About to Become a Law Partner? How to Ensure Your Newfound Wealth Lasts
By Mariia Eroshin, CFA, CPA, CFP®, MBA, Managing Director of Family Office, Foundations & Endowments
All your hard work is about to pay off. Three demanding years of law school, the late nights cramming for the State Bar and even the later nights relentlessly making sure every need of your clients are taken care of. You’ve poured your blood, sweat and tears into your law career, and at last, you’re about to make law partner. You’ve earned it, that’s for sure. But have you taken the steps to ensure the fruits of your labor last?
Once you become a partner, your compensation will likely increase significantly, but so, too, will the intricacy of your overall financial picture.
The reality is that with wealth comes complexity. Without proper financial planning, your newfound wealth could be at risk. There is no shortage of stories of otherwise successful attorneys who have squandered their wealth because they didn’t take the time to develop a comprehensive financial plan once they became partners.
Below, I share seven strategies that any attorney who is about to become a partner should explore with their financial advisor.
1. Get a handle on your cash management
First, you may need to finance your buy-in into becoming a partner with your firm. There are typically several ways to do that. Some firms offer internal financing options that require careful analysis. Relying on external financing or personal savings are also options. Various factors should be considered, such as prevailing and expected industry interest rates, terms of the financing, ability to renew for a longer term or prepay early for a shorter term, and how long you anticipate the need to perpetuate the loan.
With a significant influx of partner distributions, a sophisticated cash-flow analysis of your projected income and expenses is highly recommended. Prior to becoming a partner, you likely received regular, bi-weekly paychecks directly deposited into your bank account. Your ordinary expenses, such as mortgage or rent and other living expenses, probably relied on the regular frequency of that income. However, as a new law partner, you should carefully evaluate the timing and frequency of draws. For example, some law partner draws can be semiannual. So, the timing of those distributions should be matched with the timing of your expected expenses. For instance, a July draw would need to cover expenses for July through December, including estimated taxes, and any other significant projected expenses.
One potential solution is constructing a mechanism for saving and investing each income distribution and estimating yield and principal from it with projected cash outflows.
Core to a cash-flow analysis is to develop a clear perspective on the lifestyle you want to live going forward and your perspective on spending and saving for the future. What does that look like? Be specific and realistic to ensure that vision aligns with what your new role as partner can provide. Be disciplined in sticking to that “financial roadmap.”
2. Revisit your tax planning
Once you become a partner, that will likely trigger a change from a regular paycheck to an interval draw (as mentioned above), as well as a change from a W-2 to a K-1 form for your annual tax filing. Typically, a partnership has a flow-through taxation, and its income and expenses are passed through to the partners and reflected on form K-1. Typically, a K-1 does not necessarily equate to cash distributions.
It is important to understand how partnership distributions/draws are taxed and what the implications could be for your overall tax planning. Working with your financial advisor and your CPA, plan for quarterly tax estimates to avoid inadvertent (and unpleasant) surprises. Include budgeting for estimated tax payments, as K-1s do not contain automatic withholdings, as with W-2s.
On the bright side, there may be new tax deductions you can now take, depending on your situation, such as unreimbursed business expenses, self-employed health insurance, interest on capital account loans, and pension plan contributions. These should be evaluated by your CPA on a frequent basis.
If your firm operates in multiple states, you may also have new state reporting obligations in the states in which you do not live. Another topic to address with your CPA sooner rather than later.
3. Don’t forget trust and estate considerations
Becoming a partner is an ideal time to revisit (or explore for the first time) your trust and estate planning. Working together with your financial advisor and a qualified estate planning attorney, ensure your heirs and loved ones are protected in the event of your incapacity or untimely passing. That may require the creation of a revocable trust, perhaps irrevocable trusts for your children, or other estate planning vehicles to protect your family’s future.
Now, you may not have a fully fleshed out estate plan, but at minimum, you should have a will, durable power of attorney, and a healthcare directive. And be sure to designate someone to act on your behalf, if necessary, and make financial and critical medical decisions for you. Don’t put this off and fall into the trap of, “I can do this when I’m older.” You never know what tomorrow may bring, and there is no time like the present.
4. Develop a comprehensive investment strategy
It is important to recognize that partnership in a law firm is an investment. Do you know how much that investment is worth? It is important to quantify your investment so that you can appropriately incorporate it into your overall investment strategy.
With that understanding, begin to explore investments outside of your partnership interest that can diversify your financial portfolio. A whole new world of investment opportunities as a potential qualified investor will most likely be available to you, including a variety of alternative or private investments. Work closely with a financial advisor who is experienced working with these types of investments.
