The Socially Responsible Retirement Guide

You already know how important it is to contribute to your retirement fund—but did you know that it’s possible to invest in a way that aligns with your principles? Read to learn how.

SustainFi Updated October 1, 2021

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If you put your retirement money in traditional funds, you likely support companies that extract or refine oil and gas, mine coal, or sell cigarettes. Yet, according to the investment bank Nordea, moving your pension savings to sustainable funds can be 27 times more efficient than many other ways of reducing your carbon footprint, like flying less, eating less meat, and taking the train instead of driving.

Let’s take a look at several strategies to change how you save by introducing environmental, social, and governance (ESG) investments to your 401(k).

What is ESG investing?

Environmental, social, and governance (ESG) investing considers factors like greenhouse gas emissions and employee relations. ESG investing is also known as sustainable, socially responsible, and impact investing.

ESG investing is about more than just aligning your goals with your values. After all, your retirement depends on how well your investments do over time. Studies show that ESG investing can reduce volatility and improve returns, debunking the old perception that you had to sacrifice returns to do good.

🔔 Want to learn more about ESG investing? Read our sustainable investing guide.

What are ESG funds?

ESG funds are graded on environmental, social, and governance factors. They aim to include companies that conform to certain principles.

There are several approaches to creating ESG funds. Money managers like BlackRock are creating stock and bond funds using ESG scores from rating providers like MSCI. Funds including Change Finance U.S. Large Cap Fossil Fuel Free ETF (CHGX) divest from oil and gas companies. Exchange-traded funds (ETFs) such as SPDR SSGA Gender Diversity Index ETF (SHE) invest in companies led by women.

Most ESG funds exclude companies involved in tobacco, gambling, nuclear power, and controversial weapons. Some also exclude oil, gas, and coal reserve owners.

Why do many 401(k) plans lack ESG options?

Employer-sponsored 401(k) plans offer 20 to 30 funds, usually mutual funds, which invest in stocks, bonds, and money markets. Someone in your HR department works with the plan administrator, such as Fidelity or Vanguard, to pick these funds. 

Although sustainable ETFs and mutual funds are now widely available, most employers have been very slow to jump on the ESG bandwagon. According to a 2019 Morgan Stanley study, 88% of respondents with 401(k) plans were interested in sustainable options. According to another recent study by Schroders, 90% of plan participants who knew about their plan’s ESG options invested in them.

Unfortunately, according to the Plan Sponsor Council of America, in 2019, only 3% of 401(k) plans had an ESG option, and only 0.1% of 401(k) assets were held in ESG funds.

There are several reasons for that.

1. Government policy on ESG pension funds has been inconsistent

Pension plans have been slow to add ESG options due to inconsistent government policy.

Under Trump, the Labor Department curbed the role of ESG in pension plans. New rules required employers to exclusively consider financial (and not environmental or social) factors when choosing 401(k) plan options. The Labor Department also ruled out using an ESG fund as the default investment option. The Biden administration will not enforce these rules, but policy changes created uncertainty, and employers are cautious when it comes to changing pension plans.

In the meantime, California, the European Union, and the U.K. have proposed or passed rules requiring pension funds to add ESG options.

We would argue that pension funds must consider ESG factors, such as climate change, because they will impact stocks in the future.

2. Popular target-date funds lack ESG options

Target-date funds are mutual funds that invest in equities (stocks) and bonds with an allocation targeting your retirement age. Equities generate higher returns, but they are also more volatile. Bonds generate a steady income stream, so you should own more bonds and fewer risky stocks as retirement approaches. Target-date funds do this math for you.

The Labor Department approved target-date funds as the default 401(k) investment choice. They also allow employers to keep things simple and reduce the number of funds in the plan. As a result, target-date funds represent one-fifth of all 401(k) dollars.

Unfortunately, most target-date funds invest in oil, gas, or coal extraction, tobacco, and controversial weapons. As a target-date fund investor, you are probably using your biggest source of savings to support these industries. In fact, this is true for most mutual funds in 401(k) plans.

There are still very few ESG target-date funds despite recent launches from fund managers Natixis and BlackRock.

