DOL Opens Door for Private Equity in Defined Contribution Retirement Plans

On June 3, the Department of Labor issued an Information Letter addressing the inclusion of private equity in qualified defined contribution (DC) plans. The letter confirmed that plan fiduciaries can add private equity to DC plan investment line-ups – as long as private equity investments are available through professionally managed, multi-asset funds, such as target-date funds or target risk funds.  

Adding private equity to plan investment menus could help improve retirement outcomes.  

For decades, plan sponsors have sought ways to help participants better financially prepare for retirement. As a result, plan design features and plan investment menus are frequently scrutinized and adjusted. Fidelity’s May 2020 Plan Sponsor Attitudes Study found that 44% of plan sponsors review their investment options quarterly or more often.  

Almost three-fourths (75%) of those surveyed had modified plan investment options during the past two years to:  

• Expand the number of funds available,
• Replace an underperforming fund and/or
• Add target date funds.  

In light of recent market volatility – and with the expectation that volatility may continue – many plan sponsors and advisors are re-evaluating investment line-ups. Improving diversification can help reduce volatility. As a result, one way for DC plans to potentially strengthen investment menus is by offering professionally managed funds that include private equity investments.  

Private equity also could improve return potential. Many defined benefit (DB) plans portfolios have included private equity and other alternative assets to great effect.  

A 2018 research report from the Center for Retirement Initiatives at Georgetown University (CRI) and Willis Tower Watson stated that corporate DB plans delivered annualized net returns of 5.4% from 2006 to 2016, while DC plans earned annualized net returns of 4.9%. The difference was attributed to asset allocation.  

CRI’s paper concluded that target date funds with allocations to private equity, real estate and hedge funds could improve the likelihood of retirement success for DC plan participants 25 and 30 years into retirement.  

Today, the average life expectancy for 65-year-olds is about an additional 19 years, meaning half of the population will live beyond age 84. Consequently, improving outcomes for long-lived retirees could become critically important.  

Adoption could be slow. 

If past is prologue, it may take time for DC plan sponsors and advisors to become comfortable offering investments that include exposures to private equity.  

For one thing, alternative investments, like private equity, tend to have higher fees. Consequently, plan sponsors will need to decide whether the potential benefits of alternatives assets balance the higher cost. There is no fiduciary requirement that sponsors choose the lowest cost investment options for plans; however, some may be reluctant to include higher cost options because of recent litigation. 

The DOL letter offered an analytical framework that describes a prudent process for plan fiduciaries that are considering offering private equity opportunities to plan participants. Jeanne Klinefelter Wilson, the Employee Benefits Security Administration Acting Assistant Secretary, commented, “This letter should assure defined contribution plan fiduciaries that private equity may be part of a prudent investment mix and a way to enhance retirement savings and investment security for American workers.” 

Another Way to Add Private Equity to Retirement Portfolios

Retirement investors whose employer-sponsored plans do not offer diversified funds with private equity exposure may want to consider another option that has been in place for many years.

Self-directed Individual Retirement Accounts (IRAs), which are available through specialty custodians like Millennium Trust, give experienced investors the opportunity to invest tax-deferred retirement savings in alternative assets, like private equity, real estate, commodities and hedge funds.

Private equity and other alternative assets may not be for everyone, so individuals can work with their advisors to determine what best meets their investment goals.

You can learn more about alternative assets in Build a More Resilient Portfolio with Alternative Investments. 

The material in this blog is presented for general informational purposes only. The information presented is not investment, legal, tax or compliance advice. Millennium Trust Company performs the duties of a directed custodian, and as such does not offer or sell investments or provide investment, legal or tax advice.