Amidst private credit turmoil, the U.S. government plans to go against the trend and permit its entry into 401(k) retirement plans.

The U.S. Department of Labor proposed a new rule on Monday, which would provide employers with a legal “safe harbor” protection for introducing alternative investments such as private equity and private credit into retirement plans like 401(k)s. The move is seen as a major policy win for the private fund industry on Wall Street, but its timing is considered quite sensitive, as the private credit market is currently in turmoil and some funds are facing pressure for net outflows.

The core goal of the new rule is to mitigate litigation risk. Over the past two decades, there have been hundreds of retirement-plan-related lawsuits filed by employees against employers, causing many employers to shy away from alternative investments.

The Department of Labor said that plan sponsors that follow the procedures set out in the new rule will receive safe harbor protection, and it also explicitly notes that choosing alternative assets for the purpose of diversification can provide a reasonable basis for higher fees. The rule will enter a 60-day period for public comment, after which it will be finalized.

Analysts believe that the introduction of the new rule may gradually open up the 401(k) market, which is as large as $142.0 trillion, but given that this market historically moves slowly with reforms, actual penetration of private alternative investments is not expected to happen overnight.

** Litigation Shadow Is the Biggest Obstacle **

Federal law does not explicitly ban the use of alternative investments in 401(k) plans, but litigation risk has long been a substantial barrier.

Legal requirements governing 401(k) plans require employers to act according to the best interests of plan participants, but this standard is worded ambiguously, giving employees broad room to bring lawsuits. Over the past two decades, similar lawsuits have totaled in the hundreds, many involving allegations of excessively high fees.

It is this litigation ecosystem that has made it difficult for private fund managers to introduce products with costs higher than those of publicly offered stock and bond fund products into the 401(k) market.

Daniel Aronowitz, director of the Employee Benefits Security Administration at the Department of Labor, said unequivocally in testimony before a Senate committee this June that he is determined to “end the era of using lawsuits instead of regulation.” Recently, the Department of Labor has also filed friend-of-the-court briefs in multiple 401(k)-related lawsuits, supporting the position of employers.

President Trump previously signed an executive order in August that clearly pointed out that past lawsuits and regulations have “deprived millions of Americans of opportunities to invest in alternative assets,” and that such assets have long been exclusive to retirement accounts, endowments, and wealthy individuals.

** New Rule Framework: Six Criteria and the Safe Harbor Boundary **

The new rule provides plan sponsors with a more detailed set of investment selection guidelines and draws the boundaries for when the safe harbor applies.

The Department of Labor lists six factors that must be taken into account, including risk-adjusted returns, liquidity, fees, and valuation methods. Notably, the new rule explicitly excludes so-called “continuation funds” from the safe harbor—these funds use proprietary valuation methods by the management company to purchase fund shares from affiliated parties, creating a higher risk of conflicts of interest.

Brian Graff, chief executive officer of the American Retirement Association, said the rule is not targeting any specific type of investment, but rather is intended to apply equally across all investment categories on a 401(k) menu—from stock and bond funds to alternative investments such as private markets and cryptocurrencies. The association represents the interests of the 401(k) industry.

On legal effect, Fred Reish, a lawyer who focuses on employee benefits, said the new rule cannot grant employers an exemption from lawsuits. “I’m not sure it will reduce lawsuits, but I think it will provide plan sponsors with an effective litigation defense roadmap,” he said.

** Implementation Pace Depends on Target-Date Funds **

Even if the new rule is ultimately implemented, the pace at which private alternative investments enter the 401(k) market is still expected to be fairly gradual.

Reish believes that more employers will include private investments in diversified funds within 401(k) plans, but the growth rate will remain slow until providers of the largest target-date funds across the country join in. “That’s the real inflection point,” he said.

Target-date funds hold diversified portfolios and, as investors grow older, gradually shift assets from stocks to bonds. They are typically the default investment option for automatically enrolling new employees and play a major role within the 401(k) system.

** Market Turmoil Adds Uncertainty to Policy Progress **

The timing of the new rule creates a delicate tension with the pressure currently facing the private credit market.

Concerns that artificial intelligence will upend the software industry have continued to intensify among investors, and software is one of the main areas where private investment firms’ loans flow. This sentiment is putting private credit funds under pressure to see capital withdraw.

According to people familiar with the matter, when Treasury officials participated in drafting the rules, they focused on how to prevent fund managers from imposing underperforming investment products on 401(k) holders, and as market sentiment turns more pessimistic, those concerns have intensified further.

Private credit industry executives, however, believe the market reaction has been excessive and that a few bad investments cannot represent the overall health of the industry. At the same time, they insist that in an era when the number of public companies is steadily shrinking, ordinary investors should have access to asset-allocation opportunities comparable to those available to pension plans, endowments, and affluent households.

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