Retirement planning strategies for lawyers

Author: Reed Nothwang, CFP®, VP & Wealth Advisor

After decades of long hours, high-stakes cases, and demanding clients, you're finally ready to hang up your law license and enjoy a well-deserved retirement. But will your finances be ready when you are?

As a lawyer, you've likely grown accustomed to a certain lifestyle. Maintaining that standard of living in retirement requires careful planning and saving. While your firm's 401(k) plan is a good start, it's often not enough to maintain your lifestyle in your golden years.

Traditional retirement advice doesn't always cut it for high-earning lawyers. Contribution caps, taxes on distributions, and the potential for rising tax rates can all throw a wrench in your plans. To retire on your terms, you need a strategy tailored to your unique needs and challenges.

In this post, we'll dive into advanced retirement planning tactics specifically designed for attorneys. From maximizing your firm's retirement plans to saving tax-efficiently in brokerage accounts, we'll cover all the bases.

Maximizing Your Firm's Retirement Benefits

The foundation of your retirement plan starts with fully understanding and leveraging the benefits offered by your firm. Let's dive into the types of plans commonly offered and how to make the most of them.

Types of Law Firm Retirement Plans

1. 401(k) plans: Most law firms offer 401(k) plans, often with elevated contribution levels for partners. You can contribute pre-tax dollars (and potentially after-tax Roth contributions) up to annual IRS limits. Many firms offer a matching contribution up to a certain percentage of your salary.
2. Profit-sharing plans: These plans allow the firm to make additional contributions to your retirement account based on the firm's profitability.
3. Defined benefit or cash balance pension plans: While less common, some firms still offer these plans which provide a guaranteed benefit in retirement, based on factors like your salary and years of service.
4. Deferred compensation plans: Often available to partners, these plans allow you to defer a portion of your income to the future, potentially reducing your current tax burden.

Maximizing Your Contributions

As a high earner, your goal should be to max out these plans to the greatest extent possible. For 2024, here are the contribution limits you should aim for:

• 401(k) employee deferral: $23,000 if you're under 50, or $30,500 if you're 50 or older (including catch-up contributions).
• Total 401(k) contribution (including employer contributions): Up to $69,000, or $76,500 if you're 50 or older (including catch-up contributions).

Many law firms offer elevated contributions beyond the standard employee deferral. These are often mandatory and come directly from your draw or partnership distribution. Make sure you understand your firm's specific contribution structure and take full advantage of any matching or profit-sharing contributions.

Understanding Deferred Compensation Plans

If your firm offers a deferred compensation plan, it's crucial to understand the specific types and their implications:

1. Supplemental executive retirement plans (SERPs): These plans provide additional retirement benefits beyond qualified plans, often used to recruit and retain top talent.
2. Deferred bonus plans: Allow you to defer a portion of your annual bonus, spreading the tax burden over multiple years.
3. Unfunded deferred compensation: Enables you to defer a portion of your current income to be paid out later, often in retirement.

Benefits of deferred compensation plans:

• Tax deferral on a portion of your income
• Particularly valuable in high-earning years
• Can help catch up on retirement savings

Potential drawbacks:

• Typically unsecured liabilities of the firm, potentially at risk if the firm faces financial trouble
• May result in too much pre-tax income, pushing you into higher tax brackets in retirement

Action steps:

1. Review your firm's retirement plan options with HR or the benefits coordinator.
2. Calculate the maximum amount you can contribute across all available plans.
3. If offered, carefully evaluate deferred compensation options, considering your current tax situation and long-term financial goals.
4. Consult with a financial advisor to determine the best contribution strategy across different plan types.

Balancing Roth and Pre-Tax Contributions

One key decision in your retirement planning is whether to make pre-tax or Roth contributions to your retirement accounts. This choice can significantly impact your tax situation both now and in retirement.

Pre-tax contributions

Pros:

• Reduce your current taxable income
• Beneficial if you expect to be in a lower tax bracket in retirement

Cons:

• You'll pay taxes at your ordinary income rate on distributions in retirement
• Required Minimum Distributions (RMDs) start at age 73

Roth contributions

Pros:

• Qualified withdrawals are tax-free in retirement
• No Required Minimum Distributions
• Protect against potential future tax rate increases

Cons:

• No current-year tax deduction
• Income limits may prevent direct Roth IRA contributions (but see "Backdoor Roth" strategy below)

The Case for Roth Contributions, Even for High Earners

While pre-tax contributions might seem like the obvious choice for high-earning attorneys, there are compelling reasons to consider Roth contributions:

• Tax diversification: Having both pre-tax and Roth accounts provides flexibility in retirement. You can strategically withdraw from different account types based on your tax situation each year.
• Hedge against rising tax rates: Many experts predict tax rates will increase in the future. Roth contributions lock in your current tax rate.
• No RMDs: Roth IRAs don't have Required Minimum Distributions at age 73 like pre-tax accounts do. This allows your money to grow tax-free for longer and can be a valuable estate planning tool.
• Backdoor Roth conversions: If your income is too high for direct Roth IRA contributions, you can still leverage this account type through a "backdoor" Roth conversion. Implementing a Backdoor Roth Strategy

Here's how to execute a backdoor Roth conversion:

1. Make a non-deductible contribution to a traditional IRA.
2. Convert the traditional IRA to a Roth IRA.
3. Pay taxes on any earnings that occurred between the contribution and conversion.

