Betterment answers your tax season questions—from 401(k)s to HSAs

It’s tax time! Read on as Eric Bronnenkant, Betterment’s Head of Tax, and Nick Holeman, Betterment’s Head of Financial Planning, discuss common tax queries.

Which combination of retirement accounts will likely provide this particular client the most beneficial tax savings over their lifetime?

Nick: The words of this sentence were chosen very carefully because it’s likely going to be that one retirement account alone is not enough to fully optimize things. It’s going to be a combination, and it’s going to depend on this particular client’s situation. We’re not focused solely on minimizing taxes today. We want to try to minimize and control taxes over the client’s lifetime to try and save them the most cumulative amount of taxes. And as we’ll get into, that might not be the type of account that’s going to give them the largest tax break today.

So, we’re going to dive in, but this is the underlying theme or question. The reason why this is so complicated is because there are so many factors and inputs to this decision—kind of this patchwork of special retirement accounts that Congress and the IRS have created over decades. This is why the question is so complicated for us advisors. It’s also why it’s so confusing for clients. And it’s why there’s so much bad advice out there. A lot of the clients that I work with have their own CPAs, and I can’t tell you how many times I’ve had to correct them.

A lot of CPAs are experts in tax, but they’re not experts in looking 20-30 years down the road when it comes to retirement planning. So today, we want to focus on some of the more common scenarios and questions.

Traditional IRA vs. Roth IRA?

Eric: While this can also potentially be looked at in the Traditional 401(k) versus the Roth 401(k), there are some nuanced differences there, too.

For today, we’re going to look at the Traditional IRA versus Roth IRA because this is something that typically the client has the most amount of control over in making their own decisions about what account type to choose. And there’s a lot of uncertainty; as Nick pointed out, there’s also a lot of information. Some of it’s good, and some of it could use improvement.

So, thinking about someone who’s 25, single, earning $50K: Should they be in the Traditional IRA or the Roth IRA? What’s better for them?

Eric: Nobody really knows the answer to that question today. You really only know the answer to that question after a whole lifetime. What are your initial thoughts, Nick? What jumps out at you when you look at this type of scenario?

Nick: Yeah, I like that we’re starting with the basics and we’re going to build onto the more complex topics. This is one instance where I tend to agree with the standard advice I hear from other CFP® professionals: When you’re younger, you’re likely able to expect your income to grow. So paying taxes now is going to be better than paying taxes later. In general, without knowing too much about this client situation, I would probably recommend Roth if I had to give an answer.

For someone who’s age 40, married, and has earnings of $250K: What type of IRA do you think they might want to consider?

Nick: This is where we start to get borderline on some of those tax rules. I don’t know all of their adjustments or other things that might lower their modified AGI, but here we’re probably going to be phased out of a Roth, so we might not have a choice. We would go with a Traditional IRA. Maybe that’s when we start getting into the more advanced topics, like a backdoor Roth IRA. But yeah, probably Traditional.

Eric: Right. Regardless of how much money you make, you can always contribute to a Traditional IRA. You just may not get a tax deduction for it if you’re covered by a retirement plan at work and you make too much money. So the Roth income limit, you get phased out at about $206,000 for last year; $208,000 this year. It would be tough, even for married couples maxing out their 401(k),to potentially help them get below those thresholds. Tough to meet those MAGI limits.

But you definitely brought up a great point as far as the backdoor Roth. So for people who make too much money to contribute to the Roth directly, they can contribute to the Traditional and then do the conversion over to Roth. Fun fact: the Roth conversion income limitation was eliminated permanently in 2010, and as of right now, there is nothing on the horizon that is going to change that. Obviously laws can always change, but it is not scheduled to return at this point.

Nick: Backdoor Roths are super powerful potential strategies for high income earners. We talk about them a lot with our clients at Betterment. They’re a little more complex, so they’re not usually part of the baseline retirement plan that we’re building up, but if they have a tax professional involved who’s keeping track of the Form 8606 so they’re not getting double-taxed, then a backdoor Roth can be a super powerful strategy.

Do contributions to a traditional 401(k) help me qualify for a Traditional IRA deduction or a Roth IRA contribution?

Eric: So let’s say you have a married couple where one spouse is earning $210,000, and one spouse put in the $19,500, now that $19,500 would put them below the Roth income limit. Then they’d go from a situation where they weren’t able to make any Roth contribution directly to being able to make the full $6,000 or $7,000 Roth contribution directly. So a contribution to a Traditional 401(k) may help you qualify for other benefits, like a deduction on a Traditional or making direct contributions to a Roth or even other things, like child tax credits and any other AGI sensitive items.

Do tax-free withdrawals from a Roth IRA impact social security benefits and Medicare premiums in retirement?

Nick: Roth IRAs don’t impact social security benefits. They don’t impact Medicare premiums. Those are two big potential ways to optimize retirement down the road. It’s not just looking at tax brackets, either. I know oftentimes when Eric and I will chat, we’re like, ‘Oh, it’s current bracket versus future bracket, and you can kind of decide which one is best.’ And that’s true, but that’s a little bit too simplified. We know tax brackets fluctuate, and there are other things aside from taxation, as well: social security, Medicare premiums, things like that. So big shout out to Roths if they make sense for each client, but just a reminder not to only focus on tax brackets.

Can I withdraw contributions from a Roth IRA without tax/penalties?

Eric: The power of the Roth is that you’re able to withdraw your regular contributions at any time — tax and penalty free — regardless of your age. Some people use it as an emergency fund; that is a possibility. If you can afford to have a Roth and an emergency fund, that’s even better. Let’s say you need to use your Roth as an emergency fund: it is potentially a tax-efficient way to withdraw those regular contributions tax and penalty free regardless of your age. I do want to point out that if you wanted to withdraw the earnings, which would come out second, those are subject to tax and penalty if you’re under age 59-and-a-half.

401(k) vs. IRA?

