$340K Tax Savings: Optimizing Custodial Account Setup for High-Net-Worth Clients

$340K Tax Savings: Optimizing Custodial Account Setup for High-Net-Worth Clients

Executive Summary

Precision Financial, a leading RIA, faced a significant challenge in optimizing custodial account setups during the onboarding of high-net-worth clients, leading to unnecessary tax liabilities. By implementing a strategic approach to custodial account selection based on individual client tax situations and utilizing a proprietary algorithm, Precision Financial delivered a combined $340,000 in tax savings for new clients within the first year. This case study details how a focused emphasis on tax-advantaged strategies within custodial account structures can significantly improve client outcomes and enhance advisor value.

The Challenge

Precision Financial prides itself on providing comprehensive financial planning for high-net-worth individuals and families. However, their existing client onboarding process, while thorough in many respects, lacked a dedicated focus on the tax implications of custodial account structures. This oversight was costing clients significant sums of money annually.

Specifically, the challenge manifested in several key areas:

• Suboptimal Account Selection: Custodial accounts were often selected based on generalized assumptions rather than a deep understanding of the client’s unique tax landscape. For example, a client with significant capital gains income might have been unnecessarily placed in a taxable brokerage account instead of a more tax-advantaged option like a 529 plan for education savings or a strategically structured trust.
• Missed Tax-Loss Harvesting Opportunities: The initial onboarding process didn't consistently identify opportunities for tax-loss harvesting within existing investment portfolios that were being transferred into custodial accounts. One client, for instance, transferred a portfolio with unrealized losses of $50,000 that could have been immediately used to offset capital gains, but the opportunity was missed due to lack of proactive assessment. This led to an estimated $12,500 in unnecessary capital gains taxes (assuming a 25% combined federal and state capital gains tax rate).
• Inefficient Gifting Strategies: For clients establishing custodial accounts for minors (UTMA/UGMA), the existing process didn't adequately explore the tax implications of Kiddie Tax rules or strategies to minimize their impact. In one instance, a client gifted assets that generated over $2,500 in unearned income for their child, triggering the Kiddie Tax and resulting in a higher tax liability compared to other potential gifting strategies. This resulted in an estimated tax liability increase of $500, calculated at the child's parent's marginal tax rate of 20% on the income exceeding $2,500.
• Lack of Proactive Tax Planning: The onboarding process failed to adequately educate clients on the long-term tax implications of different custodial account structures and how they could integrate these accounts into their overall tax planning strategy. This resulted in clients making uninformed decisions that ultimately led to higher tax burdens. For example, a client with a high marginal tax rate contributed to a custodial account without understanding the potential tax benefits of other investment vehicles such as Roth IRAs or tax-deferred annuities.

The cumulative impact of these inefficiencies was a substantial tax burden for Precision Financial's high-net-worth clients, diminishing their overall investment returns and negatively impacting their long-term financial goals.

The Approach

To address these challenges, Lisa Thomson, a senior financial advisor at Precision Financial, spearheaded a comprehensive overhaul of the client onboarding process, specifically focusing on optimizing custodial account setups. The approach was multi-faceted, incorporating a blend of enhanced data gathering, strategic custodial account selection, and proactive tax planning.

Here's a breakdown of the key strategies implemented:

• Detailed Tax Questionnaire: Lisa introduced a mandatory, in-depth tax questionnaire to the onboarding process. This questionnaire went beyond basic income and asset information, delving into specific details such as:
  • Capital gains and losses realized in previous years
  • Anticipated future income streams
  • Tax bracket projections
  • Existing tax-advantaged accounts
  • Charitable giving strategies
  • Specific financial goals for each custodial account (e.g., education, future expenses)
  • Current and planned estate planning strategies
• Custodial Account Selection Matrix: Lisa created a comprehensive matrix outlining the tax implications of various custodial account structures, including UTMAs, UGMAs, 529 plans, trusts, and taxable brokerage accounts. The matrix detailed the tax treatment of contributions, distributions, and capital gains for each account type, allowing advisors to quickly identify the most tax-efficient option for each client's specific circumstances.
• Tax-Loss Harvesting Protocol: A standardized protocol for identifying and executing tax-loss harvesting opportunities during the account transfer process was implemented. This protocol involved a thorough review of the client's existing investment portfolio to identify securities with unrealized losses. The protocol also included a process for reinvesting the proceeds from the sale of loss-generating securities into similar, but not identical, investments to maintain the client's desired asset allocation.
• Kiddie Tax Mitigation Strategies: Lisa developed a series of strategies to mitigate the impact of the Kiddie Tax on custodial accounts for minors. These strategies included:
  • Structuring gifts to minimize unearned income below the Kiddie Tax threshold.
  • Investing in assets that generate minimal taxable income.
  • Utilizing trusts to distribute income strategically over time.
• Client Education and Communication: Enhanced client education materials were created to explain the tax implications of different custodial account structures and the benefits of proactive tax planning. Lisa also incorporated regular tax planning discussions into client meetings to ensure that clients were fully informed and engaged in the process.
• Proprietary Algorithm Integration: Lisa partnered with Golden Door Asset to integrate a proprietary algorithm into Precision Financial’s onboarding platform. This algorithm analyzes the data collected from the tax questionnaire and generates customized recommendations for the optimal custodial account structure, considering factors such as the client's tax bracket, income, assets, and financial goals.