Important considerations:

• Be aware of the "pro-rata" rule if you have other pre-tax IRA balances.
• Consider converting soon after contributing to minimize taxable earnings.
• Keep meticulous records of non-deductible contributions for tax purposes.

Finding the Right Balance

The key is striking a balance between pre-tax and Roth savings to optimize your tax situation both now and in retirement. Some contributions (like certain profit-sharing contributions) may only be available as pre-tax, so focus on the contributions you can control.

Action Steps:

1. Review your current retirement account types and contribution allocations.
2. Estimate your current and anticipated future tax brackets.
3. Consider implementing a backdoor Roth strategy if your income exceeds Roth IRA limits.
4. Consult with a financial advisor and tax professional to determine the optimal mix of pre-tax and Roth contributions for your situation.

Tax-Smart Investing in Brokerage Accounts

For high-earning attorneys who max out their tax-advantaged retirement accounts, investing in a traditional brokerage account is often the next best step. While you won't get the same tax benefits as retirement accounts, there are still strategies to minimize taxes and maximize growth.

Prioritizing Tax-Efficient Investments

Focus on investments that generate fewer taxable events:

1. Index funds and ETFs: These typically generate fewer capital gains than actively managed mutual funds.
2. Municipal bonds: Interest is often tax-free at the federal level and potentially at the state level if you purchase bonds issued in your state of residence.
3. Growth stocks: Companies that reinvest profits rather than paying dividends can be more tax-efficient, as you'll only pay taxes when you sell.

Implementing Tax-Loss Harvesting

Tax-loss harvesting involves strategically selling investments at a loss to offset capital gains. Here's how to do it effectively:

1. Regularly review your portfolio for positions with unrealized losses.
2. Sell losing positions to realize the loss for tax purposes.
3. Immediately reinvest the proceeds in a similar (but not identical) investment to maintain your asset allocation.
4. Use the realized losses to offset capital gains and up to $3,000 of ordinary income per year.

Pro Tip: Consider using tax-loss harvesting software or working with an advisor who offers this service to automate the process.

Exploring Direct Indexing

Direct indexing involves owning individual stocks that mimic an index, rather than owning an index fund. This strategy allows for more granular tax-loss harvesting and portfolio customization.

Benefits of direct indexing:

• More frequent tax-loss harvesting opportunities
• Ability to customize your portfolio (e.g., excluding specific stocks or sectors)
• Potential for better after-tax returns

Considerations:

• Typically requires a larger investment (often $100,000 or more)
• More complex to manage than traditional index funds
• May require specialized software or professional management

When selling appreciated investments, aim to hold them for over one year to qualify for long-term capital gains rates, which are typically lower than short-term rates.

Charitable Giving Strategies

Consider donating highly appreciated stock directly to charity instead of cash. This strategy allows you to:

1. Avoid paying capital gains taxes on the appreciation
2. Receive a tax deduction for the full fair market value of the stock
3. Potentially reduce your adjusted gross income (AGI), which can have cascading tax benefits

Implementing Asset Location

Asset location involves strategically placing investments in different account types based on their tax efficiency. Here's a general framework:

• Hold tax-inefficient investments (e.g., bonds, REITs) in tax-deferred accounts
• Keep tax-efficient investments (e.g., index funds, municipal bonds) in taxable accounts
• Place high-growth investments in Roth accounts to maximize tax-free growth potential

Planning for Potential Higher Tax Rates in Retirement

As a high-earning lawyer, you need to plan for the possibility of facing higher tax rates in retirement than you do currently. Even if your income drops, overall tax rates could increase due to factors like growing national debt, expiring tax cuts, and rising state and local taxes.

Strategies to Mitigate Future Tax Risk

1. Roth conversions: Consider converting traditional IRA or 401(k) assets to Roth accounts during lower-income years. This could include:
   • Early in retirement before RMDs begin
   • During a sabbatical or career break
   • In years with unusually high deductions
2. Prioritize tax-free retirement accounts: Increase contributions to accounts that offer tax-free withdrawals in retirement:
   • Roth 401(k)s
   • Roth IRAs (including backdoor Roth conversions)
   • Health Savings Accounts (HSAs) for medical expenses
3. Municipal bonds: Consider allocating a portion of your fixed-income investments to municipal bonds, which provide tax-free interest at the federal level.
4. Life insurance retirement plans (LIRPs): These specialized life insurance policies can provide tax-free income in retirement if structured correctly.

Developing a Tax-Efficient Withdrawal Strategy

Plan to strategically time withdrawals from different account types each year based on your tax situation. Here's a general framework:

1. Take Required Minimum Distributions (RMDs) from traditional accounts first.
2. Fill up lower tax brackets with withdrawals from traditional accounts.
3. Use Roth accounts for additional income needs to avoid jumping to higher tax brackets.
4. Tap taxable accounts strategically, being mindful of capital gains implications.