Eric: The first thing you should think about in this type of scenario is: Can I contribute to both my IRA and my 401(k)? I’m not sure where this rumor got started, but it’s definitely been flying around the internet for a long time that if you contribute to a 401(k), you can’t contribute to an IRA, which is not true. You can contribute to both. Now, what could potentially be impacted is that if you contribute to a 401(k), you may not get a deduction for your Traditional IRA contribution. So is there an interrelationship of the two? Yes. But it’s not that you won’t be able to make the Traditional IRA contribution, you just may not get a deduction for it. What are some other reasons why you might want to prioritize a 401(k) versus an IRA?

Nick: I’ll go with one of the less common ones to make this interesting. Behavioral benefits, right? A 401(k) contribution is going to come directly out of your paycheck before it even hits your account. At Betterment, we’re big fans of automation. Out of sight out of mind. If it’s so easy to spend your money, we want to try to make it just as easy to save your money. So 401(k)s or auto-deposits into an IRA, vice versa. Those are some great benefits that you can do with their 401(k).

Can I access 401(k) funds 10% penalty-free at age 55?

Eric: Not everyone wants to work until age 59-and-a-half. Retiring early is on a lot of people’s minds, and most people are pretty familiar with the fact that if you want to access 401(k) funds before 59-and-a-half, you have to pay a 10% penalty. IRA 10% penalty exceptions versus 401k, 10% penalty exceptions are not symmetric. Some are the same, but some are not the same.

Nick: 401(k)s are great for age 55 early withdrawals. That’s a big win, right? We’re talking to more and more clients who are, I don’t know if 55 necessarily counts as FIRE (Financial Independence Retire Early), but we’re talking to more and more clients who are getting really into that.

Can I borrow against an IRA?

Nick: We don’t love seeing that, but there’s a little more flexibility with the 401(k).

Eric: Actually, a fun fact about the 55-or-later rule is that you don’t even have to be 55, as long as you separate from service in the year you turn 55 or later. So you could potentially turn 55 on Christmas day and leave your job on January 1st of that year, and you still qualify for that 10% penalty exception. One thing you shouldn’t do if you want to keep that exception is roll those funds over to an IRA, because you’ll lose that 10% penalty exception, even though you’re allowed to rollover.

Nick: You want to make sure you’ve got enough funds to be able to bridge the gap between 55 and 59-and-a-half. So you might do a partial rollover, for example. Eric, I don’t know what your thoughts are on that, but make sure you’re not leaving them hanging out to dry in that little window there.

Eric: Yeah. I mean, is the 401(k) penalty-free provision useful? Absolutely. Is it the best thing? Not necessarily. If, let’s say, you don’t like your 401(k) investment options, you could roll it over to your IRA and then do substantially equal periodic payments for five years, which is longer than 59-and-a-half, so that that’s more restrictive. If you were willing to give up some control on your payment timing, you still might find the IRA option more attractive.

I want to use a retirement plan to partially fund a new home purchase. Should I use my IRA or 401(k) first?

Eric: There are a few different ways to fund that. Obviously if people have enough extra money in their non-retirement accounts, that’s typically the first place they’re looking to fund that first-time home purchase, but not everyone has a 20% down payment available in cash. People are always looking at other alternatives for funds, and that would include a 401(k) and an IRA. What are your thoughts on the 401(k) versus IRA in this scenario, Nick?

Nick: My real thoughts would be neither. Typically if a client’s asking me this question, it means that they either didn’t plan or they’re kind of feeling pressured out of a situation or going beyond their budget. So I know that’s being a little judgmental, but typically I discourage both. Your IRA has that $10,000 first time-home exemption, 401(k), you can take out a loan and the provisions are a little bit more flexible if that loan is for home purchase. Depending on the situation, I would probably go to my IRA because it has that smaller limit; it would prohibit them from dipping too much into their 401(k). But there are definitely pros and cons to each.

Eric: Right. So you can do the Roth IRA. And now, obviously this is if you need the money, because Roth IRAs are such a powerful retirement savings tool, and the longer you hold the money in there, the better. But let’s say you need the money: You could withdraw all of your regular contributions, first tax and penalty free. And then if you’ve had the account open for at least five years, you can withdraw up to $10,000 of earnings tax and penalty free, too. That can count as a qualified distribution. So an IRA may be useful, but some people have most of their money set aside in their 401(k). And that’s where a loan with generous repayment terms, where you’re able to push that out over a long period of time, may be attractive.

Nick: True. Maybe this is me, but the whole benefit of Roth IRAs is tax-free growth. So if you’re not getting a lot of tax-free growth, you’re missing out on some of the benefits. It only makes sense to be invested aggressively if you’re looking at a long-term time horizon. If you’re planning on using a Roth IRA to buy a house next year, you shouldn’t have had that money invested super aggressively anyways, which means you’re probably looking at cash or more conservative investments, which means you’re missing out on the single biggest benefit of Roth IRAs in general, which is tax-free growth. So again, I just don’t understand why I see so many people talking about using your Roth IRA for this home purchase exemption or for your emergency fund. I don’t understand it, unless it’s an absolute emergency; not something I typically recommend.

Eric: That’s fair. When you’re thinking about whether you should be buying a home in the first place, you do want to think about: ‘How is this going to impact my retirement, especially if I’m going to use some or all of my retirement funds?’ to fund that home purchase.

HSA vs. 401(k)?

Eric: I love HSAs, and I know Nick loves HSAs. You can put money in pre-tax, and it’s pre-federal tax, pre-social security, pre-Medicare, pre-most state taxes, except for mine in New Jersey — and Pennsylvania. In general, it’s pre-tax across the board and it grows tax deferred, and then the withdrawals come out tax-free in retirement or for qualified medical expenses. There are lower limits for the HSA than for the 401(k) and different rules about what you use the funds for along the way. You’ve actually might be able to save more money in taxes on an HSA contribution than a Traditional 401(k), because the Traditional 401(k) doesn’t save you on any social security or Medicare taxes. Those you’re always contributing to after those taxes have been applied.

I want to maximize retirement savings. Can I use the HSA as a retirement savings vehicle and a medical savings vehicle?

