(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.