The decision-making framework involved prioritizing tax efficiency while also considering factors such as investment flexibility, control, and administrative complexity. Lisa emphasized a holistic approach, ensuring that custodial account setups were aligned with the client’s overall financial plan and long-term goals.

Technical Implementation

The successful implementation of Precision Financial's optimized custodial account setup process relied on a combination of readily available tools and a proprietary algorithm. Here's a detailed breakdown of the technical implementation:

• Platform Integration: Lisa leveraged existing technology platforms provided by Schwab Advisor Services and Fidelity Institutional. These platforms offered the necessary infrastructure for opening and managing custodial accounts, processing transactions, and generating performance reports.
• Data Collection and Management: The new tax questionnaire was integrated into Precision Financial’s CRM system, ensuring that all client data was securely stored and readily accessible to advisors. Data encryption and security protocols were strictly adhered to, complying with all relevant regulatory requirements.
• Tax-Loss Harvesting Automation: Lisa utilized the tax-loss harvesting tools available within the Schwab and Fidelity platforms to automate the process of identifying and executing tax-loss harvesting opportunities. These tools provided real-time alerts when securities in a client's portfolio experienced significant losses, allowing advisors to quickly take action.
• Algorithm Development: Lisa partnered with a data science team at Golden Door Asset to develop a proprietary algorithm for optimizing custodial account selection. The algorithm was built using Python and incorporated key tax variables, financial planning assumptions, and investment return projections. The algorithm works as follows:
  1. Data Input: The algorithm receives data from the client's tax questionnaire, including income, tax bracket, investment holdings, and financial goals.
  2. Scenario Analysis: The algorithm simulates the tax implications of different custodial account structures under various market conditions.
  3. Optimization: The algorithm identifies the custodial account structure that minimizes the client's overall tax liability while maximizing investment returns. The optimization process considers factors such as capital gains tax rates, income tax rates, Kiddie Tax rules, and estate tax implications.
  4. Recommendation Generation: The algorithm generates a customized recommendation for the optimal custodial account structure, along with a detailed explanation of the underlying assumptions and calculations.
• API Integration: The proprietary algorithm was integrated into Precision Financial’s onboarding platform via API, allowing advisors to seamlessly access the algorithm's recommendations without having to manually input data. This integration significantly streamlined the onboarding process and reduced the risk of human error.

The entire system was designed to be scalable and adaptable, allowing Precision Financial to easily incorporate new tax laws, investment strategies, and client preferences as needed.

Results & ROI

The implementation of the optimized custodial account setup process yielded significant results for Precision Financial and its clients:

• $340,000 in Tax Savings: In the first year after implementation, Precision Financial delivered a combined $340,000 in tax savings for new high-net-worth clients. This figure was calculated by comparing the estimated tax liabilities under the previous onboarding process with the actual tax liabilities under the new process.
  • Example 1: A client with $1 million in assets transferred to a taxable brokerage account saved $85,000 by strategically allocating $300,000 to a 529 plan (state tax deduction, tax-free growth, and tax-free withdrawals for qualified education expenses).
  • Example 2: Proactive tax-loss harvesting for 15 clients resulted in an average tax savings of $11,000 each, totaling $165,000.
  • Example 3: Optimization of UTMA/UGMA accounts and Kiddie Tax mitigation strategies saved approximately $90,000 across 20 clients.
• Improved Client Retention: By demonstrating a commitment to tax-efficient investing, Precision Financial improved client retention rates by 15%. Clients were more likely to stay with the firm knowing that their advisors were proactively working to minimize their tax burdens.
• Increased Client Referrals: The firm experienced a 20% increase in client referrals as satisfied clients shared their positive experiences with others. The $340,000 tax savings became a key selling point for Precision Financial, attracting new high-net-worth clients.
• Enhanced Advisor Productivity: The integration of the proprietary algorithm and automation of key processes streamlined the onboarding process, allowing advisors to spend more time focusing on client relationships and strategic planning. Advisors reported a 25% increase in productivity.
• Higher Client Satisfaction: Client satisfaction scores related to the onboarding process increased by 30%, reflecting the enhanced transparency, personalized recommendations, and tangible tax savings delivered by the new system.

The ROI of the optimized custodial account setup process was substantial, demonstrating the value of investing in technology and expertise to improve client outcomes.

Key Takeaways

Here are 3 key takeaways for other advisors looking to optimize their custodial account setup process:

1. Prioritize Tax Planning Early: Integrate a detailed tax questionnaire into the client onboarding process to gather comprehensive information about the client's tax situation. This data will be invaluable in identifying tax-saving opportunities.
2. Leverage Technology: Utilize technology platforms and algorithms to automate key processes, such as tax-loss harvesting and custodial account selection. This will improve efficiency and reduce the risk of human error.
3. Educate and Communicate: Educate clients about the tax implications of different custodial account structures and the benefits of proactive tax planning. Keep them informed throughout the process and ensure they understand the rationale behind your recommendations.

About Golden Door Asset

Golden Door Asset builds AI-powered intelligence tools for RIAs. Our platform helps advisors unlock deeper client insights and automate complex financial planning processes. Visit our tools to see how we can help your practice.