President Donald Trump is reportedly planning to open the door for retirement plans like 401(k) plans to include private equity and other alternative assets. While the move may favor high-net-worth investors, what could it mean for the average American saver?
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Experts explained what it means, the pros and cons and whether the average retirement saver should look to make this move if it opens up.
At first glance, this move could be positive, according to Chad D. Cummings, Esq., CEO at Cummings & Cummings Law.
“Everyday workers might be able to invest in private companies and other assets not traded on public exchanges. The average 401(k) investor could potentially see higher returns.”
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The key word here is potentially. With greater returns comes the trade-off of greater risks, and “much less visibility of the underlying asset performance since the assets are not publicly traded,” Cummings warned.
Additionally, the average 401(k) investor would not likely see these available options for months or even a year, because all investment options for 401(k) plans must first be established through the Department of Labor (DOL) regulations.
While private equity may sound like an exciting new vista to tap, according to Bill Harris, former CEO of TurboTax, founding CEO of PayPal and founder of Personal Capital, “Private equity funds do not belong in the 401(k) of an ordinary investor.”
The biggest downside is the high fees that managing this kind of equity tends to bring with it at a time when, “the average 401(k) plans are finally moving from higher-fee mutual funds to lower-fee ETFs,” he said. “[This] is the wrong time to go the other direction.”
Additionally, distributions from private equity funds are typically treated as long-term capital gains, which are taxed at a maximum federal tax rate of 20%, Harris said. That is, unless you hold them in a tax-deferred account like a 401(k), in which case, “the gains are automatically converted to ordinary income, which is taxed at a maximum federal tax rate of 37%.”
“The kicker is that PE funds are illiquid, which means you often can’t get your money out for up to 10 years,” Harris said.
To sum it up, he suggested that this shift will not do much for the average investor at all. “So, PE fund fees are too high, a 401(k) is the wrong place to hold them, and you can’t get your money when you need it. Wrong thing, wrong place, wrong time.”
Regardless of what happens, Cummings assured that the Department of Labor’s regulations will still require employers and plan administrators to uphold their legal responsibility to always act in the best interest of the 401(k) investors.
“If the 401(k) assets are administered through a plan administrator who adopts private equity investments, the employer must also decide whether to offer the investment asset to its 401(k) participants,” Cummings said.
Employers also have a fiduciary responsibility to evaluate investment risks, cost and fairness of each investment option as well as ensure the investment is suitable for long-term retirement goals.
In a nutshell, Cumming said that retirement savers should consider private equity “only if they understand the differences among existing investment options in their plans such as the difference between stocks and bonds and understanding that riskier investments could result in big swings in their asset value and even complete loss of investment.”
Most retirees should be focusing on stable, low-risk investments. “Riskier retirement investments are usually better suited for investors who have a longer retirement timeline and are aware of the risk and return tradeoff,” Cummings said.
Should PE become more available in 401(k) plans, Cummings pointed out that a financial advisor can help review whether it makes sense as part of a larger strategy.
“If the investor values simplicity and steady growth, even with lower earnings, this type of investment might not be the best fit.”
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This article originally appeared on GOBankingRates.com: Trump’s 401(k) Overhaul: What Retirement Savers Need To Know Now