Fiduciaries have typically provided a lengthy menu of investment options for defined contribution plans. These commonly include mutual funds, index funds, and bond funds.
Fiduciaries have had the option to give plan participants the ability to pursue diversification and higher returns through alternative investments such as private credit, real estate, and, more recently, digital assets. Yet, fiduciaries have historically steered clear of alternative investments because they don’t want to risk a lawsuit that second-guesses their decision to provide riskier assets that can command higher fees.
A proposed rule (opens a new window) from the U.S. Department of Labor (DOL) attempts to soothe those concerns and encourage fiduciaries to consider alternative investments in target-date funds. The DOL rule follows a 2025 executive order from President Donald Trump (opens a new window), which asserted that regulatory overreach and “opportunistic trial lawyers” stifled investment choices in retirement plans regulated under the Employee Retirement Income Security Act of 1974 (ERISA).
The DOL proposal sets forth a six-part safe harbor test that, if satisfied, could limit litigation risk for fiduciaries considering new investments. If the rule goes into effect, plan fiduciaries might feel more comfortable including alternative investments in participant-directed defined contribution plans. The DOL estimates that as much as $178 billion could flow annually into target-date funds that include alternative investments.
Still, the safe harbor test does not completely eliminate a fiduciary’s risk if they include alternative investments in ERISA-governed plans. In addition to the possibility of lawsuits, fiduciaries must also navigate the higher fees commonly associated with alternative investments, as well as the liquidity and valuation challenges inherent in these assets.
Details of the safe-harbor test
Under ERISA, fiduciaries must oversee a retirement plan with “the care, skill, prudence, and diligence” that someone else in a similar capacity would exercise. Fiduciaries are judged not just by investment outcomes but also by the processes they use to arrive at their investment decisions.
Proponents of the DOL proposal argue that ERISA’s wide latitude invites lawsuits that effectively constrain fiduciaries to a limited set of investments, mostly publicly traded stocks and bonds.
An analysis by Encore Fiduciary (opens a new window) referenced in a 2025 amicus brief to the Supreme Court shows that a plan with $500 million or more in assets faces a 10% chance of being sued each year. Defending these cases exacts a financial toll on plans and sponsors. Encore’s analysis indicates that defendants in these cases could spend as much as $2 million preparing a motion to dismiss. A trial can cost $10 million or more to defend. Little wonder, then, that fiduciaries want to avoid these lawsuits and prefer to follow investment strategies that mirror those of other fiduciaries. Feedback from plan sponsors and participants currently shows very little appetite (opens a new window), if any at all, for alternative investments.
The DOL’s prudence test sets forth the following factors, which apply to any asset class:
Performance: Did the fiduciary determine whether an asset’s risk-adjusted returns over time and net of fees benefited the plan?
Fees: Were the asset's fees appropriate, given its value to the plan?
Liquidity: Does the asset have sufficient liquidity to support the appropriate level of plan flexibility?
Valuation: Does the nature of the asset allow a fiduciary to determine its value in a reasonably accurate and timely manner?
Benchmarking: Can the asset’s value and performance be measured against an authoritative benchmark?
Complexity: Does the fiduciary have enough knowledge and experience to understand the asset?
Meeting these factors could reduce exposure to so-called prudence litigation, in which plaintiffs sue fiduciaries for failing to take appropriate care in managing a retirement plan. Conversely, some experts feel that these conditions actually set higher bars to be cleared. Courts are not required to obey or follow the new DOL rule, but rather might view it as just another way that plan fiduciaries can show their duty of prudence.
Risks to consider
While plan participants may appreciate a diverse selection of investment options, particularly those that can deliver higher returns, plan sponsors and fiduciaries may find the broader asset universe more complex and costly to evaluate.
The value proposition of many alternative investments, particularly private equity, is the potential for higher returns. But investors compensate private equity managers with substantially higher fees than those charged by, say, an index fund manager. At the immediate outset of the new rule, many advisors and plan sponsors may be reluctant to offer the potentially higher returns of alternative investments if they feel it is not worth the risk of higher fees and uncertainty.
The DOL proposal also comes at a pivotal time for alternative investments. Private credit, a booming industry that raises capital from investors and lends to companies that can’t or won’t obtain bank loans, is under considerable stress.
In recent months, investors have sought billions in redemptions from various private credit funds amid concerns about the deteriorating value of loans. Those redemption requests have been met with caps on the amount of funds that can be paid out each month, effectively limiting private credit’s liquidity.
Private credit can tend to be opaque, expose investors to riskier borrowers, and be difficult to monitor, all factors that may complicate a fiduciary’s willingness to invest in the asset class.
Insurance considerations
Fiduciary liability insurance protects retirement plan decision-makers against claims of mismanagement and lack of care or prudence in considering a plan’s investments. And while most fiduciaries likely have coverage under such a policy, they should be mindful of how insurance companies may adjust policy limits, retentions, premiums, and policy wording for fiduciaries who wade into a deeper pool of investments.
Fiduciaries and plan sponsors should consult with an experienced insurance broker in the fiduciary space to prepare for heightened underwriter scrutiny, ensure that limits and retentions meet their appetite for risk, and watch for exclusions or other restrictive policy wording that an insurer may want to impose.
The proposed safe harbor may widen the investment menu for defined contribution plans, but fiduciaries will still be judged on whether they understand the risks they choose to serve.
For more information on how we protect businesses from fiduciary-related risk, please visit Lockton’s fiduciary liability insurance page here. (opens a new window)