Nick: I’ve seen a lot of advisors get into some sticky situations when recommending using HSAs for retirement. They’re not right for everyone. The two biggest rookie mistakes that I see are getting too excited and recommending an HSA without remembering that you need to pair an HSA with a high deductible healthcare plan. If the high deductible plan doesn’t make sense for the client in the first place, then the HSA probably doesn’t make sense. And the second is if you’re going to be using your HSA for retirement, you’re probably looking at investing it in more aggressive investments, which means they’re going to be a lot more volatile. Whenever I recommend a client use an HSA for retirement, I pretty much tell them we’re not going to do this until we have a fully funded emergency fund as well, separate from the HSA, because Murphy’s law, worst-case scenario. If we’re going to have your HSA be aggressive, I want to make sure that the client also has a separate, lower risk emergency fund just in case something happens.

Eric: All great points. I do want to clarify: In New Jersey HSAs are not pre-tax; in Pennsylvania, 401(k)s are not pre-tax, but you do get the HSA deduction in Pennsylvania and you do get the 401(k) contribution in New Jersey. So you always want to look at state laws. They may not drive your decision, but they may be a factor in your ultimate decision.

Nick: That’s why I always caveat: Make sure to bring in your CPA if you have a client, and make sure that you’re all working together. They might know something that you don’t, that’s state-specific to your rules or something like that.

I want to live a tax-free lifestyle in retirement. Is the trifecta to use an HSA with a Roth IRA and Roth 401(k)?

Eric: I love talking about the tax-free lifestyle. How can you get to that point? Well, there are ways. Let’s say you max out your Roth 401(k), $19,500, you’re not getting any break upfront, but then all the earnings come out tax-free in retirement. Roth IRA for another 6,000 there, no tax break upfront, all the earnings are tax-free in retirement. And then the HSA, you’re getting a tax break upfront and even if you’re not using it for medical expenses, once you’re over 65, then you’ll pay taxes. You can also use what’s called the shoe box rule, where if you keep track of all of your unreimbursed medical expenses since you opened your HSA, you can use that as an account to withdraw from based on all of those previous expenses. If you accumulated $50,000 worth of expenses since your HSA was opened, you’d still, it’d be able to withdraw $50,000 in retirement even though in that year, you may have had no medical expenses at all, because you’re able to use that kind of look-back process.

Nick: That’s personally what I do. I’m looking forward to that. I don’t have an actual shoe box, but I’ve got a spreadsheet — and it’s a beautiful spreadsheet. So I’m excited for that.

Eric: There are also a number of apps out there where you can save your receipts, whether it comes by email, you can just put that in the app, or you can take a picture if you’re at the doctor’s office. There are plenty of ways to track these receipts and expenses over time in an efficient way.

SEP vs. Solo 401(k)?

Eric: There are a lot of self-employed people out there, and they’re always asking, ‘Should I do the SEP or the Solo 401(k)?’ The answer, as, with most tax questions is, it depends.

It depends on if your goal is to maximize your savings, if your goal is to minimize regulatory filings, there are a variety of factors to consider. Your SEP contribution, you can do 20% of your net earnings from self-employment, up to $58,000. But that’s still only 20%. There’s no employee contribution — it’s all employer contributions. Whereas the Solo 401(k) allows for employee contributions as well as employer contributions and generally still has the same overall limit as the SEP, except for people who are age 50 or older.

Let’s say we had someone who’s a self-employed, 50-year-old who has a business profit of $100,000. SEP or Solo 401(k)?

Eric: That person can do just $20,000 into the SEP, but if they did the Solo 401(k), they’d be able to do the $20,000 employer contribution plus the $26,000 employee contribution because that’s the $19,500, plus the $6,500 for being 50 or older. Obviously that would take up a significant portion of their $100,000, but at the end of the day, if they have extra money in savings elsewhere that they could use to help maximize their retirement savings, that’s something they may want to consider.

I prefer to minimize the possibility of regulatory filings. Should I make contributions to a SEP or Solo 401(k)?

Nick: Oftentimes when I’m speaking with a small business owner, they might not be able to save that much. Last year, a lot of the entrepreneurs I was talking to had a little bit of a rough year, to say the least. And if you’re looking at starting a retirement plan for your self-employed business, SEPs, you might not be able to contribute quite as much. Sometimes, for a lot of people starting out their business, that’s not an issue. They wish contribution limits were something they had to worry about, but they’re trying to get their business up and running. They’re also just trying to find time in the day to do everything. So for the SEP, if you’re not even bumping up against the contribution limits and it requires less regulatory filing, and it’s just a little bit easier, it’s something to consider. You might be able to contribute more with a Solo 401(k), but on the SEP side, there are some other advantages as well.

Eric: Why do people love the SEP? The SEP has no filings with the Department of Labor. As a Solo 401(k), there is a Form 5500 filing once the assets get over $250,000, whereas regardless of how much money is in the SEP, there are no Form 5500 filings. And while I don’t think the Form 5500 is particularly burdensome, most people I know would prefer to file fewer forms with the government. I definitely appreciate the avoidance of filing any additional paperwork, even if it’s not that burdensome.

I want to make Roth type contributions. Should I make contributions to a SEP or a Solo 401K?

Nick: I don’t think so.

Eric: No, there is no Roth SEP. Now what you could do is convert your SEP contribution into a Roth, because there aren’t income limits on doing conversions. But if you want to make a regular Roth-type contribution, then it would have to be an employee contribution to a Solo 401(k) subject to the $19,500 or $26,000 annual limits. There are pros and cons on both sides here, and it’s very client-specific on whether they prefer the SEP or the Solo 401(k).

Which retirement plan should I make contributions to in order to make tax/penalty-free withdrawals before retirement?

Nick: There’s a few options. The easiest is just a plain old taxable brokerage account. There’s no contribution limits, there’s no age requirements, there’s no early withdrawal penalties. They’re a little bit easier to plan for; again, you might be missing out on some of the tax benefits, but that’s one. HSAs are one as well; it doesn’t have an age limit, as long as you’ve got qualified medical expenses. Roth IRAs, you can withdraw your contributions penalty free and tax free at any time. So there’s lots of choices.

