Crafting Credit Facilities For Defined Contribution Plans

Introduction

Over the past 50 years, the retirement landscape has steadily shifted from defined benefit (DB) pension plans to defined contribution (DC) plans. In fact, as of the fourth quarter of 2024, private sector DC plan assets nearly quadrupled DB pension plans, with $12.4 trillion in DC plans compared to $3.3 trillion in private sector DB pension plans.¹

While DC plan fiduciaries strive to achieve higher returns for defined benefit plans by venturing into alternative investments (e.g., real estate, private equity or private credit), many DC plan fiduciaries have historically hesitated to embrace such products due to the specter of ERISA² litigation risk. However, the prior Trump Administration looked favorably on providing retirement plan investors with access to private markets and, in 2020, issued an Information Letter stating that it is consistent with ERISA’s duty of prudence for plan fiduciaries to offer a professionally managed, multiasset class fund with an allocation to private equity.³ The second Trump Administration maintains the same position, and is even considering issuing a new directive to pave the way for private assets to become a larger portion of US retirement savings in DC plans.⁴

Given the substantial amounts of capital funded in DC plans, the continued desire of DC fiduciaries to improve investment returns, and the favorable political climate,⁵ fund sponsors are actively courting DC plans and establishing investment funds with a private markets component that is tailored to the needs of DC plans (“DC Funds”). The DC Funds with an allocation for private assets are designed either as a designated investment alternative or, more commonly, as part of the glide path of a custom target date fund or as a component of a managed account solution.

Access to a line of credit offers several benefits to both DC plan fiduciaries and DC Fund sponsors. A credit facility can help DC plan fiduciaries and DC Funds manage the daily liquidity required by DC plan participants and fiduciaries, as well as provide bridge capital to fund DC Fund investments. While alternative investments, such as real estate or private equity, are typically illiquid, the higher rates of return offered by such investments may offset the illiquidity-related risks to DC plans and fiduciaries, particularly when a credit facility can mitigate much of the illiquidity concerns.

In this Legal Update, we discuss considerations for DC Fund sponsors and lenders in connection with a credit facility to a DC Fund (“Facilities”) and offer potential structural solutions.

Facility Size and Uses

Compared to credit facilities provided to typical private equity or real estate funds, Facilities for DC Funds tend to be relatively small in relation to the total size of the DC Fund. Facilities may vary, but they typically account for 10-20% of the total DC Fund size. While there is potential for Facilities to increase relative to DC Fund size as lenders get more comfortable lending to DC Funds and DC Funds continue to find new ways to take advantage of the liquidity provided by a Facility, limitations on collateral (discussed below) and the DC Fund’s need for liquidity may prevent such Facilities from reaching the relative size of credit facilities traditionally sought by other types of private equity funds or real estate funds.

Historically, DC Funds have relied on Facilities primarily for standby funding to align redemption requests of DC plan participants to the timing of redemption windows of the DC Fund’s underlying investments. Accordingly, such Facilities have generally been used infrequently and have not typically maintained long-term outstanding balances beyond the redemption windows of the DC Fund’s underlying investments.

For DC Funds that have longer track records and historically reliable streams of participant cash in-flows, Facilities could potentially be used to fund investments in advance of capital contributions from DC plan participants. Fiduciary concerns related to increased leverage and potential losses for DC plan participants, however, may prevent the use of facilities to further leverage investments.

Structuring/Security Issues

Borrower Structures

DC Funds rely on several different legal structures and pooling vehicles, including separate managed accounts, collective investment trusts, and insurance company separate accounts. A description and summary of these structures and vehicles is beyond the scope of this article, but it is important to recognize that each of these structures and vehicles carries distinct legal consequences that shape a Facility’s structure.

It is essential for lenders to fully understand the relationship between DC Funds and the actual borrower under the Facility. Some structures used by DC Funds do not utilize a separate legal entity for the borrower; instead, the borrower consists solely of a specific set of assets or funds within a larger legal entity. Lenders should consult with legal counsel to ensure they have sufficient legal recourse with respect to a facility’s borrower and to protect corporate formalities of the DC Fund related to distinct pools of assets belonging to one or more related legal entities.

Security and Collateral

While a subscription-backed credit facility looks to a fund’s investors for repayment as the ultimate collateral, the participant-funded nature of DC Funds is not compatible with such an approach.⁶

Instead, lenders can rely upon a variety of security packages tied to a DC Fund’s investments for collateral. Collateral packages for Facilities typically fall into three categories: illiquid investments, liquid investments, and distributions proceeds. A pledge of illiquid investments, such as interests in private equity funds, real estate funds or private credit funds, may be complicated by transfer restrictions applicable to such interests. Moreover, any such pledge may also require additional consents from third-party entities.

An indirect pledge of such interests could be structured with a pledge of the equity of an aggregating vehicle that holds such underlying investments. Lenders should carefully review the underlying investment documentation to ensure that the indirect pledge does not breach any transfer restrictions or require any third-party consents.

