Advisors who use Betterment’s tax smart transition features, a suite of tax-aware portfolio management tools, should consider the following information before using any of the features, and for communicating it, as necessary, to their clients.
Advisors should be aware of how tax smart transition features interact with other Betterment portfolio management features. When Betterment’s trading algorithm evaluates an account to identify tax loss harvesting and rebalancing opportunities, it will only initiate one such instruction at any given time and typically prioritizes harvesting tax losses over rebalance opportunities. Advisors also should be aware that Smart Transitions features may work differently for custom portfolios than for Betterment constructed or third-party portfolio strategies, and that rebalancing transactions could be more or less effective at reducing drift depending on the portfolio strategy of a given goal.
Custom rebalance settings
Advisors have the option to enable or disable automated rebalancing on any of their clients’ eligible goals. When automated rebalancing is disabled for a particular goal, Betterment will seek to reduce drift for that goal in response to cash flows (such as deposits, withdrawals, or dividend reinvestments) but will not initiate an automated rebalance based solely on drift from the portfolio’s target allocation. Betterment endeavors to process updates to rebalancing configurations as quickly as possible, but Advisors should be aware that such updates may not complete until the next market day.
Advisors also can set customized drift thresholds for goals. Without a custom drift threshold, Betterment typically will rebalance a client's portfolio when it is identified as having drifted by 3% or more (except for certain portfolio strategies that use different default drift thresholds and DFA models, which we typically rebalance at 5%) and cash flows are not sufficient to enable Betterment to reduce such drift. Advisors can set thresholds that are higher or lower than the standard drift threshold. Betterment's trading algorithm typically checks accounts approximately once each market day to identify rebalancing opportunities, but Betterment does not guarantee that any automated rebalancing transaction will occur at a specific time. Betterment also reserves the right to limit or postpone rebalancing transactions in order to prioritize other trading activity on any given day, including days where extreme market conditions produce a higher volume of trading.
Advisors are also able to set an annual realized gains allowance target for each client. Once the target is exceeded in a given year, Betterment’s algorithm will seek to avoid rebalancing transactions that would result in the realization of gains but may still initiate automated rebalancing transactions that are expected to realize a gain. Exceeding the gains allowance target will not impact tax loss harvesting trades, which may occur regardless of year to date gains incurred. In addition, once the annual target is exceeded, if an advisor initiates a "no short term capital gains" type portfolio change, resulting transactions may realize losses or sell assets not held at a gain or a loss.
In-kind transfers to Betterment are subject to applicable terms and conditions. Certain single stocks, mutual funds, and other security types which Betterment is unable to hold on an ongoing basis will be sold upon arrival regardless of gains allowance constraints, and even if rebalancing is disabled. Advisors have the ability to view in the application which assets are supported to hold on an ongoing basis.
Transactions initiated by Advisors/their clients are never blocked on account of having reached the gains allowance target and could cause a client to exceed their allowance target. In addition, fee assessments and goal-to-goal transfers could cause a client to exceed their gains allowance target. Advisors should be aware that their clients will not be able to see their gains allowance target in the interface and could initiate transactions that cause the gains allowance target to be exceeded. Clients will be warned that client-initiated withdrawals, allocation changes, and goal-to-goal transfers will impact a setting that their Advisor has selected for their account.
If a client reaches their gains allowance target but then realizes losses (either through user-initiated transactions or automated transactions such as tax loss harvesting), year-to-date net realized gains will decrease and could cause rebalancing transactions that realize gains to resume. Advisors also can change gains allowances at any time.
The gains allowance is a target that Betterment seeks not to exceed for any automated rebalancing transaction. Betterment typically will not initiate a rebalancing transaction if the expected realized gains from that transaction exceed the gains allowance, but there are certain circumstances under which a rebalancing transaction may inadvertently result in the gains target being exceeded. These situations include, but are not limited to, transactions that are initiated when 1) market data relied on by the algorithm is stale or delayed, or 2) there is price movement in the window between the algorithm’s identification of the trade and trade execution. In addition, certain portfolio actions, including but not limited to transfers to or from accounts at other custodians, can result in retroactive changes to cost basis that would not be reflected at the time rebalancing transactions occur and may therefore also result in exceeding the gains allowance.
The gains allowance can be configured to support most tax situations. For example, a married couple filing separately can each have their own gains allowance, and an irrevocable trust can also have its own gains allowance.