3. Plan fiduciaries are afraid of lawsuits

Unrelated to ESG, the number of lawsuits related to 401(k) plan underperformance is rising. Nearly 100 lawsuits were filed against plan sponsors in 2020 alone. Naturally, employers are worried that including a new type of funds will open them up to more lawsuits, whether justified or not.

However, things may be changing. In 2022, America’s largest retirement plan, the $760 billion Thrift Savings Plan, will start offering ESG options to federal employees for the first time.

How to invest your 401(k) responsibly

If you’re worried about the climate transition risk and want to align your investments with your values, you can try moving your assets to ESG funds. Here are the several steps to do that.

1. Check if your plan has ESG options

Ask your employer or the plan manager (such as Vanguard or Fidelity) if your 401(k) plan has any ESG funds. You should have access to the plan through an online portal.

Search for any fund with “ESG,” “SRI,” “Socially Responsible,” “Impact,” or “Sustainable” in its name. Any fund with an ESG name is your best bet, though with the rise of “greenwashing,” we recommend further diligence. We provide a list of top ESG mutual funds here.

You can also see if there are any ESG fund managers in the line-up. Calvert, Green Century, Domini Impact, Boston Common, and Parnassus only offer ESG funds.

If you do find an ESG option, you’re in luck.

2. Move to a self-directed brokerage account  

More likely than not, your 401(k) doesn’t offer an ESG option. In that case, check if your employer offers a “brokerage window.”

The window allows you to pick a self-directed brokerage account (SDBA) to invest how you like, including in funds not available through the 401(k). Some plans allow you to transition during the enrollment period.

SDBAs have the same contribution limits as regular 401(k) plans ($19,500 in 2021). Withdrawal rules are also the same (withdrawals before age 59 ½ trigger a 10% penalty).

The SDBA can give you:

  • Flexibility to pick ESG funds and stocks
  • Lower fees and expenses (many mutual funds offered through 401(k)s are notoriously expensive)

According to Aon Hewitt, around 40% of American employers offer the self-directed option. In spite of this, participation is only 3-4% because most beneficiaries are not aware of the brokerage window.

Note: Greater flexibility can come with greater risks. The self-directed option is best if you are already a confident investor who understands asset allocation.

3. Ask your employer to add ESG funds

If your 401(k) doesn’t have any sustainable plans or a brokerage window, you can ask your employer to add ESG funds to the line-up. We recommend taking the following steps:

  • Build a coalition with your colleagues

You are more likely to succeed if you ask as a group. Try to find like-minded coworkers who care about climate change or want to reduce risk through sustainable investing. It’s also smart to seek out influential people at your company who have an interest in ESG issues. It could be the CFO or Head of HR, or even the Chief Sustainability Officer (if you work at a large company). Your voice will be much stronger if it represents more than one person.

  • Find the right person to talk to

Employers have an HR person or a committee that works with the plan sponsor, such as Fidelity or Vanguard. They pick the line-up of mutual funds to include in the 401(k) plan. HR can give you the name and contact information of the person responsible for making these decisions.

  • Approach the plan administrator with a proposal

Approach the plan administrator as a group and ask them to include a sustainable fund in the 401(k) lineup. Fossil Free Funds offers a sample letter to a plan administrator here. You could reiterate that you want your retirement savings to reflect your values. You could also highlight your reservations about the future of fossil fuel investments in light of the shift to clean energy.

You can make the following points:

  • ESG does not mean sacrificing returns
  • ESG is a rapidly growing field endorsed by asset management giants such as BlackRock
  • ESG funds can be added to the existing 401(k) without removing traditional funds   

You don’t have to have a specific ESG fund in mind, but a large-cap U.S. equity fund is a good first pick. Any 401(k) should already have a traditional large-cap U.S. stock fund. Adding a sustainable alternative won’t impact those who want to stick with the non-ESG version.

Companies like Social(k) and Green Retirement work with businesses to create sustainable retirement plans.

This should be a productive conversation, and you have nothing to lose by trying. Most employers want to boost employee morale and improve retention; expanding the benefits package is an excellent way to do that.

4. Use screening tools to find the best available funds  

If you haven’t convinced your employer to add ESG funds, you can make the best out of what you’ve got and pick from the traditional funds.

