Defined contribution plan investments: A regulatory explainer

Summary

Congress established a useful regulatory framework for defined contribution (DC) plan investments and delegated implementation of this framework to the U.S. Department of Labor (DOL). The DOL’s rules delineate a safe harbor limiting the liability of employers that select a menu of investments for participants in a DC plan—requiring three diversified funds with different return and risk characteristics. With the rise of auto enrollment in DC plans, the DOL set ground rules for the default investment of plan participants who do not choose their own investment. These default investments are most often target date funds, which change their asset allocation as participants age. But the DOL has shifted positions between Democratic and Republican administrations on whether a fiduciary may consider non-pecuniary factors such as climate change in designing a plan’s investment menu. In selecting any plan investment, a fiduciary must primarily analyze its financial risks and returns, although Environmental, Social, and Governance (ESG) factors may be relevant to either analysis. Under the DOL’s current rule proposal, a fiduciary would be allowed to create an investment menu that includes alternative assets. However, to obtain the benefit of “significant deference,” the fiduciary would have to follow rigorous procedures in evaluating any plan investment including consideration of the six factors identified in the rule proposal.

The rise of DC plans and why their investments are regulated

Over the last few decades, almost half of U.S. employers in the private sector have adopted DC plans, such as 401(k) plans, for the retirement savings of their employees. These plans have exploded both in terms of employee coverage and accumulated assets in these plans: approximately 70% of private-sector workers had access to a DC retirement plan at work according to the Bureau of Labor Statistics, and the cumulative assets in these plans total almost $14 trillion in assets according to the Investment Company Institute.

A key feature of DC plans is employee discretion over their plan investments. In a typical DC plan, participating employees elect to make regular contributions from their salaries to their individual plan accounts. In some plans, employee contributions may be matched by employer contributions according to a formula. Participating employees also choose to invest all these contributions in one or more investment funds from a menu of investment options selected by their employer. Then at retirement, or earlier in special circumstances, employees may withdraw monies from their DC plan accounts.

Because the amounts available for withdrawal at retirement depend to a substantial degree on the investment results of DC plan accounts, Congress has been very interested in the investment menus selected by employers in their DC plans. Congress established a regulatory framework for DC plan investments in the Employee Retirement Income Security Act (ERISA) of 1974. Congress has also delegated the authority to make rules on plan investments to the DOL and preempted the application of most state laws to retirement plans covered by ERISA. This explainer addresses key questions related to the regulation of investment options in DC accounts, including recent action by the Trump administration to change the scope of allowable investments.

1. What is the basic regulatory framework for DC plan investments in ERISA?

ERISA delineates the obligations of retirement plan fiduciaries—to make prudent decisions, to act for the exclusive benefit of plan participants, to diversify plan investments, and to comply with the plan’s documents. While the employer sponsoring a DC plan is an ERISA fiduciary, it may limit its liability for plan investments made by plan participants if the arrangement meets the conditions of a safe harbor in Section 404(c) of ERISA, as elaborated in DOL rules.¹ Under that safe harbor, plan participants must be given the chance to exercise control over the investments in their DC plan account. They must also be allowed to transfer between investments at least quarterly, and more frequently for volatile investments.

Most significantly, to qualify for the safe harbor, the plan must offer at least three core diversified investment options—each with materially different risk and return characteristics. This requirement is usually met by a plan offering a money market fund, a high-quality bond fund, and a broad-based U.S. stock fund. However, even if a plan meets all these conditions, the employer retains the fiduciary responsibility to prudently design the menu of plan investments made available in a DC plan and to monitor them on a regular basis.

Beyond the three funds required by this safe harbor, most DC plans offer diversified funds in other asset categories. These may include, for example, an international stock fund, an emerging markets fund, a high-yield bond fund, a Treasury inflation-protected bond fund, or a real estate investment trust.

In addition, an employer may include its own stock as a DC investment option for its employees or match employee contributions with employer stock. However, if DC plan participants opt for employer stock, they must be allowed to transfer their contributions out of employer stock at any time. And plan participants with at least three years of service must be permitted to transfer out of matching contributions in the form of employer stock. Moreover, because of successful lawsuits against a few employers offering their own stock as a DC plan investment, many have decided against including employer stock in their DC plans or have limited the holdings of employer stock in any participant plan account.

2. What are the investment implications of auto enrollment in DC plans?

Although many employers were offering 401(k) plans to their employees in the 1980s and 1990s, the participation rates were initially low—especially among low-income and minority employees—when they had to affirmatively opt into a DC plan. However, behavioral economists found that the participation rates in DC plans were much higher under an arrangement called auto enrollment with an opt-out. In this arrangement, the employer automatically enrolls all its employees at a specified contribution level in a specified investment, but any employee may opt out entirely or choose a different contribution level or plan investment.

In the Pension Protection Act of 2006, Congress expressly allowed employers to utilize auto enrollment in their DC plans. Congress also created exemptions from complex non-discrimination tax testing if an employer’s contributions or matching contributions reached specified levels. In 2022 legislation called SECURE 2.0, Congress went further by requiring auto enrollment in most new DC plans—again with an employee opt-out.

