Mega Backdoor Roth Disclosure

You should carefully read this disclosure and consider your personal circumstances before making after-tax contributions to your Betterment Traditional 401(k) and converting those balances to a Roth 401(k) through an in-plan Roth rollover (an “in-plan Roth conversion”). Together, these two steps are commonly referred to as a "mega backdoor Roth" ("MBR") strategy. The benefit of an MBR strategy is that converted amounts can then grow tax-free, subject to certain conditions. An in-plan Roth conversion is irrevocable and is a taxable event.

Betterment LLC (“Betterment”) currently offers in-plan Roth conversions only for after-tax balances in traditional Solo 401(k) accounts (not for pre-tax balances), whose plan documents permit after-tax contributions, Roth 401(k) contributions, and in-plan Roth conversions.

You, or to the extent you are a client advised through Betterment Advisor Solutions ("BAS"), you and your third-party BAS advisor, are solely responsible for determining whether to pursue an MBR strategy and whether you would benefit from doing so. The value provided by an MBR strategy will vary depending on each investor's personal circumstances, and depends on assumptions about future income, future tax rates, and future tax law that cannot be known at the time you contribute or convert. Because a conversion is irrevocable, future circumstances can affect amounts you have already converted. The tax consequences of an MBR strategy are complex and depend on facts specific to you and to your plan. Betterment does not represent in any manner that an MBR strategy will result in any particular tax consequence or that specific benefits will be obtained for any individual investor.

1. After-Tax Contributions

After-tax contributions are employee contributions made with amounts that have already been taxed. They are a separate contribution type from pre-tax and Roth deferrals, and are held as a separate source within your Traditional 401(k). Employer contributions cannot be directed to the after-tax source.

After-tax contributions are not subject to the annual limit on employee deferrals, but together with employee deferrals and employer contributions, they count toward the limit on total annual contributions to your 401(k) under Section 415(c) of the Internal Revenue Code (the “Code”).

2. In-Plan Roth Conversions

Betterment only supports in-plan Roth conversions from the after-tax balance source; in-plan Roth conversions of pre-tax balances are not available. An in-plan Roth conversion is not automatic and does not happen at the same time as your after-tax contribution. An after-tax contribution must be received into your 401(k) account and securities transactions must settle (if applicable), before it becomes eligible for conversion, and you must then access your account to initiate the in-plan Roth conversion. Your after-tax contributions are invested in accordance with your portfolio strategy, so your after-tax balance can change, due to market gains or losses, between the date your after-tax contributions are invested and the date you convert.

Completing an in-plan Roth conversion is a taxable event to the extent you convert amounts on which you have not already paid tax. Your after-tax balance has two parts: your after-tax contributions, on which you have already paid tax, and the earnings on those contributions, which are pre-tax amounts that are subject to taxation. Any amount subject to taxation at the time of conversion is part of the "taxable amount," and is taxed as ordinary income for the tax year of the conversion.

Once converted, the full amount, including your after-tax contributions together with any earnings converted with them, becomes basis in your Roth account, since you have paid tax on it through the Roth conversion process. The taxable amount of each in-plan Roth conversion continues to be tracked, however, because it determines whether the additional tax described below can apply to a later withdrawal.

Under the IRS pro rata rule, you cannot convert only your after-tax contributions, and any amount you convert to Roth includes a proportionate share of contributions and earnings, whether you convert all or part of your after-tax balance. If you convert when little or no earnings have accrued, the taxable amount will be smaller; if you convert after earnings have accumulated, it will be larger. Any portion of your after-tax balance (contributions and earnings) that you do not convert remains in your after-tax source. If your after-tax balance has declined so that no earnings exist when you convert, the taxable amount is zero and your remaining basis carries forward.

Betterment does not withhold federal or state taxes on an in-plan Roth conversion. You are responsible for the resulting tax, including any estimated tax payments and any interest or penalties arising from underpayment.

An in-plan Roth conversion is final, irrevocable, and irreversible. Betterment cannot reverse a conversion under any circumstances, including a change in your income or tax circumstances after you convert, a tax result you did not anticipate, or a conversion you initiated in error.

3. Roth Distributions

You should be aware of how distributions are processed out of a Roth account, and of the potential additional tax the IRS imposes on Roth converted amounts.

Two separate five-year rules apply to distributions of Roth amounts in your 401(k), including Roth contributions and amounts converted to Roth. One determines whether the earnings in a distribution are tax-free. The other determines whether the additional 10% tax applies to Roth converted amounts.