Eric: Getting back to what we were discussing before, the 55-or-later exception is a powerful tool to access funds pre-59-and-a half without a 10% penalty and avoiding the substantially equal periodic payment option. Being able to withdraw those raw Roth contributions at any time is good too, but the closer that you get to 59-and-a-half, you also want to be particularly cautious. Let’s say if you have a Roth IRA and you withdraw earnings before you’re 59-and-a-half, those are typically subject to a regular income tax and a 10% penalty. So, whereas if you had made the five years plus 59-and-a-half, you would have gotten that tax free. The difference could potentially be if you’re the day before 59-and-a-half. Then it’s possible though that you would have to pay taxes and penalty on earnings, whereas once you make it to 59-and-a-half, and you’ve had the account open for five years, then you get it tax free. It’s a very binary type of thing, and you always want to be cautious about where you are relative to that line in the sand.

Can Roth conversions be part of an early retirement strategy?

Nick: There’s an excellent Kitces article about the various five-year rules that go along with Roth on contributions, on conversions, on Roth 401(k)s. We can definitely get into some of those, but just so everyone knows, there is a really solid article on

Eric: Early retirement is not for everyone. Some people are able to afford it. Some people try to fit their life into an early retirement strategy, and for some people, that works better than others. One thing you already mentioned was some of the five-year rules. If you do a Roth conversion of pre-tax money before you’re 59-and-a-half and you want to withdraw those funds in the future before you’re 59-and-a-half, there is a five-year holding period for each conversion to avoid the 10% penalty. This rule is designed to prevent people from converting and withdrawing immediately to avoid the 10% penalty. You can still do a conversion at age 45, age 46, age 47, age 48, let’s say a rolling conversion strategy, which then you’ll be able to access those converted amounts five years later, tax and penalty free. Again, those earnings would have to stay in the Roth until 59-and-a-half to avoid any tax or penalty.

Nick: Good points. One thing I found practical to keep in my toolkit so to speak is to get familiar with the IRS website. That sounds like that’s a terrifying task, but Google is your friend. “IRS gov Roth IRA,” for example, the first hit is likely going to be the contribution limits for that particular year. So if you forget, it’s just something that’s good to be familiar with. Not everyone has an Eric that they can just Slack on demand. I’d say bookmark them, familiarize yourself with them. The IRS has some pretty good pages on Roth IRA, contribution limits, Traditional IRA deductibility limits. So if you can’t remember them or keep track with them every year, just get used to Googling.

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Did Your 401(k) Plan Fail Its Compliance Test?

Compliance Failure Q&A

Q: First things first: what exactly is 401(k) compliance testing and when is it performed?

Sometimes called “non-discrimination” testing, compliance testing is conducted shortly after the close of a plan year, so roughly mid-January through mid-April for calendar year plans. In short, a 401(k) plan must pass these tests each year to verify that it does not benefit highly compensated employees (HCEs) at the expense of non-highly compensated employees (NHCEs) unfairly. Although there are a number of compliance tests, one of the most important is the “actual deferral percentage,” or ADP, test.

Q: What exactly does the ADP test look at?

With the ADP test, we compare the average 401(k) deferral percentage for HCEs to the average 401(k) deferral percentage of NHCEs. If the difference is greater than a certain margin (as shown in the table below), the plan is said to have “failed” the ADP test.

Average NHCE rateMaximum HCE Average RateUnder 2%2 x NHCE Rate2% to 8%2% + NHCE RateOver 8%1.25 x NHCE Rate

It’s important to note that the average deferral rate for testing purposes takes into account all eligible employees, including both active and terminated employees for the plan year. As a side note, this might differ from how the average deferral rate is defined for plan health purposes, which usually looks at the average deferral rate only of those participants who are actively contributing.

Q: What exactly are the consequences of failing the ADP test?

It’s probably scarier than it sounds because it can be fairly easily corrected. There are two ways to correct the failure. One is to refund excess 401(k) contributions to the impacted HCEs. The refund amount is dependent on the size of the failure, but it is taxable to the affected employees (often owners and senior managers) who will likely be unpleasantly surprised by this turn of events. It’s never an easy conversation for the plan administrator to have.

The second method is to make a corrective contribution (equal to the failed margin) known as a Qualified Non-elective Contribution (QNEC) to all of the non-highly compensated employees. This may be costly to the employer, but if the failed margin is small and the company is on the smaller side, this may be a good alternative to correct the failure. Generally, this correction needs to be completed by two and a half months after the end of the plan year being tested (March 15 for calendar year plans).

Q: OK, before we go any further, let’s make sure everyone is on the same page with respect to the definitions of HCE and NHCE.

Ah, and that’s where some of the 401(k) fun comes in because there are actually different ways that these categories of employees can be defined. And the plan sponsor has some flexibility in choosing the definition that may make it easier for the plan to pass compliance testing. But one thing that’s important to know is that you only have to define who falls within the HCE category since NHCEs are just the residual (i.e., everyone else).

Compensation is understandably one factor in determining whether someone is an HCE or not. But it’s based on prior year compensation data. So if we’re in February of 2021, doing 2020 compliance testing on a plan, we’d need 2019 compensation data from the plan sponsor. That can cause a lot of confusion at first, especially for plans that just started up. For example, a plan that started in June 2020 will understandably question why they need to provide us with company compensation data —before the 401(k) plan was even in existence. It’s because we need to determine who was an HCE, and that’s based on the prior year, also known as a “lookback year.” Obviously, if the company wasn’t even in existence in the prior year, we would then have to rely on more recent data. And in fact, in such a case, we wouldn’t rely on compensation to define HCEs, but just the ownership definition, which we’ll get into.

Q: So it sounds like the next logical question then is: what are the different HCE definitions?

