Tuesday, October 19 2021

By Jared Tanimoto, CFP

Why not like investing in a sustainable ESG fund in your 401 (k) defined contribution pension plan or similar? The answer is not as obvious as you might think.

Jared tanimoto

The idea is attractive: while saving tax-advantaged for your own retirement, why not also make the world a better place by investing in companies with responsible environmental, social and governmental (ESG) practices? But in reality, ESG investments remain a relative rarity in 401 (k) plan offerings. In May 2021, Morningstar reported:

“Although the number of ESG funds available in the sector tripled between 2014 and 2020, we find that less than 5% of defined contribution plans include at least one sustainable fund. “

Understanding the ESG 401 (k) investment gap

There are several reasons for the disconnect between plan members who seek ESG investments and the plan sponsors who provide them.

  1. The Ministry of Labor hesitates: The Department of Labor (DOL) is responsible for ensuring that employer-sponsored pension plans fulfill their fiduciary duty to prioritize the highest participants financial interests. He has been cautious about welcoming ESG funds into the 401 (k) mix, lest plan members sacrifice available market returns in pursuit of ESG goals. As advertised in a release in March 2021, the DOL does not prohibit or formally approve ESG investments under 401 (k) plans.
  2. Employers are risk averse: Employers have also moved slowly. Outside of your employer’s pension plan, it’s up to you to decide whether investing sustainably is more important to you than taking every dollar out of every asset. But without clear regulatory guides, your employer may be reluctant to increase their exposure to costly legal and regulatory issues by including ESG funds in their standard menu.
  3. The results remain mixed: Is ESG investing really meant to harm, help, or make no difference to your end returns? I would say the jury is still out. For every study or analysis that suggests that ESG investing can hurt your end returns, it’s easy to find others that disprove that claim. This is probably in part because it is even difficult to define what “it is” (as evidenced by a recent article, “What is ESG? Depends on who you ask“).

Bridging the gap

Barriers aside, what if you still want to invest your retirement money in ESG funds? At least until ESG investing becomes more common in 401 (k) plans, you might need a creative solution to fill the void.

Reversals: You may be able to transfer old 401 (k) plan assets to an individual IRA account to access more investment options. Be careful when making a proper rollover, so as not to incur unwanted taxes or penalties.

Self-directed brokerage accounts: If permitted, you can open a self-directed brokerage account under your employer’s pension plan. This gives you more choices beyond the plan’s limited menu, although you’re also essentially on your own if you make a horrible choice.

Do-it-yourself retirement savings: You could open a traditional, independent brokerage account dedicated to retirement savings. You could then invest as you see fit, even if you would sacrifice any beneficial tax status on the holdings.

Plan before you continue

Each of these possibilities can allow you to invest in a more sustainable way. But each is also loaded with important caveats when it comes to investment management and tax planning. Poorly equipped, flying solo can be expensive. Additionally, while your pension plan is one of the few that offers ESG funds in its standard lineup, not all funds are a recommended investment to start with. So however you do it, we strongly suggest that you do your due diligence first.

How much will it cost? Beware of excessive fees; they exist as much among ESG funds as elsewhere. How much is “excessive”? With core index funds available at a tiny fraction of 1%, any expense ratio that goes over or over 1% should give you a significant break.

Does this match your investment strategy? Before we start choosing particular investments, let’s talk about a bigger picture. The most reliable way to achieve the retirement you are considering is to pursue an investment strategy that reflects your financial goals and your tolerance for risk. Your strategy tells you how much to split between stocks and bonds, and various factors within each.

The bottom line is, remember: the real reason you invest for your retirement is to fund your eventual retirement. So, if the available ESG funds are expensive or don’t fit your carefully structured strategy, you might want to move on. Consider investing effectively and then using a portion of the income to donate to the charities of your choice.

Whichever way you proceed, keep in mind the importance of your investment choices for this long journey and choose your “traveling companions” accordingly. A one-off consultation with an independent financial advisor can go a long way to help you accurately assess where you stand.

About the Author: Jared Tanimoto

Jared Tanimoto is CERTIFIED FINANCIAL PLANNER ™ based in Irvine, California and has worked in the financial services industry for over 10 years. He is currently president of the Financial Planning Association of Orange County and was recently named to the InvestmentNews 40 Under 40 list for 2021. Outside of his professional life, Jared and his wife lead active lives with their daughter. and enjoy everything that involves the outdoors. . www.ascentwealthadvisors.com

Do you have questions about your taxes, your personal finances and your investments? Get answers!

Email Jeffrey Levine, CPA / PFS, Director of Planning at Buckingham Wealth Partners, at: AskTheHammer@BuckinghamGroup.com

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