Whether you owe federal income tax on a distribution from your Roth 401(k) depends on whether it is qualified. A distribution is generally qualified if you take such distribution at least five (5) taxable years after January 1 of the year of your first Roth 401(k) contribution or in-plan Roth conversion (or, if earlier, your first Roth contribution to a prior employer's plan that you rolled directly into this one), AND you have reached age 59½ or are taking it on account of death or disability. A qualified distribution is not subject to federal income tax, including the earnings portion. If a distribution is not qualified, the earnings portion is taxable as ordinary income.

Further, if a distribution is not qualified AND you have not reached age 59½, the taxable amount of a conversion and any earnings included in the distribution can also carry an additional tax. Any earnings included in the distribution are includible in your gross income and are subject to the additional 10% tax under Section 72(t) of the Code, unless an exception applies. Separately, if you withdraw the taxable amount of a conversion within five taxable years of January 1 of the year of that conversion, that amount is also treated as includible in your gross income for purposes of the additional 10% tax under Section 72(t) of the Code (“72(t) recapture”), unless an exception applies. The additional 10% tax can therefore apply to an amount on which you have already paid tax, and can apply even where the withdrawal would otherwise be a recovery of your basis. Each conversion carries its own five-year holding period.

You cannot choose which amounts a distribution comes from. Under IRS rules, a distribution from your Roth 401(k) must be allocated pro rata between your basis and your earnings. Betterment allocates the basis portion of your distribution as coming first from your Roth basis other than converted amounts that are subject to 72(t) recapture, meaning your direct Roth contributions, amounts you rolled in, and your earliest converted amounts if no longer subject to the five-year recapture period described above. Only after that basis is used up is a distribution treated as reaching more recently converted amounts that are still subject to 72(t) recapture, and within these converted funds, the distribution reaches the taxable amount first. For avoidance of doubt, this allocation methodology means that converted amounts are distributed as part of your basis in the order you converted, earliest conversion first, and within each conversion the taxable amount is treated as distributed before the rest of that conversion. Where a distribution reaches the taxable amount of a conversion still within its five-year period, the additional 10% tax described above can apply.

State income tax treatment can differ from federal treatment, including whether a distribution is treated as qualified and whether an additional state tax applies. Therefore, you should talk to your personal tax advisor.

If you later roll your Roth 401(k) to a Roth IRA, the Roth IRA is subject to its own five-year period, which runs from your first contribution to any Roth IRA. Time during which the amounts were held in your Roth 401(k) does not count toward the five-year holding period in a Roth IRA.

4. Tax Reporting

Betterment reports in-plan Roth conversions and distributions to you and to the IRS on Form 1099-R. Multiple conversions made within the same taxable year are reported on a single form.

Betterment reports based on the information in its records. This matters if you transfer an existing 401(k) plan to Betterment and have previously made after-tax contributions, Roth contributions, or in-plan Roth conversions under that plan. Particularly if you have a pre-existing 401(k) account, you, or your third-party BAS advisor if you are an advised client, must provide accurate information about your prior after-tax contributions, Roth contributions and conversion history (including but not limited to applicable years, taxable amounts, basis, and earnings), so that they can be reflected in your account. You and your third-party BAS advisor (if applicable) are responsible for the accuracy of the information provided to Betterment.

Depending on what information is missing or incomplete (if any), Betterment will assume that the applicable five-year periods began on January 1 of the year your plan transferred to Betterment, that the entire previously converted amount is the taxable amount, and, where the amount converted is not known, that your entire Roth balance is attributable to converted amounts. Each of these assumptions is conservative, and it can cause a later distribution to be reported on your 1099-R as not qualified, or subject to an additional 10% tax when it is not.

You and your tax advisor are responsible for how transactions conducted in your account are reported to the IRS, or any other tax authority, on your personal tax return, including correcting any information that does not reflect your actual contribution and conversion history. No Betterment entity assumes responsibility for the tax consequences to any client of any transaction associated with a MBR strategy.

5. Risks

An MBR strategy is not suitable for all investors. Factors that may affect the potential benefits and tax consequences of an MBR strategy include: (1) you are under age 59 ½ and anticipate withdrawing converted amounts within five taxable years of conversion; (2) you are uncertain about your total compensation for the year, and therefore about the contribution limits and tax rates applicable to you, or; (3) your conversion would produce a taxable amount, and you either expect to be subject to a lower income tax bracket when you withdraw from the account than you are subject to now, or would need to fund the tax on that amount from the retirement account itself rather than from other sources. Other issues may exist that could materially affect the value of a MBR strategy for any individual investor. Betterment is not a tax advisor, and does not provide tax advice.

Betterment does not provide investment strategy recommendations related to making after-tax contributions or electing an in-plan Roth conversion. Please consult your personal tax advisor when considering a MBR strategy in light of your individual tax circumstances.