The DOL's 401(k) Rule Gets the Goals Right but the Guardrails Wrong

Ian Ayres

By Ian Ayres and Quinn Curtis

The Department of Labor’s new proposed changes to 401(k) plan regulations, framed by the Trump administration as democratizing retirement investment options for everyday Americans, instead reads as though its primary aim is to benefit the financial advisory industry.

Last August, President Trump signed an executive order calling on the Department of Labor to make it easier for employers to offer alternative investments – private equity, hedge funds, real estate, and the like – in the 401(k) plans that more than 90 million Americans rely on for retirement. Last week, the DOL responded with a proposed rule, which it frames as a "safe harbor" checklist of steps that, if followed, would shield employers from liability when they add these options to their plans. Responsibly broadening access to alternative assets can usefully improve portfolio diversification. But the proposed rule is too deferential to employers who retain professional advisers and fails to include two protections that would make this expansion work: guardrail caps and participant monitoring.

The rule's core framework is sound. It begins, as it should, by requiring plan fiduciaries, the employers and committees responsible for managing workers' retirement options, to evaluate investments based on risk-adjusted returns, net of fees. But that sensible starting point is undermined by a safe harbor so permissive that it offers little practical constraint.

16 of the rule's 20 illustrative examples conclude that no fiduciary violation occurred. Among the 16, those addressing fees are particularly permissive. One example blesses paying annual fees that are a quarter of a percent higher for a fund offering "knowledgeably staffed call centers" and "short wait times." But Empower, one of the nation's largest retirement plan administrators, reports that only 10 to 26 percent of plan participants ever make a service or advisory call in a given year. A rule that lets employers justify fees based on services that the vast majority of participants never use is not adequately protecting those participants.

Another example approves adding hedge funds and private equity to a target-date fund – the most common default into which workers are automatically enrolled – with any resulting fee increase justified only by a professional adviser’s forward-looking return projections. Still another permits fund managers to bundle the complex, variable fee structures unique to alternative assets into a single flat charge, absolving the employer of any need to understand the underlying cost structure. 

An explanation for this permissiveness is not hard to find. One gets the sense the rules were drafted by and for the benefit of professional plan advisors.  These advisors are referenced nearly 50 times in the proposed rule. Every example that clears the employer features a fiduciary who hired a professional adviser, while two of the four violation examples explicitly flag the absence of an adviser as part of the failure narrative. The advisory industry has basically drafted a mechanism to guarantee their employment. 

The proposed rule should drop many of the illustrative examples that unreasonably immunize imprudent plan menus.  The rule also needs, and lacks, are investment guardrails.

First, alternative asset classes – which, unlike the traditional stocks or bonds, can be difficult to sell quickly if needed – should have percentage caps limiting how much of a worker's savings can flow into any single alternative investment. Many plans already limit company stock contributions, and roughly two-thirds of such plans cap contributions at 20 percent.

When ForUsAll, a 401(k) provider, launched a digital-currency investment option in 2021, it wisely limited contributions to 5 percent of a worker's account. These caps protect individuals prone to irrational decisions without constraining those making informed, deliberate ones. We would suggest a 10 percent cap on any single alternative asset class – though even a 20 percent cap, matching the existing norm for company stock, would be far better than the current proposal, which places no limit at all on how much a participant can concentrate in a single hedge fund or cryptocurrency.

Second, employers should be required to monitor whether workers are misusing their plans’ investment menus. The advisers who administer plans typically do not give employers any information on how individual workers are allocating their savings. Employers receive reams of data about fund returns and comparisons to benchmarks, but are never told whether participants are creating undiversified or excessively expensive portfolios. The proposed rule's six safe-harbor factors – performance, fees, liquidity, valuation, benchmarks, and complexity – are entirely about the characteristics of the offered investment products. None address whether workers actually use those options wisely.

Making matters worse, the rule explicitly excludes "brokerage windows" – a feature that lets participants invest in virtually any security on the open market, outside the plan's curated menu – from the safe harbor's requirements. That means the avenue through which workers already have the most freedom to make risky, undiversified bets will face no new scrutiny at all.

The Trump administration deserves credit for seeking to open 401(k) plans to a broader set of investment options. Allowing workers to gain exposure to private equity and other alternatives can genuinely improve diversification and reduce risk. But workers should not be able to use their 401(k) accounts to essentially gamble their tax-subsidized retirement savings on a speculative bet while professional advisers profit. The proposed safe harbor framework is so spacious that too many fiduciary failures would fit inside.