Why Greening Your 401(K) Isn’t As Easy As It Should Be

A version of this story first appeared in the Climate is Everything newsletter. If you’d like sign up to receive this free once-a-week email, click here.

There is nothing like a tax filing deadline (May 17 this year, for Americans) to make you think about where your money goes, especially when news reports are full of headlines about the latest company (or country) to lay out net-zero carbon targets. Shouldn’t I, a climate correspondent, ensure my investments are doing the same? Turns out, it’s not so easy. For the approximately 30% of American workers who, like me, contribute a portion of their salary to an employer-sponsored, tax-deferred 401(k) retirement plan, there is no easy way to figure out how much of my money is going into carbon-irresponsible companies, let alone divest myself from fossil fuel holdings.

And believe me, I tried. After noodling around my own company’s 401K plan, run by the financial services firm Principal, with little success, I ended up speaking with their director of policy, Lance Schoening. Apparently, I’m not the only customer with this concern. And just as apparently, there is not much they can do about it, at least not yet. Why? Well, blame a tiny parting gift from the outgoing Trump Administration back in December 2020.

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Unlike retail investing, where consumers can select company stocks and mutual funds based on performance as much as an adherence to Environmental, Social and Governance goals (ESG for financial wonks, and shorthand for sustainability) American pension fund administrators are governed by a much stricter set of laws. Which makes sense, given that they make the difference between a comfortable retirement, and well, not being able to retire at all.

The Employee Retirement Income Security Act (ERISA) of 1974 is long and complicated, but what it all boils down to, says Shoening, is that plan sponsors, like Principal, “are required to first consider the risk and return profile and the economics of an investment before they can go on to consider what has kind of always been thought of as secondary considerations, like ESG objectives.”

So, first and foremost, any investment made with retirement funds has to make money. But if “climate risk is investment risk,” as BlackRock chief Larry Fink wrote in his 2021 letter to CEOs, it doesn’t make sense if those retirement funds are invested in companies whose actions might eventually result in there not being a planet worth retiring upon. BlackRock is now categorizing ESG issues as a “core risk” to investors, forcing companies to track, account for and disclose climate concerns. But BlackRock is private, and investors can choose whether or not they agree with Fink’s assessment. 401(k) managers don’t have the same liberty, and that’s where Trump’s Christmas Surprise comes in.

In late November, the Department of Labor issued a little-noticed (outside of the financial community) ERISA interpretation warning that “private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives” but rather for “providing for the retirement security of American workers.” It was a reversal of an Obama-era ruling acknowledging that ESG issues could, in fact, have an impact on a plan’s economic value, and thus should be considered.

So where does that leave us now? The good news, says Shoening, is that the Department of Labor under President Joe Biden has signalled that it will not enforce Trump’s rule. But 401(k) managers are a notoriously skittish bunch for good reason—penalties for messing with ERISA are very high—so until there is formal encouragement by the Biden Administration to take ESG issues into account, American 401(k) customers will be limited in how they can use sustainability factors while making investment decisions for their retirement. That has repercussions.

According to a recent piece by Rachel Mann in The Regulatory Review, a publication of the University of Pennsylvania, assets in 401(k) and similar retirement plans in the U.S. exceed $7 trillion—a potential boost for ESG focused investments. And demand for ESG investing is on the rise, according to a report from financial services giant Morgan Stanley: 85% of American investors expressed interest in sustainable options in 2019, up from 71% in 2015. For good reason, according to Mann. Another 2019 study shows high ESG portfolios outperformed low ones by 16 basis points per year. Mann credits lower risks of worker safety incidents, pollution spills, litigation, and other public relations disasters that could damage a company’s brand and valuation.

But ESG-aware investing is also common sense. If investors like me can choose between high-risk, high reward portfolios vs. more conservative investments, we should also be able to select for climate risk as well — both for the sake of our own golden years, and for those of the planet.