A typical 401(k) plan includes 20 to 30 funds. You can manually run them through one of the free screening tools, but keep in mind that ratings change over time as funds sell and buy stocks.

Of course, ESG means different things to different people. Maybe you care the most about climate, or perhaps you’re more concerned with governance or diversity. Depending on your interests, you may or may not want to invest in Tesla, which usually gets high scores for environmental impact and low scores for how it treats workers. Various rating agencies also give different scores to the same stocks and funds based on their methodology.

But if you only have a few funds to choose from, it makes sense to pick the funds with the highest ESG scores, even if the scores are subjective.

  • MSCI

You can look for funds with high ESG scores from MSCI, an ESG rating provider. MSCI rates funds from AAA to CCC on their (free) site.

  • Fossil Free Funds

The non-profit group As You Sow offers a screening tool called Fossil Free Funds. They assign scores from A to F based on what percentage of the fund is invested in fossil fuel stocks.

Note: We don’t think you should only go for A-rated funds. Fossil Free Funds penalize funds that own utilities. While utilities continue to rely on natural gas and other fossil fuels, they are also among the biggest developers of wind and solar energy.

  • Gun Free Funds

As You Sow offers more screening tools covering gun-free, gender equality, and other funds. For example, most ESG funds exclude guns, but if you don’t have an ESG option, you can check the funds you own through the Gun Free Funds database.

5. Convert your 401(k) to an IRA

If you change employers, you can convert your 401(k) into an IRA by calling your broker or using robo-advisors.

You are eligible for an IRA if you are over 18 and under 70 ½ and earn taxable income. You can choose between a traditional and a Roth IRA. Both provide tax breaks because you pay taxes once, either when you add or withdraw money. With a traditional IRA, you pay taxes when you take money out on retirement. With a Roth IRA, you pay taxes now and get tax-free withdrawals later.

An IRA is much better than a taxable investment account. With a taxable account, you pay taxes twice, both on your income and on earnings from your investments.

If you are self-employed, you can create a simplified employee pension plan (SEP).

With an IRA, you can invest your assets in ESG ETFs or mutual funds of your choice. You can download the full list of sustainable ETFs here and mutual funds here. Fidelity has an ETF screener (login required).

Alternatively, you can get a robo-advisor to manage your retirement portfolio. The following robo-advisors currently offer ESG portfolios and a 401(k) rollover option into a traditional or Roth IRA:

🔔 Read our comprehensive guide to ESG robo-advisors here.

Another hands-off option is to invest in ESG target-date funds or balanced mutual funds. (Balanced funds invest in stocks and bonds, usually in a ratio of 60% stocks and 40% bonds.)

Asset manager Natixis offers Sustainable Future target-date funds with retirement dates from 2025 to 2060. The funds launched in 2017 and have high ESG ratings. For example, the Natixis Sustainable Future 2055 Fund (NSFLX) has a five-globe rating from Sustainalytics and an A from MSCI (both firms provide ESG ratings). The fund’s performance over its 4-year history has been promising.

In 2020, the world’s leading asset manager BlackRock launched the LifePath ESG Index Funds series. The BlackRock LifePath ESG Index 2050 has an A rating from MSCI and a four-globe rating from Sustainalytics. The funds are available through brokerages and advisors.

Some of the more popular balanced funds are Pax Sustainable Allocation Fund (PAXWX) and Calvert Balanced Fund (CSIFX).

Aspiration, a green “pay-what-you-want” bank and mutual fund, offers a traditional IRA. The IRA invests in the Redwood Fund (REDWX), a sustainable mutual fund (the fund is not pay-what-you-want and charges 0.50% of invested assets annually).

🔔 Check out our review of the Redwood Fund.

If you are a sophisticated investor, you can set up a self-directed IRA or a solo 401(k) and invest in alternatives, like clean energy startups or businesses led by women. Startups like Rocket Dollar can help you set this up.

🔔 Learn more about setting up a self-directed retirement account with Rocket Dollar.

Adding ESG funds to your retirement portfolio can boost your returns and align your investments with your values.

🔔 If you want to learn more about options for non-retirement portfolios, check out our guide to ESG investing.