ESG Investing: You Can Align Your Investments with Your Values, But Should You?

When it comes to growing your money, sometimes what you do or do not invest in matters as much as how well your investment performs. It’s not just about risk, it’s about personal values. In this modern era, we have the unique opportunity to not only feel good about our portfolio returns, but also what we invested in and how we achieved those returns. That is precisely why sustainable investing is gaining popularity as investors increasingly seek to align their investments with their personal values and seek to work with financial professionals who not only understand them as an investor, but also as a value-driven individual.

One way to accomplish this goal is to use an investment approach that focuses on environmental, social and governance (ESG) criteria. An ESG lens considers issues such as climate change, pollution control, gender equality and diversity, human rights or corporate board composition. ESG-aware investing pursues opportunities by managing risks associated with corporate actions, policies and trends related to things like sustainable business, environmental impact, societal and community contributions, DI&E (diversity, inclusion and equity practices) practices and the demonstration of sound corporate governance.

Since the 1960s, sustainable investment strategies have shifted from an exclusionary approach to an inclusionary one. Over time, this shift has broadened the supply of investment offerings to meet growing investor demand. Interest in sustainable investing accelerated significantly in the 2000s. According to a recent McKinsey & Company study, assets in these types of investments grew by an estimated 38% from 2016 to 2018 in the U.S., rising from $8.7 trillion in 2016 to $12 trillion in 2018. Globally, sustainable investments total $23 trillion, which represents 26% of all professionally managed assets.

Debunking 2 Myths about ESG Investing

A common misconception is that sustainable investing — including ESG-driven strategies — imposes hurdles on performance. After all, aren’t most companies more motivated by profits than they are values? You might be surprised to find out reality is quite the contrary. Thankfully, you do not need to throw ethics and values out the window to achieve good returns. Studies of longer-term historical performance suggest that ESG strategies have performed similarly to comparable traditional investments on an absolute basis and a risk-adjusted basis. Remember, though, sustainable investment strategies do come with risks, like any investment.

Another misconception is that demand is being driven mainly by younger investors. Yet, research suggests that investors across generations are interested in sustainable investing. While Millennials are apt to discuss sustainable investing with their financial advisers, other generations have expressed interest as well. A 2020 Wells Fargo/Gallup survey found that 82% of surveyed investors showed interest in choosing investments based on the environment, human rights, diversity, and other social issues — if those investments provided returns similar to the market average.

One interesting case in point: Thompson Reuters, under the corporate brand Refinitiv, created an index to transparently and objectively measure the relative performance of companies against factors that define diverse and inclusive workplaces. The index ranks more than 7,000 companies globally and identifies the top 100 publicly traded companies with the most diverse and inclusive workplaces, as measured by 24 metrics across four key pillars: diversity, inclusion, people development and news and controversies. Not only have these companies scored well, but the index has outperformed the Thompson Reuters Global Total Return benchmark, demonstrating that diversity and inclusion can also lead to profitability. Perhaps values really can drive growth!

A Growing Investment Sector

Industry professionals predict that sustainable investment choices for investors will continue to expand. In fact, some analysts predict that ESG factors could become a normal consideration of most investment strategies, particularly those intended for younger investors who tend to expect greater transparency from their investments. In fact, it may surprise you to know that today, sustainable investing accounts for about $1 out of every $3 under professional management in the U.S.

If you are new to socially responsible investing, a good idea is to seek an adviser with expertise in SRI and ESG investing. While most advisers remain investment agnostic, acknowledging that either an S&P 500 index fund or a socially responsible green fund can accomplish your objectives if that is what fits best, some practitioners have chosen to specialize more in this area. Advisers helping consumers interested in values investing may perform rigorous invest selection and screening processes that not only support optimal performance but also measure the societal and environmental impact of the firms themselves.

 Find an adviser who is confident about utilizing traditional vehicles, but passionate about finding unconventional ways to accomplish your goals, especially if doing so better aligns with your personal beliefs. The right adviser’s role should be simple: to understand not just where you want to go, but who you are and what values you have so that he/she can examine all the appropriate options that can fit and empower you to move forward.

Founder, Vice President, The Haney Company

Brian Haney is proud to say he was recently voted (by his daughter) to the illustrious title of “World’s Most Embarrassing Dad!” So that’s his full-time gig, but he also masquerades as a Certified Income Specialist, advising clients on how to achieve the retirement of their dreams. Founder of The Haney Company, Brian is a speaker and also the author of “The Retirement Income Pyramid,” your retirement income road map.

Source: kiplinger.com

What is a 401(k) Profit Sharing Plan?

Like a traditional 401(k) plan, a 401(k) profit share plan is an employee benefit that can provide a vehicle for tax-free retirement savings. But the biggest difference between an employer-sponsored 401(k) and a 401(k) profit share plan is that in a profit share plan, employers have control over how much money—if any—they contribute to the employee’s account from year to year.

In other ways, the 401(k) profit-sharing plan works similarly to a traditional employer-sponsored 401(k). Under a 401(k) profit share plan, as with a regular 401(k) plan, an employee can allocate a portion of pre-tax income into a 401(k) account, up to a maximum of $19,500 per year (in 2020 and 2021).

