(This story originally appeared in American Lawyer, an ALM sister publication of ThinkAdvisor.)
Big-firm lawyers may be smart and successful, but they make retirement planning mistakes just like everyone else, say financial planners and wealth managers who work with them.
These include failing to start early enough, not saving and investing enough in their prime earning years, investing too conservatively, insufficiently diversifying their portfolios and carrying too much debt. They also have a few quirks particular to members of the profession, such as being generally risk-averse, planners say.
But now that firms are moving away from defined benefit pensions and putting more responsibility for retirement risk on the shoulders of lawyers themselves, it’s imperative that lawyers pay more attention to their retirement.
Longer life spans, lower expected returns on investments and firm incentives to retire earlier compound the situation. “The real problem with all of this, bordering on a potential for crisis, is that several things are changing right now, and I don’t think the legal industry appreciates what they are facing,” says Michael Nathanson, a former senior tax partner at Hale and Dorr (now Wilmer Cutler Pickering Hale and Dorr) and chairman and chief executive officer of The Colony Group, a Boston-based wealth management firmwith more than $5 billion in assets under management. “It really is a perfect storm.”
Adding to the uncertainty, more firms are dropping mandatory retirement age policies. In the absence of a mandatory date, productivity becomes a more important determinant of when a lawyer will retire, which means that some lawyers will retire before they intended. In fact, some firms are encouraging partners to retire earlier to make room for younger lawyers to move up, and others are requiring that they give up active partner status.
The bottom line is that more responsibility is on the individual to start planning and saving early. “The big problem with lawyers is that they don’t prioritize themselves and planning for themselves. It is hard to get time with them and get them focused,” Nathanson says.
Here are some of the biggest errors that lawyers make in retirement planning, experts say, and ways to avoid them:
1. Underestimating their life span and overestimating investment returns.
Current assumptions are that many lawyers now working will live to be 90. That means that they need savings and investments sufficient to last at least 25 years in retirement. But lawyers who are currently nearing retirement already experienced several serious recessions during their careers, including the dot-com bust and the Great Recession. “We didn’t have an attorney in a major law firm retire in 2007,” said Marjorie Fox, a fee-only financial planner and attorney in Washington, D.C., who counts many lawyers as clients. “The bear market was very hard, because they saw the source of their paycheck in retirement decline in value.”
At the same time, returns on many fixed-income investments, which traditionally make up a larger share of portfolios as one ages, are mingy because of historically low interest rates and bond yields. Planners’ current postrecession assumptions about investment returns are about 2 percentage points lower than they were a decade ago, with both fixed income and equities having lower projected returns. In early August, the S&P 500 Index 10-year annualized return this year was 5.61 percent. “We see some who are very successful not being able to retire because the money they did set aside didn’t grow at the expected rate, and it will be a continuing issue in the marketplace,” says Jack Abraham, a principal at Pricewaterhouse-Coopers, who consults on pensions and retirement benefits.
Licensed and qualified financial planners revise plans and projections periodically on the basis of new information and new goals. Retirement advisers acting under a fiduciary standard must work solely in the best interest of clients.
2. Being clueless about pension plan basics.
Many partners don’t even know the fundamentals of their pension, according to a recent survey by Major, Lindsey & Africa. “Although partners were generally aware of whether their firm had a pension, they were surprisingly unfamiliar with the terms of their pensions,” says Jeffrey Lowe, global practice leader at Major, Lindsey & Africa’s law firm practice group. For example, over 50 percent of respondents were unsure whether their pension would be paid out in a lump sum or on a monthly basis; of those receiving a monthly sum, over 33 percent were unsure of what that monthly sum would be; and nearly 25 percent were unsure how long that monthly payment would continue, Lowe says.
3. Not keeping current on pension plan changes.
Hoping to trim pension obligations, many firms discontinued traditional defined benefit pension plans, in which firms promise a specific monthly benefit, or converted them to cash-balance plans, in which the firm contributes a defined percentage of the participant’s compensation each year. Payouts in that type of plan are more dependent on individual investment returns.
Professionally managed cash-balance plans allow participants to contribute more pretax dollars than they could in, say, a 401(k). But in a conversion from a traditional pension plan, longtime participants sometimes experience a benefit cut because the traditional pensions accumulate most in the last few years of work. Under new retirement plan designs introduced in 2010, more firms are increasing deferrals into cash balance-type programs. Close to 50 percent of Am Law 200 firms have such programs, and within the next five years the number is expected to reach 75 percent, Abraham says.
Some big firms have suspended employer matches to associates’ 401(k) plans in recent years. “At many firms it is already gone, and the 20-25 percent of firms that still have it, mostly in the Am Law 101-200, are going to rethink that,” Abraham says. That puts the onus on associates to increase their own contributions to their accounts.
4. Underestimating retirement expenses.
Even if investment returns aren’t soaring as they used to, expenses such as taxes—especially state, local and property taxes—are. Housing and uninsured medical costs, including prescription drugs and dental care, become a hefty expense for most people as they age. The proportion of total spending that people over 75 spend on health care, at 15.6 percent, is nearly double that of people in the 55 to 64 age group, according to the U.S. Bureau of Labor Statistics.