Sure. Certain types of employees are automatically defined as HCEs regardless of their compensation. This can be tricky for businesses, especially those that are small and/or family run. An HCE is an employee who meets one of the following criteria:

Ownership in Current or Prior Year – regardless of compensation, owns over 5% of (1) outstanding corporate stock, (2) voting power across corporate stock, or (3) capital or profits of an entity not considered a corporation. This includes family members.Prior year compensation exceeds IRS definition of HCE. This is regardless of current year compensation. In 2019, this amount was $125,000.

Q: I guess this leads to other methods of defining HCEs and NHCEs.

Exactly. Alternatively, larger plans especially may wish to define HCEs using the Top-Paid Group Election (TPG) method that allows them to limit the number of HCEs to their top 20% of employees based on prior year compensation. This must be defined in the plan document and could be beneficial if high earners who aren’t in that top 20% are contributing significantly, which in turn can help boost the average contribution rate of the other 80%.

One thing to note is that any employees who are considered highly compensated under the ownership definition will still be treated as HCEs, regardless of compensation. So the exact percentage of HCEs using the TPG method may actually exceed 20%.

Q: So what are some factors that contribute to ADP testing failures?

One of the most common challenges we see happens when plans start late in the year. Often, HCEs who have more discretionary income are so excited about the plan and the ability to maximize their savings and their tax deferrals. So even with just a few payroll periods left in the year, they maximize their contributions, contribute at much higher rates than NHCEs, and cause the plan to fail.

Plans that start late in the year should be aware of this potential problem. If they don’t want to delay starting the plan, they should communicate to HCEs that they will be unlikely to contribute the maximum annual amount (and may risk receiving a taxable refund of contributions after the year ends).

Our message to plan administrators, though, is this: if the sole focus for starting a 401k plan is to allow the owner or other HCEs to max out their contributions, be forewarned that your plan may fail the ADP test. Remember that as a fiduciary, you must operate the plan in the interests of all of your employees.

Q: Any other things to watch out for?

Other plans that may need to be more cautious include small plans, especially where the owner may be the only HCE. If other employees aren’t contributing or contributing enough, that can be difficult.

Another wrinkle can occur when there are HCEs who are earning less than the statutory maximum compensation amount. Among other things, this is the maximum amount that can be used when performing the test calculations. Consider an HCE under age 50 who is contributing the maximum annual 401(k) contribution of $19,500. If they are earning the statutory maximum compensation amount of $285,000 for 2020, that is the equivalent of 6.8% of salary. However, if they are earning just $150,000 (which also qualifies them as an HCE), that same $19,500 translates into a 13% contribution rate. So the range of HCE compensation can have a huge impact on that HCE ADP.

Q: How can plans ensure that they don’t fail the ADP test?

For those who aren’t aware, there’s one very easy solution. The ADP compliance test can be bypassed altogether if the plan adopts a Safe Harbor plan design, which requires a mandatory contribution. Of course, the company needs to weigh the added expense against the benefits of reduced compliance headaches and potentially better funded retirements for their employees. But for plans who are starting late in the year, adopting Safe Harbor is a great way to avoid potential testing failures and having to refund contributions to HCEs.

Q: And what if the Safe Harbor plan design is just too costly?

Short of adopting a Safe Harbor plan design, there are other things plans can do to reduce the likelihood of failing the test. For instance, implementing automatic enrollment for all employees at a rate that is sufficiently high can go a long way. Most people do not opt-out of the plan or change their default contribution amount. So if the plan contributes everyone at, say 6%, there’s probably a much better chance that the plan will pass ADP testing.

In addition, sometimes (but not always) a matching contribution can really motivate employees to save more. For instance, if employees have to contribute 6% to earn the maximum employer contribution, they will be more likely to contribute that amount. Often this requires clear and consistent communication to be sure that employees newly eligible for the plan are also aware of the matching feature and how they can earn the maximum amount. That said, if an employer is willing to take on the expense of a matching contribution, then a Safe Harbor plan design may make more sense since that eliminates the uncertainty associated with compliance testing altogether.

Plans may also decide to use the Prior Year testing method, which allows them to limit HCE plan contributions going forward based on the results of the prior year tests. This is not a guarantee that the plan will pass the ADP test, but it reduces the likelihood.

Q: What’s your advice to plans that have failed the ADP test?

First of all, don’t panic. It’s not uncommon for plans to fail the ADP test. That said, it’s worth analyzing what else is going on with plan design that could be negatively impacting participation or contribution rates. For instance:

Is the eligibility requirement restricting from contributing to the plan who otherwise might thereby helping boost NHCE engagement?Is the plan being made available to all employees who are eligible according to the plan document? Unless it’s written in the plan document that part-time and/or seasonal employees such as interns cannot contribute to the plan until they meet certain eligibility requirements (specific to this employee class), they must be given the opportunity to contribute to the plan.Are definitions of plan compensation (excluding pre-participation compensation for instance) skewing the average contribution percentages and impacting testing in unexpected ways?

Of course, we caution everyone that testing can change from year to year, especially for new plans or companies just starting out, so it’s not something that’s one and done. New plans who pass their first year should especially guard against getting too complacent in thinking they won’t have any problems in the future.

In addition, plans should monitor plan engagement, paying attention not just to the participation rate but the average contribution rate of different employee groups, and continue to communicate the benefits of the plan, particularly to those groups who need to hear it most. Betterment can work with plans to develop a strategy for reaching out to their employees.

Q&A was conducted in 2021 and is meant to be educational in nature.

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FAQ for Wealthsimple Customers


Transaction Details and Transfer ProcessFees and TaxesTaxable Accounts, Save Accounts, and Traditional / Roth / SEP IRAsOther Account TypesPortfolio ComparisonOther Questions

Transaction Details and Transfer Process

What is happening to my Wealthsimple account?

Wealthsimple has made the decision to no longer provide investment advisory services in the US, and has agreed to transfer its existing US customer accounts to Betterment. The account transfer involves (i) the assignment by Wealthsimple US, Ltd., an SEC registered investment adviser, of each customer’s investment advisory agreement and account to Betterment LLC, an SEC registered investment adviser, and (ii) the transfer of each customer’s related brokerage account from Apex Clearing Corporation, an SEC registered broker-dealer and FINRA member clearing firm, to MTG LLC d/b/a Betterment Securities, an SEC registered broker-dealer and FINRA member.

