At Betterment, we’re continually improving our investment advice, always with the goal of maximizing our customers’ take-home returns. Key to that pursuit is minimizing the amount lost to taxes.

Now, we’ve taken a huge step forward with a powerful new service that could increase your employees’ after-tax returns, so they can have more money for retirement.

Betterment’s Tax-Coordinated Portfolio (TCP) service is our very own, fully automated version of an investment strategy known as asset location. Automated asset location is the latest advancement in tax-smart investing.

Introducing Betterment’s Tax-Coordinated Portfolio™

Asset location is widely regarded as the closest thing there is to a “free lunch” in the wealth management industry. If your employees are saving in more than one type of account, it is a way to increase their after-tax returns without taking on additional risk.

Millions of Americans wind up saving for retirement in some combination of three account types: 1. Taxable, 2. Tax-deferred (Traditional 401(k) or IRA), and 3. Tax-exempt (Roth 401(k) or IRA). Each type of account has different tax treatment, and these rules make certain investments a better fit for one account type over another.

Choosing wisely can significantly improve the after-tax value of their savings, when more than one account is in the mix. However, intelligently applying this strategy to a globally diversified portfolio is complex.

A team of Betterment quantitative analysts, tax experts, software engineers, designers, and product managers have been working for over a year building this powerful service. Today, we
are proud to introduce Tax-Coordinated Portfolio (TCP), the first automated asset location service, now available to all investors.

Our research estimates that the benefit of TCP could range from 0.10% to 0.82% in additional after-tax return each year, on average. Its value will depend on a number of circumstances specific to the investor, discussed in more detail below. In one generalized scenario, saving in all three types of accounts showed an after-tax benefit of 0.48%, annualized over 30 years.1

How would an annualized 0.48% translate into more concrete terms? A simple example:

Assuming a compounding annual return of 7%, a $100,000 portfolio would grow by $661,226 after 30 years.

That same $100,000 compounding at 7.48% over the same 30-year period would grow by an estimated $770,622. That’s 15% more—an additional $109,396 for retirement, after all taxes are paid.

Next, let’s look at how asset location, the strategy behind TCP, adds value.

How Does a Tax-Coordinated Portfolio Work?

What is the idea behind asset location?

To simplify somewhat: Some assets in a portfolio (bonds) grow by paying dividends. These are taxed annually, and at a high rate, which hurts the take-home return. Other assets (stocks) mostly grow by increasing in value. This growth is called capital gains, and is taxed at a lower rate. Plus, it only gets taxed when you need to make a withdrawal—possibly decades later—and deferring tax is good for the return.

Returns in 401(k)s and Individual Retirement Accounts (IRAs) don’t get taxed annually, so they shelter growth from tax better than a taxable account. We would rather have the assets that lose more to tax in these retirement accounts. In the taxable account, we prefer to have the assets that don’t get taxed as much.2

When investing in more than one account, many people select the same portfolio in each one. This is easy to do, and when you add everything up, you get the same portfolio, only bigger.

Here’s what an asset allocation with 70% stocks and 30% bonds looks like, held separately in three accounts. The circles represent various asset classes, and the bar represents the allocation for all the accounts combined.

Portfolio Managed Separately in Each Account

allocation-by-aggregate-and-account-tcp-off-03

But as long as all the accounts add up to the portfolio we want, each individual account on its own does not have to have that portfolio. Asset location takes advantage of this. Each asset can go in the account where it makes the most sense, from a tax perspective. As long as we still have the same portfolio when we add up the accounts, we can increase after-tax return, without taking on more risk.

Here’s a simple animation solely for illustrative purposes:

Asset Location in Action

AssetClassesAnimationB4B

Here is the same overall portfolio, except TCP has redistributed the assets unevenly, to reduce taxes. Note that the aggregate allocation is still 70/30.

Same Portfolio Overall—with Asset Location

allocation-by-aggregate-and-account-tcp-on-03

The concept of asset location is not new. Advisors and sophisticated do-it-yourself investors have been implementing some version of this strategy for years. But squeezing it for maximum benefit is very mathematically complex. It means making necessary adjustments along the way, especially after making deposits to any of the accounts.

For an optimal asset location strategy, an automated approach works best. Our software handles all of the complexity in a way that a manual approach just can’t match. We are the first automated investment service to offer this service to all of our customers.

Who Can Benefit?

To benefit from from a Tax-Coordinated Portfolio, the participant must have a balance in at least two of the following three types of Betterment accounts:

  • Taxable account: If you can save more money for the long-term after making your 401(k) contributions, that money can be invested in a standard taxable account.
  • Tax-deferred account: Betterment for Business traditional 401(k) or a traditional IRA. Investments grow with all taxes deferred until liquidation, and then taxed at the ordinary income tax rate.
  • Tax-exempt account: Betterment for Business Roth 401(k) or a Roth IRA. Investment income is never taxed—withdrawals are tax-free.

Higher After-Tax Returns

Betterment’s research and rigorous testing demonstrates that accounts managed by Tax-Coordinated Portfolio are expected to yield meaningfully higher after-tax returns than uncoordinated accounts.

Our white paper presents results for various account combinations. Here, we excerpt the additional “tax alpha” for one generalized case—an identical starting balance of $50,000 in each of three account types, a 30-year horizon, a federal tax rate of 28%, and a state tax rate of 9.3% (CA) both during the period, and during liquidation.

Equal Starting Balance in Three Accounts: Taxable, Traditional IRA, and Roth IRA

Asset Allocation Additional Tax Alpha with TCP (Annualized)
50% Stocks 0.82%
70% Stocks 0.48%
90% Stocks 0.27%

Source: TCP White Paper.

Help Your Employees Get Started with a Tax-Coordinated Portfolio

Ready to help your employees take advantage of the benefits of a Tax-Coordinated Portfolio? Direct them here to help them get started.

Learn more about how Betterment’s Tax-Coordinated Portfolio can help your employees have more spending money in retirement.

All return examples and return figures mentioned above are for illustrative purposes only. For much more on our TCP research, including additional considerations on the suitability of TCP to your circumstances, please see our white paper. For more information on our estimates and Tax-Coordinated Portfolio generally, see full disclosure here.

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