Does a recordkeeper limit the percentage of a participant’s account that may be invested in a fund?

Ian Ayres and Quinn Curtis, in Retirement Guardrails: How Proactive Fiduciaries Can Improve Plan Outcomes (2023), suggest several ideas to improve participant-directed investment.

They suggest that a plan sponsor need not be limited to a binary choice of including an investment alternative, or leaving it out of the plan’s menu. If a goal is preventing some participants’ unwise use of an investment while not depriving participants of the availability of that investment, the professors suggest limiting a participant’s allocations to such an investment.

I’ve seen percentage restraints applied to an employer-stock fund, but haven’t seen this for other funds.

Does any recordkeeper offer a service of limiting, according to the plan sponsor’s specifications, the percentage of a participant’s account that may be invested in a fund?

Great question and now very relevant as more "specialized" investments appear headed for 401(k) plans, like hedge funds and crypto. 

Some recordkeepers limit, according to the plan sponsor’s or a plan fiduciary’s instruction, the percentage of a participant’s or other directing individual’s account invested in employer securities.

Fidelity’s offer of services about bitcoin calls for the plan’s fiduciary to specify a percentage limit on how much of an individual’s account may be in bitcoin.

But are those capabilities particular to those investment alternatives?

Or does a recordkeeper have capabilities to apply a percentage limit to any designated investment alternative?

53 minutes ago, Peter Gulia said:

Or does a recordkeeper have capabilities to apply a percentage limit to any designated investment alternative?

Corollary: if such limit is applied to one investment alternative (other than ER securities), would/should/must it apply to every alternative?

Whether a plan’s sponsor or fiduciary should set a limit on a participant’s use of any designated investment alternative and, if one does, whether to set those limits uniformly for all or a subset of investment alternatives or with differing limits based on the sponsor’s or fiduciary’s views about possibilities for wise or unwise uses that might differ with each investment alternative are important questions.

But a plan’s sponsor or fiduciary might neither need nor want to think about those questions if the plan’s recordkeeper can’t or won’t apply limits.

Suffice it to say that the more volatile investments that the fiduciaries ask to include as investment options, the more exposure they have to a participant who mismanages their account and claims that the fiduciaries shoulda, coulda have prevented the participant from harming themselves.  When the fiduciaries really, really want to include these volatile investments, they try to create rules to keep participants from harming themselves.  Here are some rules that I have seen fiduciaries apply:

• you can invest your deferrals as you like but you must invest match or employer contributions in prescribed set of funds.
• you cannot change your investments more frequently than once per week/month/quarter.
• you can trade covered call options in your SDBA only if you pass a test demonstrating you know how options work.
• you can invest no more than x% in sector funds/physical gold/REITs/commodities futures/private placements/limited partnerships.
• you can invest in any of the investment types listed above by providing a written note that you understand the associated risks of an investment.

The biggest challenge for plans that permit these rules is dealing with investments that have limited liquidity.  Participants expect that any investment available under the plan is fully liquid and they can sell anything overnight.

The larger the plan, the more challenging it is to monitor and apply these types special rules. Hence most recordkeepers for large plans will not support these types of investments.

The bottom line is there is nothing that prevents a plan from allowing some very creative investments as long as the plan provides a basic set of investments offering a conservative fund, a moderate blended fund and an equity funds.  It is up to the fiduciaries to decide what is wise or unwise for the plan it participants.

Paul I, thank you for the extra information.

I’m thinking only of funds, whether mutual funds, collective investment trust funds, or insurance company separate-account funds. And only for situations in which all of the plan’s investment alternatives are funds, all with a daily share or unit price and daily liquidity.

And I’m thinking of circumstances in which the limits must be applied with nothing beyond the recordkeeper’s computer systems.

Does any recordkeeper offer this (assuming the customer plan has enough purchasing power)?

Or is the professors’ idea a nonstarter?

Peter, it is not a nonstarter.  Most recordkeeper's will accommodate a limit on the percentages that can be elected when the participant makes the investment elections for new contributions.  Most will not accommodate a limit on the total amount invested in a particular investment.  Some may demonstrate how a periodic rebalancing of participant accounts could accomplish enforcing a limit.

What happens when through daily gains and losses pushes the investment over the threshold?

Say my plan restricts me to 50% of my account to fund A and no limit for the others.

My first deposit is $1000, 50% to fund A and 25% each to funds B and C.  So:

A: 500 B: 250 and 😄 250

Then tomorrow, my account looks like this:

A: 505 B: 245 😄 245

Now fund A has more than 50%.  Do some of the asset in fund A have to be automatically reallocated?  if so how?

And the corollary:

What if I initially put 50% in A and it goes down to 48% the next day.  does the system automatically top it off for the other funds?

Forced rebalancing?  It seems unlikely any recordkeeper would want to include this in its service agreement.  Is there any advantage to doing so?

The account balance is not affected by the limit when the limit applied to the investment election for contributions.  The account can go up or down.

I have not seen any forced rebalancing.  Some plans believe that rebalancing is an investment strategy that over time captures more gains and cuts more losses.  I have seen plans that say investments will be rebalanced periodically (commonly once a year, but I have seen quarterly) unless the participant elects not to rebalance.