BigLaw Attorneys face an envious, yet very real dilemma: after having put in the years of work to get to where you are, how do you make your income work as efficiently and diligently for you as you have for your own career goals? The answer is that you must maximize the power of your income by reducing taxes, managing debt, and optimizing savings. How do you do that?
Key Takeaways:
Know What You Spend
Prioritize Where You Save
Plan for Early Retirement if That’s Your Goal
Consider Delaying Big Ticket Purchases
Know What You Spend
One of the biggest initial mistakes a new attorney can make is not keeping track of spending, which often can lead to habits that are hard to break. While keeping tabs on a budget sounds tedious, it can be done easily via “free” websites such as Mint.com, paid sites such as YouNeedaBudget.com (YNAB), or financial planning software. Just remember that if you go the free route, you are the product that is for sale!
The point of knowing what you spend is not to take the fun out of the high income you’re earning, but to help you make that high income work for you sooner rather than later. That’s because if you know what you spend, you’re more likely to spend and more likely to have some cash leftover for savings.
Prioritize Where You Save
There is not one list we can provide that illustrates the most appropriate savings vehicles and prioritizes them for every single BigLaw Associate, but you can get a basic understanding of the different types of accounts and prioritize for yourself.
Emergency Cash Reserve
First and foremost, make sure you have enough cash on hand or liquid assets to cover your living expenses for the current month (when something happens) plus an additional 3 – 6 months, depending on your appetite for risk, your insurance policies (how long before your Disability Insurance actually pays you?), and your desire to be able to walk away from a bad situation without somewhere to land. Some people want to have even more cash to cover a longer period of time but remember that the cash is losing you purchasing power over time and weigh that tradeoff.
Traditional and Roth 401k’s
Most BigLaw employers, if not all, offer a 401k plan. To the extent your firm matches any of your contributions, you should at least take advantage of that. Choosing between Traditional and Roth contributions is choosing between when you want to pay taxes: pay taxes now (Roth) or pay taxes later (Traditional). The way to think about this is to ask yourself, “Is my current tax rate higher or lower than what I expect to pay in taxes in my retirement?” Unfortunately, this is not an easy question to answer because it involves trying to predict future tax rates and future income, among other things. If mitigating your current tax bill is important, Traditional contributions may be the way to go. Especially if you are single and therefore in one of the highest current marginal tax brackets, and you anticipate your income to continue to rise over the next 5 – 10 years. Some people choose to split the risk and contribute to both types of accounts, and that is fine. Just remember that the annual salary deferral limit is per person, so you can’t max out both your Traditional and Roth account at the same time.
Health Savings Account (HSA)
Not as well-known, this type of account is among the most tax-advantaged out there. Assuming all contributions and distributions are qualified, your contributions go in tax-free, they grow tax-free, and they are distributed tax-free. This “triple tax advantage” is very rare and should be used wisely. Generally speaking, if you can afford to pay medical costs out of pocket (along with your insurance), it is better to let your HSA account grow over time to be used later in life when your medical expenses may be higher, and your account has (hopefully) been growing tax-free.
Traditional, Roth, and “Backdoor” Roth IRA’s
Congratulations! You probably have the enviable problem of making too much money to take the tax deduction for contributing to a Traditional IRA, and you probably make too much money to contribute to a Roth IRA at all. However, there is a strategy (not a type of account) called the “Backdoor” Roth IRA contribution. The idea is to first contribute to a Traditional IRA even though you don’t get a tax deduction for doing so, and then convert those dollars to your Roth IRA. But be careful with this strategy. You may pay more in taxes than you need to or want to if your conversion is subject to the Pro Rata Rule. The Pro Rata Rule is beyond the scope of this guide but speak to your tax and/or investment advisor if you plan to implement a Backdoor Roth IRA strategy. Google can be dangerous with this one and so I have not linked to the explainers found online. Talk to a tax professional and/or investment advisor.
529 College Savings Plan
If you have children and you want to pay for their college, a 529 college savings plan can be a good option for savings. Contributions do not get an up-front tax deduction, but contributions do grow tax-deferred, and qualified distributions are tax-free. There are limitations to how the funds can be used, and potential tax penalties for non-qualified use, but that doesn’t make these bad savings vehicles if your child has a good chance of going to college and not getting a full ride. Just try to avoid overfunding it relative to what you may pay for your kids’ school.
