The Debate Over Private Equity Inclusion in 401(k) Plans
Published on by Joe Conover in Benefit Plan Audits
As President Trump gears up to sign an executive order expected to encourage private-market investments in U.S. retirement plans, the financial community is split on the benefits and risks of including private equity in 401(k) plans. This move could signify a significant shift in the retirement savings landscape, potentially opening up the $12.4 trillion defined contribution sector to private equity firms.
Supporters of the move are optimistic, arguing that access to private equity could allow individual investors to reap the benefits of higher returns generated by the illiquidity premium that private equity offers. Historically, private equity has outperformed traditional equities, with net returns of 14.3% over the past 20 years compared to 8.1% for the MSCI World Index, according to a 2024 report by Partners Group.
However, critics caution that the asset class is volatile and illiquid, which could make it a risky choice for 401(k) plans. For instance, private assets are less liquid than traditional stocks or bonds, making hardship withdrawals more challenging when a participant needs money immediately or has a retirement decumulation strategy requiring liquidity. Moreover, rising interest rates have impacted private equity returns, with annualized private equity returns falling behind public markets since 2022.
Furthermore, critics point out that private equity investments tend to carry higher fees. This opens up employers to potential Employee Retirement Income Security Act (ERISA) litigation, adding to the already significant threat of litigation in the 401(k) marketplace.
Despite these concerns, private equity is already offered in some 401(k) plans. Only a small percentage of plan sponsors currently offer any alternative investments in their 401(k) plan. However, this could change with recent announcements from financial firms like Empower, Blue Owl Capital Inc., and Voya Financial Inc. indicating that they will develop private-market investment products for defined contribution plans.
The inclusion of private equity in 401(k) plans also raises fiduciary and audit challenges. Retirement plan fiduciaries are required to act in the best interests of their plan participants. This includes ensuring that the investments are transparent, that the fees are understandable, and that the performance of the investments is comparable or outperforms traditional equities. In addition, fiduciaries must ensure that the investment has the ability to provide liquidity when needed. Plans that offer alternative investments like private equity investments could incur higher audit cost given these investments are less marketable, and whose market value are based on valuations determined by the fund administrator rather than independent pricing services. Additional management would need to evaluate if these alternative investments qualified for ERISA Section 103(a)(3)(C) audits. If they didn’t qualify, the auditor would be required to perform further audit procedures on the investments and the investment information.
Despite the potential risks, proponents argue that the potential for higher returns makes the higher fees associated with private equity worthwhile. Still, the information provided needs to be comprehensive and transparent, allowing participants to make informed decisions about their retirement savings.
Be prepared to embrace change
The forthcoming executive order signals a potential shift in the retirement savings landscape, but it’s unclear how quickly or broadly private equity will be embraced in 401(k) plans. As the issue continues to evolve, maintaining open communication with participants, regularly monitoring your investment mix, and seeking professional assistance can help navigate these complex challenges effectively.
Want to discuss how private equity investment could impact your employee benefit plan audit? Contact us today for a free consultation with one of our employee benefit plan experts. As always, we’re here to help.
