from 401(k) investors, Olinger said.

“There is still a need to remove practical obstacles[for alternative funds],” Olinger said. “And that will really require action from the SEC and possibly even legislative action.”

Even if alternatives become available, some financial advisors say most 401(k) investors would be better off without them.

Josh Brown, CEO of Ritholtz Wealth Management, said in an October interview with CNBC that average investors are better off owning index funds with broad exposure to the stock market, a strategy that often outperforms professional investors and can keep investment costs lower.

“The average investor, by definition, doesn’t need alternative assets in their portfolio,” Brown said.

Brown said there is “no chance” that 401(k) investors will have access to the best alternative managers or the best funds. Even if they did, they would be “paying through the nose” because they don’t have the purchasing power to reduce investment fees, he said.

“You’re not a Norwegian sovereign wealth fund,” he said. “You won’t be treated like that.”

The Labor Department’s proposal builds on other steps taken by the Trump administration to make nontraditional asset classes more accessible to a broader group of retail investors.

For example, in May, the Department of Labor rescinded guidance introduced during the Biden administration that urged employers to be cautious before adding virtual currencies and related digital assets such as Bitcoin, non-fungible tokens, and meme coins to 401(k) plans.

At the time, Biden labor officials warned employers to exercise “extreme caution” before making these investments available to workers, citing “serious concerns” about the wisdom of exposing investors’ retirement savings to cryptocurrencies, given the “substantial risks of fraud, theft, and loss.”