Is your investment strategy dynamic? Do you or your financial advisor have the ability to continuously source and conduct due diligence on new, distinctive, and preferably uncorrelated investment opportunities in the ever-evolving investment universe? Ensure that your financial advisor has access to institutional third-party managers, competitive asset-based lending pricing, private equity funds, separately managed accounts, tax loss harvesting strategies and sophisticated alternative investments.
Moreover, a financial advisor should have transparent fees and be obligated to act in your best interests at all times as a fiduciary.
5. Build and track a “net worth dashboard” via a comprehensive consolidated reporting system
How are you currently managing your wealth, your assets and liabilities? A good place to start is to construct your personal balance sheet, often known as a net worth statement. Ideally, you are working with a financial advisor that can offer you a state-of-the-art reporting platform that allows you to dynamically view information of multiple accounts from multiple providers that ultimately tracks your liquid investments and alternative assets. This is a very important process of understanding your holdings and following the trajectory of your overall wealth.
First, outline all of the assets you own, which typically includes a personal residence, vehicle, brokerage accounts, pension and retirement savings, potentially rental properties, personal valuables, and other asset categories. Ideally you will have a view into your investment portfolio that is updated on a real time basis.
Next, list all the liabilities that you have, which usually include a mortgage, a car loan, an educational loan, potentially personal loans, and other obligations which may include the financing of your partnership. Once you compile both lists, you will see your residual net worth, or your total assets minus your liabilities.
Furthermore, it is helpful to extend your asset section to include any income from assets and expand your liabilities section to list all cash outflows for each liability. With this more comprehensive information, coupled with your spending analysis, you can build a personal cash flow statement.
Comprehensive reporting should include capabilities for private equity, hedge funds, and real estate investments, so all of your investments are aggregated.
Finally, track your realized and unrealized gains and losses, for tax planning purposes, including planning for estimated tax payments, and even as a second review once your CPA sends you a draft tax return.
6. Begin to establish your legacy framework
You have been so busy building your legal career that you likely haven’t had time to think much about your legacy and vision for your wealth. But now that you are about to become a partner, that time has arrived. For many attorneys, this is one of the more “fun” aspects.
Working with your team of advisors, you may begin to develop (or expand upon) a philanthropic plan (if that aligns with the legacy you desire) and best ways to accomplish charitable giving.
Closer to home, think through how you would like your children or other close relatives and loved ones to benefit from your wealth, potentially for generations to come. What expectations do you want to set for how the wealth should be or should not be used? Be clear and document what you want your wealth to accomplish in your lifetime and beyond.
7. Mitigate risk wherever you can
Like any good attorney, you are likely laser focused on identifying and managing risk wherever you can. As you are no doubt aware, with an increase in wealth comes an increase in risk.
Mitigate that risk by conducting a comprehensive review of the insurance you have in place now, and what you will need going forward: life insurance, disability insurance, personal liability umbrella, health insurance, etc. Is your coverage still sufficient? Are there any gaps in that coverage? Fill those gaps wherever possible and review with your advisor the advantages to putting insurance policies in place today versus in the future.
Beyond insurance, do you have other risks that need addressing, such as interest rate risk? Do you have liabilities, such as a mortgage or a HELOC or line or credit, with floating rate risk that are tied to the ever-changing landscape of interest rates? Do any of your fixed-rate liabilities change to floating in 3, 5, or 10 years?
How about your planned and unplanned cash-flow requirements? Do you have a reserve fund? Do you have access to financing or margin lines if needed? Will your parents depend on you?
In terms of investments, how do you plan to hedge / manage your investment and market risks? Do you have any significant concentrated positions in your portfolio? Do you have outsized allocations to a particular industry or a volatile sector of the economy? Do any of your investments have lockups or illiquidity? Again, this is where a highly experienced financial advisor can provide invaluable guidance.
Clearly, there is much to consider and do to help ensure the influx of wealth that typically comes with becoming a partner lasts and fuels the legacy you hope to achieve. But don’t fret; you don’t have to go this alone. What you need is a financial “quarterback” who can help coordinate the various advisors / professionals who can help you achieve your objectives – wealth advisor, CPA, insurance providers, trust and estate counsel, concierge medicine, etc. For many attorneys who become partners, a multi-family office can provide the level of financial sophistication they need now and into the future.
To further explore the importance of financial planning for law firm partners and working with a financial advisor, please contact Mariia Eroshin, CFA, CPA, CFP®, MBA at [email protected]. Learn more about Certuity and Mariia.