Personal Finance

Private equity investments may be coming to your 401(k)

Key Points
  • The Labor Department issued guidance aimed at encouraging businesses to add certain 401(k) funds that invest in private equity. 
  • Some large firms, such as Intel and Verizon, had previously been sued over their use of alternative investments in 401(k) plans. 
  • Proponents think the guidance will promote higher returns, while others think it's a handout to the private equity industry that increases fees and risk for investors. 
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Savers using 401(k) plans may soon be able to invest their retirement money in private equity, long considered strictly the province of the well-to-do.

The U.S. Labor Department issued guidance Wednesday stipulating that business owners with 401(k) plans can more safely offer certain funds with a private equity component to their employees.

While some experts believe 401(k) savers could use those funds to get stronger returns, others believe doing so would expose them to high fees, more risk and predatory practices. 

The funds addressed by the Labor Department include popular types like target-date funds, which are comprised of several different underlying investments and which generally decrease investment risk as a saver's retirement date nears.

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The guidance gives more legal protection to businesses whose 401(k) plans offer TDFs that bundle in private equity.

However, the agency doesn't give the same blessing to those with a fund that invests solely in private equity, according to the guidance, which took the form of an information letter.

The SEC proposed rules late last year that would loosen restrictions around access to risky investments, such as private equity and hedge funds, for retail investors.

Such people, who invest money outside an institutional setting like a 401(k), need to be "accredited" to access these private investments, meaning they need at least $200,000 in annual income, a net worth exceeding $1 million (excluding the value of a home), or joint annual income with a spouse of more than $300,000.

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Companies like Intel and Verizon have been sued by employees in the past few years over the firms' use of alternative investments in TDFs, and other business owners may have shied away as a result, said Kevin Walsh, an attorney at Groom Law Group.  

Advocates for using private equity in 401(k) plans believe the investments deliver higher returns than other funds and question why they are used in pension plans but not 401(k) plans. 

"This Information Letter will help Americans saving for retirement gain access to alternative investments that often provide strong returns," U.S. Secretary of Labor Eugene Scalia said, in a statement.

However, not all groups view the DOL's guidance as beneficial for retirement savers.

They see this huge pot of money ... and they are anxious to get that money.
Barbara Roper
director of investor protection at the Consumer Federation of America

"The private equity part of private markets are some of the riskiest investments with extremely high-leverage and very high fees," said Dennis Kelleher, president and CEO of Better Markets, a consumer advocacy group.

"Additionally, while the [Labor] Secretary plays salesman for private equity, claiming 'strong returns,' the truth is that private equity performance and returns have often been poor at best," Kelleher added.

Since there will two levels of scrutiny — from the target-date fund manager and the employer — before the private equity investment reaches the end investor, savers would likely have more protection than they'd have in the retail market, Walsh said.  

But some investors may not know they're investing in private equity, since many 401(k) savers are automatically enrolled into TDFs.

Plus, the typical employer won't have the financial sophistication to examine private equity fund investments and know whether the risks and costs are appropriate and know whether it would be a prudent option for the 401(k) plan, said Barbara Roper, director of investor protection at the Consumer Federation of America.

"What you've seen in recent years is that private equity looks at how the world is changing and the decline of the defined benefit plan, which has been a major market for their funds," Roper said. 

"They see this huge pot of money — in terms of [401(k)] plans — and they are anxious to get that money," she added. 

-- CNBC's senior personal finance correspondent Sharon Epperson contributed to this story.