At year’s end, employers can choose to contribute part of their profits to employee’s plans, tax-deferred. As with a traditional 401(k), maximum total contributions to an account must be the lesser of 100% of the employee’s salary or $58,000 a year per the IRS; that number jumps to $64,500 for older employees who are making catch-up contributions.

How Does 401(k) Profit Sharing Work?

There are several types of 401(k) profit-sharing setups employers can choose from. Each of these distributes funds in slightly different ways.

Pro-Rata Plans

In this common type of plan, all employees receive employer contributions at the same rate. In other words, the employer can make the decision to contribute 3% (or any percentage they choose) of an employees compensation as an employer contribution. The amount an employer can share is capped at 25% of total employee compensation paid to participants in the plan.

New Comparability 401(k) Profit Sharing

In this plan, employers can group employees when outlining a contribution plan. For example, executives could receive a certain percentage of their compensation as contribution, while other employees could receive a different percentage. This might be an option for a small business with several owners that wish to be compensated through a profit-sharing plan.

Age-Weighted Plans

This plan calculates percentage contributions based on retirement age. In other words, older employees will receive a greater percentage of their salary than younger employees, by birth date. This can be a way for employers to retain talent over time.

Integrated Profit Sharing

This type of plan uses Social Security (SS) taxable income levels to calculate the amount the employer shares with employees. Because Social Security benefits are only paid on compensation below a certain threshold, this method allows employers to make up for lost SS compensation to high earners, by giving them a larger cut of the profit sharing.

Pros and Cons of 401(k) Profit Sharing

There are benefits and drawbacks for both employers and employees who participate in a profit-sharing 401(k) plan.

Employer Pro: Flexibility of Employer Contributions

Flexibility with plan contribution amounts is one reason profit share plans are popular with employers. An employer can set aside a portion of their pre-tax earnings to share with employees at the end of the year. If the business doesn’t do well, they may not allocate any dollars. But if the business does do well, they can allow employees to benefit from the additional profits.

Employer Pro: Flexibility in Distributions

Profit sharing also gives employers flexibility in how they wish to distribute funds among employees, using the Pro-Rata, New Comparability, Age-Weighted, or Integrated profit sharing strategy.

Employer Pro: Lower Tax Liability

Another advantage of profit share plans is that they allow employers to lower tax liability during profitable years. A traditional employer contribution to a 401k does not have the flexibility of changing the contribution based on profits, so this strategy can help a company maintain financial liquidity during lean years and lower tax liability during profitable years.

Employee Pro: Larger Contribution Potential

Some employees might appreciate that their employer 401(k) contribution is tied to profits, as the compensation might feel like a more direct reflection of the hard work they and others put into the company. When the company succeeds, they feel the love in their contribution amounts.

Additionally, depending on the type of distribution strategy the employer utilizes, certain employees may find a profit-sharing 401(k) plan to be more lucrative than a traditional 401(k) plan. For example, an executive in a company that follows the New Compatibility approach might be pleased with the larger percentage of profits shared, versus more junior staffers.

Employee Con: Inconsistent Contributions

While employers may consider the flexibility in contributions from year to year a positive, it’s possible that employees might find that same attribute of profit sharing 401(k) plans to be a negative. The unpredictability of profit share plans can be disconcerting to some employees who may have come from an employer who had a traditional, consistent match set up.

Employee/Employer Pro: Solo 401(k) Contributions

A profit share strategy can be one way solo business owners can maximize their retirement savings. Once a solo 401(k) is set up with profit sharing, a business owner can put up to $19,000 a year into the account, plus up to 25% of net earnings, up to a total of $58,000. This retirement savings vehicle also provides flexibility from year to year, depending on profits.

Withdrawals and Taxes on 401(k) Profit Share Plans

A 401(k) with a generous profit share plan can grow quite quickly. So what about when you’re ready to take out distributions? A 401(k) withdrawal will have penalties if you withdraw funds before you’re 59 ½ (barring certain circumstances laid out by the IRS) but the money will still be taxable income once you reach retirement age. Additionally, like traditional 401(k) plans, a profit-sharing 401(k) plan has required minimum distribution requirements (RMDs) once an account holder turns 72.

Investors who anticipate being in a high tax bracket during their retirement years may consider different strategies to lower their tax liability in the future. For some, this could include converting the 401(k) into a Roth IRA. This is sometimes called a “backdoor Roth IRA” because rolling over the 401(k) does not subject an investor to the income limitations that cap Roth contributions.

An investor would need to pay taxes on the money they convert into a Roth IRA, but distributions in retirement years would not be taxed the way they would have if they were kept in a 401(k). Any 401(k) owner who qualifies for a Roth IRA can do this, but the additional funds in a 401(k) profit share account can make these moves that much more impactful in the future.

The Takeaway

A 401(k) profit share plan allows employees to contribute pre-tax dollars to their retirement savings, as well as benefit from their employer’s profitability. But because profit share plans can take multiple forms, it’s important for employees to understand what their employer is offering. That way, employees can create a robust retirement savings strategy that works for them.

There are many retirement savings options besides an employer-sponsored 401(k) (profit-sharing or not), and some investors invest in a combination of different plans that suits their short-term and long-term needs. SoFi Invest® offers both Roth and traditional IRA accounts, both of which can help make saving for retirement easier.

Find out how to open an IRA with SoFi.


SoFi Invest®
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Source: sofi.com