5. Getting a “gray divorce” and other family crises.
Unforeseen knocks hit many individuals in midlife—not just lawyers—such as the rising phenomenon of “gray divorce” among couples over 50. Advisers say that multiple marriages, late childbearing, late-life divorce and sometimes the need to support elderly parents are key reasons that many lawyers have to keep working or need more income later in life than they originally may have estimated. “They have aging parents and young children to support financially and emotionally,” Fox says. “The sandwich generation is not just an outlier; it is almost the rule now, not the exception.”
6. Not diversifying enough.
Asset allocation within retirement plans—and outside of them—is a stumbling block for many investors, but lawyers are prone to a couple of big mistakes, experts say. One is becoming enamored of an asset class they think they know well because of their work. Being intelligent and well-informed, lawyers sometimes get carried away with investments that they think they are more informed about than most people. They “might be persuaded by their relationship with their clients to overinvest in industries or companies in which their clients are involved,” Nathanson says.
At the other extreme, though, some lawyers avoid equities altogether to avoid the appearance of conflict of interest or insider trading, investing only in mutual funds and exchange-traded funds. “They could be missing out on great opportunities,” Nathanson says, and there are ways to avoid such conflicts, including establishing a procedure with the firm for clearing trades in advance or only investing in stocks outside the sector in which the firm concentrates its practice. Lawyers also may invest too conservatively, missing out on the chance for higher gains, advisers and managers say.
Plans that include self-directed investment options with a plethora of fund and equity choices give lawyers ample opportunity to be led astray by their own biases. Studies, including one by Wharton researchers, have found that too many choices in employer-sponsored plans are counterproductive, leading to higher fees and diminished returns.
7. Tying up too much money in their homes.
In another diversification mistake, financial planners say, some lawyers put too much money into their own homes, and many still are paying mortgages in retirement. Downsizing isn’t always as easy as it seems, and high real estate expenses can quickly deplete limited retirement income. In the D.C. area, for instance, retirees often want to swap a large home in the suburbs with its maintenance and gardening costs for a smaller, in-town condominium, but with high condo prices and fees in the metro area, it’s more of an even trade, says Michael Gildenhorn, a lawyer and wealth manager for high-net-worth clients based in Washington, D.C. “When you are earning a million dollars, you can pay a lot of mortgages and do a lot of remodeling, but the overhead is remarkable, paying $35,000 in taxes for each home and having all kinds of expenses tied up, and you don’t have the income to sustain it,” he says.
8. Not accepting the need to reduce spending.
The most difficult part of retirement planning is accepting the shift in lifestyle that inevitably must come, experts say. “You can’t spend the way you were spending in the past when you were highly compensated,” Gildenhorn says. “I am dealing with a couple of attorneys earning between $1.6 million and $2 million. They have earned so much, but they are deeply in debt, and it blows me away because they have had such a high lifestyle and they need to keep working, when they in fact should have the luxury of thinking about slowing down or changing what they want to do with their life,” he says.
Reducing debt and expenses while you are still working should be part of the blueprint. Serious talks with a financial planner or wealth manager should begin at least 18 to 24 months before the planned retirement date. Conversations with other partners and a spouse and family members about the transition also need to happen then, of course, says Bill Slater, managing director and private wealth adviser for Merrill Lynch, a business unit of Bank of America, who works with attorneys at NLJ 350 firms. Estate plans also should be updated around this time. Some big firms provide estate planning as an employee benefit, he says.
9. Using the final capital distribution to splurge.
Attorneys sometimes make the mistake in early retirement of failing to use their final capital distributions as part of their retirement nest egg, spending it instead like a bonus. It should go “into the pool of assets that will help sustain your life over the next 30 years,” he says, not a splurge. The capital account distributions may need to be used to provide income for the remainder of one’s life, Slater says.
10. Overlooking all tax implications of retirement plan distributions.
Tax issues connected to Medicare premiums and additional taxes under the Affordable Care Act require consideration before taking distributions, says tax expert Ben Tallman, an enrolled agent and tax court practitioner in Brookhaven, Georgia. For example, married couples whose income exceeds $428,000 pay the maximum rate for Medicare premiums, based on their adjusted gross income from two years prior. Also, at $311,300 in adjusted gross income, personal exemptions and itemized deductions begin to phase out for joint filers. The cap is $259,400 for single filers and $285,350 for heads-of-households. “When you are retired, an extra $3,000 in Medicare premiums, you can do something with that. That is real money,” Tallman says.
If lawyers stay on the job past their 70th birthday, mandatory distributions from traditional Individual Retirement Accounts (IRAs) must start after age 70-and-a-half. But participants in 401(k) plans don’t have to start taking minimum distributions if they’re still employed unless they have 5 percent or greater ownership in a firm. Once they have taken a mandatory distribution and paid taxes on the assets, they can transfer assets to a taxable account for themselves or, for estate planning purposes, gift the assets to their children, grandchildren or a charity, Tallman says. Preparing early is the best defense against making serious retirement mistakes. “Beginning at age 50, lawyers should start talking with their financial advisers very seriously about the transition to retirement. It is difficult to make assumptions, but at 50, but you ought to sit down and make an effort,” Fox says, adding that it is better to have a plan and change it than not to have one.
(This story originally appeared in American Lawyer, an ALM sister publication of ThinkAdvisor.)
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