Every day, millions of Americans anxiously check their retirement accounts to see what the latest gyrations in the stock market will bring. Many middle-aged workers have spent decades contributing to their accounts, but pandemic-induced uncertainty is wreaking havoc on pension plans and 401(k) plans.
Fortunately, recent actions by the Department of Labor 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 private equity 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, allowing the lawsuit to proceed in February. In the resulting Wild West legal environment, companies dare not expose their workers’ savings to private equity for fear of an avalanche of lawsuits. 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 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 rules blessing 401(k) investments into private equity. Labor Secretary Eugene Scalia notes that the rule change, “will help Americans saving for retirement gain access to alternative investments that often provide strong returns.” Allowing workers access to private equity, “helps level the playing field for ordinary investors and is another step by the Department to ensure that ordinary people investing for retirement have the opportunities they need for a secure retirement.”
This move is just the latest step by the federal government to increase retirement account flexibility for workers struggling to adapt to a pandemic-plagued economy. Signed into law on March 27, the Coronavirus Aid, Relief, and Economic Security Act (CARES) Act permits workers to temporarily withdraw their retirement account savings penalty-free to cope with unanticipated Coronavirus-related expenses.
By making these changes, Congress sent a powerful message that, despite strict ordinary regulations, retirement accounts ultimately belong to the workers contributing to them. And, this latest change to permit private equity investments strengthens that message and 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 this difficult time.
Ross Marchand is the vice president of policy for the Taxpayers Protection Alliance