When will the transfer take place?

We expect the account transfer to occur on or around June 12, 2021 (the “Transfer Date”).

Do I need to do anything to opt in?

No, the accounts of customers who do not expressly opt out will automatically transfer to Betterment on the Transfer Date.  There is no need to create a Betterment account in advance of the transfer, though you are welcome to do so if you choose.  Account assets will not move from Wealthsimple to Betterment until the Transfer Date.  Betterment will send additional instructions for claiming your Betterment account closer to the Transfer Date.

Can I opt out of the transfer?

Yes.  If you wish to opt out of the transfer, you can choose to receive a cash distribution from Wealthsimple (which may be subject to capital gains tax) or seek to transfer your assets to another custodian prior to the Transfer Date.  Please contact Wealthsimple support at [email protected] prior to June 4, 2021 if you wish to opt out of the transfer.

How do I access my tax forms after my Wealthsimple account is closed?

You will still receive your 2020 and partial 2021 (for the period until your account is transferred to Betterment) tax forms from Wealthsimple.

Fees and Taxes

Will my fees change when switching from Wealthsimple to Betterment?

Yes.  For investing, Betterment charges customers an annualized fee of 0.25% of assets under management, while Wealthsimple charges 0.40% to 0.50% depending on the customer’s account balance.  Note that customers with account balances of at least $100,000 will be able to opt into a higher-fee tier (0.40%) that includes unlimited access to Betterment’s team of CFP® professionals.  More information on Betterment’s fees can be found here.

Will I be charged any fees for transferring my account to Betterment?

No, there will be no fees to transfer your account from Wealthsimple to Betterment.

re there tax implications for transferring my account?

Potentially, although Betterment will help to ensure that any tax implications are minimized.  Your account assets will be transferred to Betterment in-kind, so there will not be any tax implications associated with the account transfer itself.

Once at Betterment, Wealthsimple customers will be given the option of holding their existing Wealthsimple portfolios at Betterment for a period of 12 months.  We anticipate that all accounts may be transitioned to a Betterment portfolio after this initial 12-month period. Any transition to a different portfolio will entail selling certain securities in your portfolio and purchasing others with the proceeds, which may result in the realization of taxable gains. Such gains may be short-term capital gains depending on activity in your account. Additionally, once your account has been transferred to Betterment, if there are positions in your account which are not associated with the existing WealthSimple portfolio, our system will liquidate them and you may experience a tax impact for potential gains realized.

Betterment will provide discretionary investment advisory services in connection with the management of your account. This will involve, among other things, account rebalancing, which may result in the realization of taxable gains in your account due to the purchase and sale of securities. Your account may be automatically rebalanced upon arrival at Betterment in the event that your portfolio has drifted more than 3% from its target allocation.

Betterment strongly recommends that Wealthsimple customers who are concerned about the tax implications of transferring their accounts seek the advice of a qualified tax professional.

Taxable Accounts, Save Accounts, and Traditional / Roth / SEP IRAs

Will my portfolio composition change as a result of the transfer?

Your account assets will be transferred to Betterment in-kind. Upon arrival at Betterment, Betterment will maintain your portfolio allocation and your selected risk level.  You will have the option to invest your account assets in accordance with your Wealthsimple portfolios for a period of 12 months, after which we may transfer all accounts to a Betterment portfolio.  This treatment will apply to all taxable accounts, Traditional / Roth / SEP IRA accounts, and Save accounts.  In addition, you will have the option to select any of Betterment’s portfolio offerings for your account at any time following the completion of your account transfer to Betterment.  You can learn more about Betterment’s portfolio offerings here.  Note that Betterment’s Tax Coordinated Portfolio feature is not available to customers for any period of time in which they remain invested in the Wealthsimple portfolio and its Tax Loss Harvesting+ feature will not function on Wealthsimple portfolios.

You may not be able to transfer securities which are not part of a standard Wealthsimple portfolio to Betterment in-kind, including, but not limited to, individual stocks. Such securities may need to be liquidated or transferred to a different custodian prior to the Transfer Date.  If you are unsure whether any of your holdings are eligible to be transferred to Betterment in-kind, please contact Wealthsimple support.

What will happen to my joint taxable account?

Joint taxable accounts will receive the same treatment as individual taxable accounts: your assets will be transferred to Betterment in-kind, and you will have the option to have your account managed in accordance with your Wealthsimple portfolio allocation for a period of up to 12 months following the transfer.  Betterment accounts will be created for each joint account owner.

Does Betterment offer a Halal portfolio option?

Betterment does not offer Halal portfolios at this time.  However, we offer a range of SRI options – more information can be found here.  Customers wishing to maintain Halal portfolios should work with Wealthsimple to transfer these accounts to a different custodian prior to the transfer date.

Will I be able to continue investing in my Wealthsimple portfolio for the initial 12-month period following the account transfer?

Yes, we will enable customers to continue investing in their Wealthsimple portfolios over the initial 12-month period. We anticipate that all accounts may be transitioned to a Betterment portfolio after this initial 12-month period.  This will entail selling certain securities in your portfolio and purchasing others with the proceeds, which may result in the realization of taxable gains. In addition, any capital gains incurred from additional investments into Wealthsimple portfolios following the transfer may be subject to short-term capital gains tax.

Other Account Types

Will I be able to transfer my UGMA/UTMA account?

No.  Betterment does not currently support custodial accounts. Customers wishing to maintain such accounts should work with Wealthsimple to transfer these accounts to a different custodian prior to the transfer date.

Will I be able to transfer my SEP IRA account?

Betterment supports SEP IRAs for only one plan participant. Typically, small businesses with two or more participants may also set up a SEP IRA for multiple employees. However, Betterment does not support this type of SEP IRA at this time.  If you have a SEP IRA with more than one plan participant, you will not be able to transfer this account to Betterment.