Leveraging QCDs

Once you reach age 70½, you can make Qualified Charitable Distributions (QCDs) directly from your IRA to charity. This can satisfy your RMD requirement without increasing your taxable income.

Planning for Early Retirement

For some attorneys, the goal isn't just retirement – it's early retirement. Leaving the workforce ahead of the traditional retirement age requires careful planning to ensure your savings can support you for potentially decades.

Key considerations include:

• Longer retirement horizon: Your savings will need to last for more years, potentially 30-40 years or more.
• Healthcare costs: Bridge the gap until Medicare eligibility at 65 with private health insurance.
• Social Security timing: Delaying Social Security can increase your benefit, but you'll need other income sources in the meantime.
• Sequence of returns risk: The risk that poor investment returns in the early years of retirement can deplete your portfolio faster than expected.

Strategies for Early Retirement Success

1. Build a solid financial model: Create a detailed projection of your retirement expenses and income sources. Include scenarios for different market conditions and unexpected expenses.
2. Establish a "bridge" strategy: Plan how you'll fund the years between early retirement and when you can access traditional retirement accounts without penalty (age 59½). Options include:
   • Building a taxable investment account
   • Using Roth IRA contributions (which can be withdrawn penalty-free at any age)
   • Implementing a 72(t) distribution plan from IRAs
3. Create multiple income streams: Diversify your retirement income sources to reduce risk. Consider:
   • Rental real estate income
   • Dividend-paying stocks
   • Bonds and other fixed-income investments
   • Part-time consulting or teaching work
4. Implement a dynamic withdrawal strategy: Instead of a fixed withdrawal rate, adjust your withdrawals based on market performance to make your portfolio last longer.
5. Optimize your investment portfolio: Balance the need for growth to support a long retirement with the need to minimize volatility in the early years.
6. Plan for healthcare costs: Research health insurance options and consider funding a Health Savings Account (HSA) to cover medical expenses tax-free.

Consider a "glide path" approach to retirement, slowly phasing out of your law practice over several years. Benefits of this approach include:

• Continued income to support your lifestyle and savings goals
• Opportunity to train your successor and ensure a smooth transition for clients
• Gradual adjustment to retirement lifestyle
• Potential for ongoing intellectual engagement and purpose

Navigating the Regulatory and Practical Aspects of Lawyer Retirement

Retiring as an attorney involves more than just financial planning. There are specific regulatory requirements and practical considerations to ensure a smooth transition and protect your clients' interests.

Key regulations to be aware of include:

• Client notification: Most states require you to notify clients of your impending retirement in writing, giving them the option to transfer their case to another lawyer or take their business elsewhere.
• File retention: You have an ethical obligation to safeguard client files even after retirement. Understand your state's requirements for file retention periods and secure storage.
• Trust account management: If you maintain client trust accounts, you'll need to properly reconcile and close these accounts, returning any remaining funds to clients.
• Malpractice insurance: Consider purchasing "tail" coverage to protect against claims that may arise after you've retired.
• Bar Association and legal directory updates: Update your status with your state bar association and in legal directories to reflect your retired status.

Practical Steps to Prepare for Retirement

In addition to the financial and regulatory considerations, retiring from law practice involves practical steps to ensure a smooth transition. Here's a retirement readiness checklist to help you prepare:

• Review active cases: Several months before your planned retirement date, review your active cases and develop a plan for transitioning or resolving each one. Consider the complexity of the case, the stage of litigation, and the client's preferences.
• Notify clients: Draft a letter to notify clients of your upcoming retirement. Clearly explain their options for transferring their case within the firm or to another attorney, and any action steps they need to take. Include an approved list of attorneys who can assist with their matter.
• Train your successor: If you have a designated successor or team taking over your cases, invest time in training them and bringing them up to speed on each matter. Introduce them to key clients to facilitate a smooth hand-off.
• Organize files: Ensure all client files are up-to-date, organized, and easily transferable. Prepare a memo for each active case summarizing its status and any upcoming deadlines or action items.
• Notify colleagues and courts: Let colleagues, judges, and opposing counsel know of your upcoming retirement and who will be taking over your cases. File substitution of counsel motions as needed.
• Plan your send-off: Work with your firm to plan any retirement announcements, parties, or tributes. Consider whether you want to write a farewell message to clients and colleagues reflecting on your career.
• Update your estate plan: Retirement is a good trigger to review and update your estate plan, including your will, trust, powers of attorney, and beneficiary designations. Ensure your plan reflects your current wishes and family situation.

Conclusion

At Compound Planning, we specialize in helping professionals like you navigate the complexities of retirement planning. Our team of experienced financial advisors can help you develop a customized plan that takes into account your unique career trajectory, financial goals, and tax situation.

Whether you're just starting to think about retirement or are already well on your way, we're here to provide the guidance and support you need to make smart decisions and stay on track. Schedule a free consultation with one of our advisors to learn more about how we can help you maximize your retirement savings and achieve your long-term financial goals.