Since employees do not actively sign up for a DC plan with auto enrollment, they do not initially choose an investment option for their contributions. Therefore, the employer must select a Qualified Default Investment Alternative (QDIA)—which an employee may choose to change. For an investment option to qualify as a QDIA, it must be professionally managed and diversified and aim for a balance between long-term capital appreciation and preservation. But a QDIA may not invest participant contributions in employer securities.

The most popular default investments for auto-enrollment plans have been target date funds, which are asset allocation funds based on the estimated retirement date of each employee cohort. These funds typically start with large allocations to equities for younger employees, which gradually decline in favor of more bond holdings as employees reach normal retirement age of 65. Other less popular default investments are balanced funds, which maintain a fixed percentage of stocks and bonds by rebalancing at regular intervals such as annually.

3. What has been the debate about consideration of ESG factors in plan investments?

The most controversial aspect of DC plan investments has been whether plan fiduciaries may consider non-pecuniary factors such as ESG. While both Democratic and Republican administrations have stressed that financial returns are the most important criterion for any plan investment, they have differed sharply on whether plan fiduciaries may consider non-pecuniary factors, such as climate change, in selecting an investment menu.

In a 1994 bulletin, the DOL articulated what became known as the “all things being equal” test for Economically Targeted Investments (ETIs). Only when there was a tie between the economic aspects of two potential investments could the collateral benefits of one serve as a “tiebreaker.” In 2008, however, the DOL expressed the view that alternative investment options would rarely be economically equivalent. Therefore, the situations in which collateral benefits may be used as a “tiebreaker” by a plan fiduciary would be “very limited.”

In 2015, the DOL went back to the “all things being equal” test from 1994 and for the first time used the term “ESG.” Moreover, the DOL did not restrict ESG factors to collateral benefits but spoke in terms of ESG factors affecting an investment’s “economic merits.” Reversing positions again in 2020, the DOL adopted a rule requiring a plan fiduciary to select investments based solely on pecuniary considerations relevant to their risk-adjusted economic value. The DOL also effectively prohibited any fund using ESG factors from being a QDIA for plans with auto enrollment.

In 2022, the DOL retained the principles that a plan fiduciary must focus on the risk-return characteristics of plan investments and may not subordinate the interests of plan participants to other objectives. However, the DOL clarified that the risk-return factors evaluated by a plan fiduciary “may include” the economic effects of climate change and other ESG factors. The DOL explained that the new rule is “designed to eliminate the substantial chilling effect caused by the current regulation” on fiduciary consideration of non-pecuniary factors.²

The attorneys general of 26 states sued to invalidate the DOL’s 2022 rule on the grounds that it violated the Administrative Procedure Act and ERISA’s requirement that plan fiduciaries act solely for the benefit of plan participants. Although a federal district court upheld the validity of the DOL’s 2022 rule in early 2025, attorneys for the Trump administration announced soon afterwards that the DOL would not defend the 2022 rule and would propose a new rule to replace it. This proposal is discussed below in the section on alternative investments.

4. What is the proposed rule on the inclusion of alternative assets as DC plan investments?

During the Biden administration, the DOL issued two statements against the inclusion of alternative assets in the investment menu for DC plans. One was a compliance release cautioning plan fiduciaries to “exercise extreme care” before adding cryptocurrency investments to menus for 401(k) plans. The second was a statement stressing that private equity was generally too complex and opaque an investment to be offered to participants in 401(k) plans. Both these statements were rescinded by the DOL in the first year of the Trump administration.

In August of 2025, President Trump issued an executive order directing the DOL to re-examine its guidance regarding a fiduciary’s duty to make available to plan participants “an asset allocation fund that includes investments in alternative assets.”³ In contrast to publicly traded stocks and bonds, alternative assets are private market investments such as private equity or private credit funds, interests in real estate, investments in digital assets, investments in commodities, interests in infrastructure projects, and lifetime income investment strategies.

According to this executive order, participants in DC plans do not have the chance to participate “in the potential growth and diversification opportunities associated with alternative asset investments”—which are owned directly by many wealthy Americans and indirectly by government workers through their defined benefit (DB) plans. However, since alternative assets are not publicly traded, they have significant drawbacks as DC plan investments—limited ability to be sold, difficulties in obtaining accurate prices, and relatively low levels of disclosure.

Responding broadly to the executive order, the DOL in March of 2026 proposed a process-oriented rule applicable to all DC plan investments, including alternative assets.⁴ Stating that ERISA fiduciaries have “maximum discretion” in choosing plan investments, the proposed rule adopts an asset-neutral stance, expressly declining to favor or disfavor any type of plan investment. Instead, the proposed rule emphasizes that ERISA fiduciaries should conduct an objective and thorough analysis of all factors relevant to the prudence of any specific plan investment. The proposed rule identifies a non-exhaustive list of six key factors that fiduciaries should consider when selecting plan investments—performance, fees, liquidity, valuation, benchmarking, and complexity. If a fiduciary goes through the proper processes in considering these and other relevant factors in selecting plan investments, the judgment of the fiduciary would be “presumed” to be prudent and entitled to “significant deference,” according to the DOL.