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How Advisors Can Help Clients Invest Sustainably in Retirement Accounts

Don’t let limited plan options prevent clients from investing the way they want.

This article is part of a series providing a framework for incorporating sustainable investing into your advisory practice.

During one of my first client meetings as a financial planner, my client asked me to help them choose investment options in their 401(k) that aligned with their values. All of my client’s investable assets were held within their employer-sponsored account, a common situation in the United States. Around one half of U.S. investors own some public market investments, mostly held within their retirement accounts. As an advisor, you might support your clients in evaluating their sustainable investment options within employer-sponsored accounts or advise clients on the best retirement plan for their business. In this column, I’ll outline how to help your clients invest sustainably within employer-sponsored retirement plans.

Evaluate the Sustainable-Investing Options

Within a defined-contribution employer-sponsored retirement plan, such as a 401(k) or 403(b), if investors want to divest from industries driving climate change or mass incarceration, their options most likely will be limited. Investors can assess the sustainability ratings of funds on their plan’s menu of investment options using free screening tools such as As You Sow, Ethos, and USSIF’s Sustainable Investment Mutual Funds and ETFs Chart. Investors can also use Morningstar’s Sustainability Ratings. Then, if the menu of options doesn’t contain investments that align with the investor’s values, advocating to the plan sponsor for better options might be a viable next step.

Advocate for Better Sustainable Options

Although some plan sponsors are hesitant to adopt or incorporate sustainable offerings into fund menus, employees and employers can advocate for shifting toward more-sustainable investing options in their plan. The Employee Retirement Income Security Act is the federal law that sets the minimum requirements for employer-sponsored retirement plans with the goal of protecting employees. According to John McAvoy, CFP and founder of The 401k Concierge, “Erisa is a procedural statute, by which I mean process is more important than outcome. Fiduciaries have personal liability and, therefore, must establish a prudent process to vet investment options, monitor the process, and document the process.”

To support plan sponsors in meeting Erisa requirements, the Intentional Endowments Network created the Guide to Sustainable Retirements, where they address fiduciary-duty concerns and misconceptions to integrating ESG in retirement plans. As You Sow’s Invest Your Values portal is another resource for employees and plan administrators to learn more about shifting their investment options toward sustainability.

Employees can also request that their employer work with an administrator who specializes in sustainable investing, such as Green Retirement and Just Futures. Employers may also arrange to add a self-directed brokerage account option with their 401(k) plan, which would allow employees to choose public market investments beyond the menu of funds chosen by the plan administrator.

Consider the Self-Directed Route

The Next Egg is a subscription-based online learning community for investors, financial professionals, and employers. Members can gain access to resources about self-directed retirement accounts, as well as private market investments grounded in building equitable wealth, such as Community Land Trusts, community loan funds, and direct investments in cooperatively run businesses.

Private investing is not currently possible within most employer plans. For self-employed people, a self-directed solo 401(k) (SD401k) or a self-directed SEP IRA allow for flexibility and choice in investments in public and private markets. Contributions to these accounts must come from 1099 income or other income from a business, and it’s important to consider prohibited transaction IRS rules that apply to self-directed 401(k) accounts and self-directed IRAs.

Compared with individual plans, sponsoring self-directed plans for multiple participants is more complicated. The simplest option is sponsoring a self-directed SIMPLE IRA. Compared with 401(k) plans, SIMPLE IRAs are less costly to administer and have less administrative requirements, which are critical factors to consider when it comes to the self-directed versions of these employer-sponsored plans.

Few employers offer self-directed 401(k) plans owing to the added responsibility of overseeing employee investments as a fiduciary. In their essay, “Rethinking Retirement Savings,” attorneys Janelle Orsi and Jason Fernandes provide an overview of the consequences and limitations of Erisa’s requirements—and they imagine an alternative. The LIFT Economy, a worker-owned cooperative and Certified B Corp., is part of a small and growing number of organizations that enable team members to practice sustainable investing both inside and outside of public markets while staying within Erisa rules. The LIFT Economy established a self-directed 401(k) plan that it calls a “worker-controlled 401(k),” with the support of Qualified Pension Services. The LIFT Economy hosted a publicly accessible webinar to share how it created this plan.

Making Sustainable Investing More Accessible

Both investors and advisors can have a hand in increasing access to sustainable options for themselves and future generations of investors. In the next column in this series, I’ll explore how advisors can support clients across income and wealth spectrums to invest sustainably outside of employer-sponsored retirement plans.

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About Morningstar, Inc. Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The Company offers an extensive line of products and services for individual investors, financial advisors, asset managers and owners, retirement plan providers and sponsors, and institutional investors in the debt and private capital markets. Morningstar provides data and research insights on a wide range of investment offerings, including managed investment products, publicly listed companies, private capital markets, debt securities, and real-time global market data. Morningstar also offers investment management services through its investment advisory subsidiaries, with approximately $251 billion in assets under advisement and management as of June 30, 2021. The Company has operations in 29 countries. For more information, visit www.morningstar.com/company. Follow Morningstar on Twitter @MorningstarInc.

Phuong Luong, CFP, is an educator and financial planner focused on economic justice and closing racial wealth divides. She is a Principal at Saltbox Financial, a virtual, fee-only RIA. She is also the online facilitator for the Boston University Financial Planning Program. Phuong is a subject matter expert in ESG and regenerative investing. Follow Phuong on Twitter: @pt_luong The views expressed in this article do not necessarily reflect the views of Morningstar.