In addition to illiquid investments, DC Funds typically hold certain liquid investments in the form of cash/cash equivalents or other liquid securities. DC Funds rely on such liquid investments to support liquidity requirements of DC plan participants and aggregate cash in-flows pending new investments. Liquid investments are unlikely to be subject to transfer restrictions or consent requirements, and to the extent such liquid investments are held in one or more securities accounts with the lender, perfecting rights in the collateral is usually straightforward.

Lastly, the collateral package could include a pledge of distribution proceeds from a DC Fund’s underlying investments, along with one or more account(s) held with the lender into which such proceeds are deposited. Again, lenders should carefully review the documents to ensure that such a pledge does not breach any of the underlying investment documentation.

Of course, given a borrower’s creditworthiness, the reliability of DC plan contributions, the value of the underlying DC Fund investments and the multiple sources of repayment, a lender may also be comfortable offering a Facility.

ERISA Concerns⁷

Facilities for DC Funds may present different ERISA concerns than credit facilities for more traditional private equity funds or real estate funds. Unlike other fund financing products where ERISA issues are focused on ensuring loan parties will not be deemed to hold “plan assets,”⁸ DC Funds, by their nature, may hold “plan assets” and accordingly are subject to ERISA, including ERISA’s prohibition on party-in-interest⁹ transactions. In a Facility, the primary ERISA concerns arise regarding relationships between the lender, the DC Fund itself, and/or the underlying DC plans participating in DC Funds as such relationships may trigger prohibited transaction excise tax penalties for the lender.

If a DC Fund that holds “plan assets” is a borrower under a credit facility, lenders typically require the fund to make representations and covenants that the transaction will not result in any prohibited transaction excise taxes or penalties under ERISA or the Internal Revenue Code, due to the applicability of an available prohibited transaction exemption. Borrowers often rely on two such exemptions: the so-called “qualified professional asset manager” (“QPAM”)¹⁰ exemption and the “Service Provider”¹¹ exemption.

The QPAM exemption provides prohibited transaction relief for certain transactions, including extensions of credit, between a party-in-interest and a “plan asset” fund if the fund is managed by a QPAM.¹² To qualify for this exemption, the decision to enter into the transaction must be made by the QPAM, and the QPAM must have the authority to negotiate the terms of the transaction, among other requirements.

The Service Provider exemption provides exemptive relief for certain transactions between a “plan asset” fund and persons who are parties-in-interest to the plan solely by reason of providing services, or certain affiliates of such service providers, provided that the “plan asset” fund receives no less and pays no more than “adequate consideration.”

Conclusion

While Facilities for DC Funds have been relatively rare to date, as more fund sponsors seek to establish DC Funds, the opportunity is ripe for new market participants. With a careful review of a DC Fund’s legal structure, including the Facility’s borrowing entity, and attention to the collateral package, a Facility can be structured to provide essential liquidity to a DC Fund while also satisfying the lender’s credit criteria.

¹ “Quarterly Retirement Market Data”, Investment Company Institute, March 20, 2025.

² Employee Retirement Income Security Act of 1974, as amended, and the rules and regulations promulgated thereunder by any U.S. governmental authority, as from time to time in effect.

³ Department of Labor Information Letter dated June 3, 2020.

⁴ “White House Weighs Directive to Bring Private Equity to 401(k)s,” Bloomberg News, May 21, 2025.

⁵ Stating that private investments could offer long-term growth potential for younger workers with extended time horizons, U.S. Securities and Exchange Commissioner Mark Uyeda recently called for renewed efforts to bring private market exposure into retirement accounts, emphasizing that doing so would better align 401(k) plans with professionally managed defined benefit pension plans. “Uyeda Advocates for Private Market Access for Retirement Plans”, Alts Wire, May 14, 2025.

⁶ For a more detailed description of the subscription facility market and features of the subscription credit facility product in general, see Subscription Credit Facilities: Understanding the Collateral | Insights | Mayer Brown.

⁷ Beginner’s Glossary to Subscription Finance | Insights | Mayer Brown: In the context of a Subscription-backed Credit Facility, borrowers and lenders have concerns regarding ERISA Funds and potential prohibited transactions with lenders which may subject the Fund and the lender to heavy tax penalties.

⁸ “Plan Assets” has the meaning given in 29 C.F.R. §2510.3-101, et seq., as modified by Section 3(42) of ERISA.

⁹ Under ERISA, a “party in interest” is defined broadly to encompass a range of individuals and entities with a direct or indirect relationship to a plan. This includes plan fiduciaries, employers whose employees are covered by the plan, service providers, and certain affiliates and relatives of these parties. 29 U.S. Code Section 1002(14). A similar concept exists under the Internal Revenue Code, which refers to “disqualified persons.” 26 U.S. Code Section 4975(e)(2).

¹⁰ Prohibited Transaction Class Exemption 84-14, as amended (“PTE 84-14”).

¹¹ 29 U.S. Code Section 1108(b)(17) and 26 U.S. Code Section 4975(d)(20).

¹² To qualify as a “QPAM,” a manager must be an independent fiduciary which is (1) a bank, savings and loan or insurance company with a minimum net worth as set forth in PTE 84-14 or (2) an investment adviser under the Investment Advisers Act of 1940, as amended, that meets certain assets under management and shareholders’ or partners’ equity thresholds.