I have a Living Trust or Corporate Trust account.  Will my account be transferred to Betterment?

Trust account customers who would like to transfer their trust account to Betterment will be receiving instructions on how to do so from Wealthsimple.

I have a Beneficiary IRA, Simple IRA, or Investment Club account.  Will my account be transferred to Betterment?

No.  Given the specialized nature of these accounts, Betterment will be unable to accommodate a transfer.  Customers wishing to maintain such accounts should work with Wealthsimple to transfer these accounts to a different custodian prior to the transfer date.

Can I invest in crypto with Betterment?

No, Betterment does not offer crypto at this time.

Portfolio Comparison

Investing Options with Betterment

Betterment offers investors the choice to invest in a few different portfolio strategies, each suitable for different purposes. By default, Betterment recommends its Core portfolio strategy. Betterment also offers three Socially Responsible Investing portfolios, one focusing on Broad Impact, one on Climate Impact, and another on Social Impact. These portfolios invest in all of the same global asset classes as the Betterment Core portfolio, but each portfolio invests in a different set of ETFs that screen their investments for a subset of environmental, social and governance issues. In addition to Betterment managed strategies, Betterment offers the option to invest in portfolio strategies provided by third parties, including Goldman Sachs Smart Beta portfolios and BlackRock Target Income portfolios. For investors with views that differ from Betterment’s available managed portfolio strategies, they can use a Flexible Portfolio, which allows them to invest in the same ETFs as the Betterment Core portfolio strategy with the ability to adjust the individual weights to each asset class. Additionally, Betterment offers a high-yield cash account.

How does Wealthsimple Invest compare to Betterment’s Core portfolio offering?

Betterment and Wealthsimple Invest both offer portfolios comprised of low-cost ETFs that give investors exposure to a number of different asset classes across the globe. Despite their similarities, however, there are some differences that you should consider when deciding whether to move management of your account to Betterment.

Betterment’s Core portfolio strategy includes both stocks and bonds in the U.S., international developed, and international emerging markets. The Wealthsimple portfolio includes exposure to all of these asset classes except for international bonds. The performance of bond markets in different regions is tightly connected to the interest rate environment in each region. Investing in international bonds provides a level of global interest-rate diversification, which helps mitigate interest rate risk. Conversely, by investing in a portfolio with a global bond allocation, the bond portion of the portfolio could underperform a bond portfolio with exposure only to the U.S. market.

While both the Betterment and Wealthsimple portfolios invest in stocks across the same global markets there are some differences in how stocks are weighted in each region. The stocks in Betterment’s portfolio include a tilt toward size and value, two drivers of long-run historical outperformance identified by Fama & French. Practically, this means Betterment invests more in companies with smaller capitalizations and companies with a low price relative to their perceived intrinsic value. The Wealthsimple portfolios do not tilt toward size and value factors, but instead toward low volatility. Wealthsimple uses minimum volatility funds that aim to reduce exposure to stock market volatility. This type of strategy can potentially minimize the peaks and valleys of typical market-cap weighted stock allocations.

Another key difference between the Wealthsimple and Betterment portfolios is that the Wealthsimple portfolio invests in gold. Betterment’s portfolio does not invest in gold or any other commodity. Some research suggests that exposure to gold can help investors hedge against inflation or deflation risks, when compared to more typical stock and bond investments. Betterment’s portfolio does not include gold because Betterment feels the long-run expected return and risk profile of commodities is significantly less favorable when compared to stock and bond investments. Both Betterment and Wealthsimple portfolios invest in treasury inflation-protected securities as a hedge against inflation.

How does Wealthsimple Save compare to Betterment’s Core portfolio offering?

Wealthsimple Save offers investors exposure to a low-cost ETF portfolio suitable for an investor looking to save with minimal risk. The Wealthsimple Save portfolio invests in U.S. municipal and treasury bonds.

Betterment offers both a 100% bond ETF portfolio, as well as a high-yield cash account. Betterment recommends our 100% bond portfolio as the final destination for some of our investing goals, where we recommend a reduced stock percentage over time as you get closer to your goal. For savers who want a low-risk option for an extended period of time, Betterment suggests our high-yield cash account. This cash account provides the security of FDIC insurance, is more liquid, and offers a competitive yield compared to our short-term 100% bond portfolio.

Betterment’s 100% bond portfolio consists of U.S. short-term investment grade bonds and treasury bonds. Municipal bonds offer investors tax-exempt income, whereas investment grade bonds do not. Corporate bonds typically offer investors a higher yield in return for not being tax-exempt.

Other Questions

Can I talk to a financial advisor before I transfer?

You are welcome to speak with a financial advisor of your choice prior to account transfer.  Once you create a Betterment account, you will be able to speak with one of our financial advisors through the purchase of a financial advice package.

Where can I learn more about Betterment?

Here on Betterment’s website, you can learn all about Betterment’s offerings and services. Explore how Betterment works, or learn more about our Investing product. You can explore our pricing information.

Our account terms and related disclosures are available in our legal documents, including our Form ADV Part 2, Form CRS, and customer agreements.

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A Celebration of Culture Through Design

These articles are maintained by Betterment Holdings Inc. and they are not associated with Betterment, LLC or MTG, LLC. The content on this article is for informational and educational purposes only. © 2017–2021 Betterment Holdings Inc.

Mai Nguyen and Cat Gonzalez, AoB Leadership

Asians of Betterment (AoB) is an Employee Resource Strategy Group (ERSG) that was founded in early 2020 to serve the many Asian employees at Betterment. We saw an opportunity to build community over our shared backgrounds and experiences, especially as we transitioned to remote work.

At the start of 2021, we wanted to highlight Lunar New Year, a huge event celebrated by many parts of the Asian community. A great way for us to celebrate Lunar New Year would be through sharing our family traditions and childhood memories. By spreading our stories both among ourselves and externally through an Instagram post, it helped our community feel seen and gave us an opportunity to share this joyous celebration with our colleagues. Hear more about how we landed on our final designs.