Taxable Savings and Other Goals
Taxable savings is just that, savings where the interest and capital gains you earn may be taxable to you as the account grows. Your Checking and Savings bank accounts may be considered taxable savings. However, if you open an account for the purpose of holding securities (stocks, bonds, mutual funds, ETF’s, etc), then the account will be referred to as a Brokerage account. So, you may have a Savings account (cash), Checking account (cash), and a Brokerage account (securities) all under the “Taxable Savings” umbrella. Taxable Savings is generally more readily available than money invested in the tax-preferred vehicles already mentioned. Saving for a house, vacation, wedding, or any other goal may be best achieved through a regular taxable savings account, AKA a “brokerage” account. Among the important considerations here are choosing investment options (cash, stocks, bonds, etc.) that align with the time horizon of your goal. For example, if you’re saving to buy a house ASAP, it may not make sense to invest in stocks. If you want to save to buy a vacation home in 15 years, it may make sense to take a little more risk.
Early Retirement
Many BigLaw Associates are interested in retiring earlier than the “traditional” retirement age of their parents or peers. If that is the case, it’s critical to understand that your retirement accounts may not be fully accessed, penalty-free, until age 55 (sometimes, for 401k’s) or 59 ½ (IRA’s). Therefore, it may make sense to save more than you otherwise would into your taxable savings account so that the money can be readily available for you when you need it. The obvious tradeoff here is the tax-inefficiency. Other options may include contributing to Roth accounts with the intention of using contributions earlier than traditional retirement age. Just be sure to watch out for the various 5-year clocks.
A Little Delay Can Lead to a Lot of Gratification
As a BigLaw Associate, you are likely making more money than many of your peers. You also may have been putting in much more work and long hours than your peers, potentially delaying gratification along the way. Maybe you went to the library once or twice while they went to the bar. Maybe you went to law school while they traveled abroad. Even if none of those things are true, it may be very tempting to get the coolest apartment, the nicer car, or dine at the fanciest restaurants. You’ve put in the work!
While you are certainly well deserving of the rewards for your labor, keep some things in mind:
1. Everybody knows that you’re making a lot of money; you don’t need to prove it.
2. Your friends were your friends before you made it here; you don’t have to reward them or supplement them.
3. Your law school/work friends are probably making the same income as you. If they appear to be spending more lavishly, they’re probably just saving less than you. Guess who wins that race?!
4. If you ramp up the spending early, it’s almost impossible to wind it down later. And if you do have to wind it down, that can be embarrassing to the extent the previous spending was ostentatious.
5. Know the difference between an appreciating and depreciating asset. The people you see on Instagram posing with their new bag/car/watch – they are showing you things that are worth 20% – 50% less than what they were worth when they bought them. In other words, the reaction shouldn’t be, “Wow, that bag/watch costs $10k!” The reaction should be, “Wow, that bag/watch is probably worth half what they bought it for.” If you learn to think like that, you will feel less envy. The real excitement comes when you can splurge on luxury items and don’t feel the need to brag because your financially secure lifestyle says it all for you already.
The point is that by saving and spending responsibly now, you will still have a good chunk of spending money and yet you’ll be setting yourself up for some real, sustainable comforts in just a few more years’ time. If you can prioritize getting a cash cushion in place and maxing out your retirement and intermediate goals savings, you will be in a far better place in a few years and still be living a more comfortable life than most of those around you.
Summary
As a BigLaw Associate Attorney, you’ve arrived in one sense, and yet you’re still drinking from a firehose in another. Not only are you figuring out your firm, your area of specialization, and the politics of your office, but you’re also faced with a ton of financial decisions as a result of your high income. How do you save effectively? How do you address your student loan debt? How do you know you’re setting yourself up for financial freedom, ASAP? The keys are to know what you spend, prioritize where you save, think ahead about when you want to retire, and even delay some of the big-ticket purchases and/or lavish spending for just a few more years.
Interested in learning more? Check out BigLawInvestor.com for great blogs and resources just for you.
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