EverPar Lead Advisor Tom Flanagan on why making partner can mean keeping less, the concentration risk that is not in your portfolio, and what may sit above your 402(k).
By Tom Flanagan, EverPar Advisors
If you are a law firm partner, or getting close to making partner, there are three financial issues I think you should be thinking about.
First, you can make more money as a partner and actually have less money hitting your bank account.
Second, you can have a perfectly diversified investment portfolio and still have a highly concentrated financial life.
And third, maxing out your 401(k) does not necessarily mean you have maxed out your retirement planning opportunities.
Let’s talk about all three.
Making Partner Can Change What You Actually Keep
Making partner is a huge professional accomplishment. Your compensation goes up, so financially, everything should get better.
It does not always feel that way. You can make more money and still wonder where the money went.
As an associate, you are generally a W-2 employee. When you become a partner, depending on the partnership structure, more of the tax burden may shift to you. Your benefits may change. Your retirement contributions or employer match may change. And if you are becoming an equity partner, you may also have a significant capital contribution to fund.
Then there is another issue. Partners are generally taxed on their distributive share of partnership income whether or not all of that income has actually been distributed in cash.
So higher compensation does not automatically translate into proportionately higher spendable income.
The question is not simply, how much am I making. It is, how much am I actually keeping. For someone earning several hundred thousand dollars, or seven figures, that distinction can become enormous over a career.
Your Biggest Concentration Risk May Not Be in Your Portfolio
This is the one I think gets overlooked.
Suppose a corporate executive had 40% of their net worth invested in their employer’s stock. We would immediately talk about concentration risk.
Now think about an equity law firm partner. Your income comes from the firm. You may have hundreds of thousands of dollars, or more, of your own capital invested in the firm. And depending on your firm’s retirement structure, part of your future retirement income may depend on the continued financial health of the firm.
Income. Capital. Retirement. All connected to one organization.
Those may look like three different assets on paper. Economically, they can be three versions of the same risk. You can own 100 different securities in your investment portfolio and still have an extremely concentrated financial life.
I am not predicting your firm is going to fail. That is not the point. The point is that if your firm goes through a prolonged difficult period, your income, your capital and potentially your retirement can all be affected at the same time.
For some partners, the biggest concentrated position they own is not a stock. It is their career.
You probably cannot eliminate that concentration. But you can build the rest of your financial life around it. Know how much capital you have tied to the firm. Know how and when you get it back. Understand how your retirement benefit is funded.
And then ask: if so much of my financial life already depends on my law firm, should the money I am building outside the firm be invested with that concentration in mind?
Your 401(k) May Not Be the Ceiling
A lot of highly compensated professionals assume that maxing out the 401(k) means they have done everything they can for retirement.
Maxing out one retirement account and maximizing your retirement strategy are two very different things.
Depending on your firm’s structure and plan design, there may be additional opportunities. A cash balance or defined benefit plan, for example, can potentially allow substantially larger retirement contributions. For some partners, those contributions can reach six figures annually. There may also be deferred compensation opportunities, additional Roth strategies depending on the firm’s plan, and state level tax strategies such as pass-through entity tax elections where appropriate.
Here is what matters. These are not simply investment questions. They are planning questions. Some require decisions by the partnership. Others depend on the retirement plan document or coordination with your CPA.
Who Is Looking at Everything Together?
Which brings me to the most important question in this video.
Your CPA is looking at your taxes. Your firm is looking at the partnership. Your plan administrator is looking at the retirement plan. Your investment advisor is looking at your portfolio.
But who is looking at how all of those decisions affect each other?
Because your taxes affect your cash flow. Your partnership affects your balance sheet. Your retirement structure affects what you need to accumulate outside the firm. And your investment portfolio should reflect all of it.
Some of the biggest planning opportunities, and some of the biggest mistakes, hide between those different pieces of your financial life.
That is a big part of how we approach financial planning at EverPar.
Three Questions
So if you are a law firm partner, I would leave you with three questions.
Am I keeping as much of what I earn as I reasonably can?
Am I more financially concentrated in my firm than I realize?
And are there planning opportunities available to me that nobody has ever shown me?
If you do not know the answers, they are probably questions worth asking. Because what you earn matters, and what you keep, and what that money ultimately allows you to do, is what the planning is for.
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