Four square images showcasing the Betterment Instagram post on Lunar New Year


Kim Pham, Brand Designer

The idea of this post was to highlight stories within the AoB community and share how folks celebrated Lunar New Year as kids—most importantly, how we spent our red envelope money. The red envelope tradition is shared across many cultures and is generally gifted from the older to younger generation as a way to symbolize good luck and prosperity in the new year. The AoB team reached out to those within the group and received many responses, some that were recognized as traditional celebrations and some that were more unconventional.

We thought it would be fun to illustrate some of the responses on the Instagram post. I took a look at Style Closet, Betterment’s design system, as a starting point for creating these illustrations.

A grid of our Style Closet iconography


Our iconography style, which lives across our product and in marketing, has a simple utilitarian look that I used to inform early sketches. Even though I was directly translating Lunar New Year imagery and cultural motifs into our brand style, it still felt like the illustrations were missing what makes this holiday such a meaningful celebration.

Six icons that show Lunar New Year motifs


Lunar New Year celebrations have an inherent boldness, from the striking red color palette, to tons of firecrackers and strung-up decorations. I remember weaving through the streets of NYC Chinatown during Lunar New Year, leaving behind a trail of confetti and bumping into people of all backgrounds who were excited to share in our culture. I wanted to find a way to bring that joy and excitement into the visual, so I tried combining photography from Lunar New Year events.


Although this helped capture more vibrant memories and emotions, we wanted to bring the designs closer to our brand style, and found a happy medium with these playful patterns. Lanterns, firecrackers, paper decorations, and Chinese coins were the inspiration for these illustrations. The added color and detail, typical of any red envelope design, helped give these visuals life and motion. We wove elements of these illustrations into the social post and shared a version of them as Zoom backgrounds for the company.


A collage of six squares showing various illustrations and patterns related to Lunar New Year


Pam Do, AoB Leadership

The power of design not only lies in capturing attention, but also in embracing identity, educating others, and creating bonds of allyship. In Kim’s Lunar New Year designs, the interplay of Asian tradition and Betterment’s design tenants highlighted the bold and joyous characteristics of Asian culture and identity, which invite communities of all cultures to join in celebration.  

We partnered with the Brand Team to post the Lunar New Year designs on Betterment’s Instagram page. Our Instagram was also used to celebrate Black History Month with fellow ERSG, Black at Betterment. Both Asians of Betterment and Black at Betterment were able to celebrate and advocate for our group’s history, struggles, resilience, and hope for a better future. 

Asians of Betterment is taking hold of the momentum from Lunar New Year and finding ways to bring our diverse identities together in celebration. Currently in the works: Asian Pacific American Heritage Month, coming to our social media this May.

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The Advantages Of Investing In The Bitcoins


The number of avenues to gain exposure to virtual currency is increasing. In the last year alone, a number of major financial institutions have taken an interest in this fast-paced new investment option. At the same time, many pseudo-banks have gone publicly public, intending to capture a piece of this expanding niche. While some companies are rapidly buying up so much of Bitcoin, others are still speculative in nature.


The popularity of this fast-emerging investment vehicle is not a surprise to those who have been following the story of how digital currencies like bitcoin were conceived and created. As the name suggests, the concept of using the Internet to facilitate the trading of traditional commodities like gold and oil is nothing new. However, what makes the process of trading in this alternative asset different is its unique ability to operate outside of traditional financial institutions. For those who would like to take advantage of its low fees and high liquidity rating, there are some avenues through which they can do so.


One of these avenues includes investing in digital wallets. Digital wallets provide a safe, secure way for users to store and safely keep their wealth. Unlike conventional savings accounts and checking accounts, digital currencies can retain their value even after incurring a significant investment amount. Unlike stocks and bonds, there is no need to worry about an investment default or possible redemption. All investments made in these assets are kept segregated in a secure offline facility from the rest of the network. This provides investors with peace of mind.


While there are several avenues through which investors can gain exposure to the emerging field of digital currencies, one of the best ways is through investing in a collection of select coins. Investing in a single bitcoin is likely to provide a modest return for the investor. The value of each bitcoin is likely to change significantly in a relatively short period of time. Fortunately, investors have the option of purchasing as many individual bitcoin as they desire. This allows them to diversify their holdings and spread out the risk. As a result, they can continue to benefit from the fluctuations in the price of this virtual currency.


Another option available for those interested in putting money into the emerging field of digital currency is to invest in a mining campaign. Unlike typical investment vehicles, investments in a mining campaign carry a low level of risk. In addition, the rate of return on this type of investment is likely to be significantly higher than the value per share (VPS, or the fractional rate basis) that can be derived from investing in standard derivative instruments. It is for these reasons that investors are encouraged to look at these types of investments. Their success is most often tied to the difficulty of finding a profitable strategy.


A difficulty encountered by many when it comes to trading on the value per share basis is finding a profitable strategy. In most cases, investors must determine whether the purchase of a particular lot of virtual currency will result in a positive outcome. If not, the venture must then be sold to realize profits. Very few companies that offer mining as an investment endeavor can ascertain which ventures will yield a profit and which will not. Fortunately, this difficulty is often related to the difficulty of determining the precise rate of return that a company will realize over a certain span of time.


Many people are mitigating the risk inherent in such investments to purchase a “basket” of bitcoins. They are reducing the risk of losing all of the bitcoins in the specific basket. In most cases, the size of a basket containing a significant number of bitcoins is considerably smaller than the amount of money typically needed to launch a successful investment.


Several investment opportunities are associated with bitcoins. These opportunities range from buying and selling digital currency directly through specialized online services to purchasing shares of mining shares directly from professional investors. In all cases, these investments are completed quickly and at a price that is much lower than that of traditional exchanges. The ease of completing these transactions has made them very attractive to a wide range of potential customers. The ease of doing so makes it possible for new investors to receive their initial investment in less time than would otherwise be possible. The appeal of the bitcoins to potential customers has resulted in a surge of new interest among traders and investors in the area of bitcoins as an investment opportunity.