Whether you’re pursuing private practice in bankruptcy, business, intellectual property, tax law –or another of the many possible fields – you’ll likely have money on the mind when faced with making every dollar stretch while working at a small to mid-sized firm.
By the numbers
According to the National Association for Law Placement’s (NALP) Jobs & JDs Employment for the Class of 2021 report, “jobs in the smallest firms of 1-10 lawyers (which includes graduates working for a solo practitioner) accounted for 30.7% of law firm jobs, down from 32.8% for the Class of 2020.” Additionally, NALP’s 2021 Associate Salary Survey reports that associates at firms with 50 or fewer lawyers made a median first-year base salary of $85,000 in 2021, while those working at firms with 51-100 lawyers made $127,500.
Because many smaller firms may be outside of larger metropolitan areas, associates may be able to avoid city tax and have an overall lower cost of living. This can be an advantage of these roles as it allows more flexibility for cash flow management and investing.
In real numbers, an associate working in New York State making an $85,000 gross salary would take home about $4,340 a month after taxes, health insurance premiums, and 5% (pre-tax)contributions to a 401(k). Let’s break this down further by three priorities: servicing student loans, investing, and insurance.
Managing student loans in the “gray area”
Lawyers working at smaller private firms stand in the middle ground of federal student loan management. On one hand, they may not be making a high enough income to afford a 10-year standard payment on high student loan debt, or to accelerate paying off debt – a more common goal for their Biglaw counterparts. But, on the other hand, they aren’t eligible for Public Service Loan Forgiveness (PSLF) as they don’t work for a qualifying government or non-profit employer.
To keep student loan payments affordable, many borrowers in this position steer clear of refinancing, and turn to income-driven repayment (IDR) plans to base payments on adjusted gross income. The advantages of these plans are obvious and include more breathing room in their budget and flexibility to pay the bills and pursue other financial goals. The downsides are not as well-known but potentially include having loan balances grow larger over time as set payments may not be high enough to cover accruing interest each month. This is called negative amortization, and it is (fortunately) one of the potential revisions coming to the Revised Pay as You Earn (REPAYE) repayment plan through proposed regulations.
While lawyers working in private practice using IDR plans are not eligible for PSLF, they can receive forgiveness of their remaining loan balances after a maximum period of 20 or 25 years. The big caveat here is that this type of forgiveness is taxable under current rules, so this tax bill (or, in some cases, tax bomb) is something that will have to be planned and saved for to avoid having to explore further repayment options with the IRS.
Investing in 401(k)s and Roth IRAs
Keeping living expenses at reasonable levels, avoiding over-borrowing with credit and consumer loans, and using income-driven repayment to pay student loans can all translate to having more flexibility to simultaneously pursue other financial priorities, like saving and investing for the future.
Most firms will offer you access to a 401(k) (or a variation of another type of retirement plan like a SEP IRA for very small firms, for example), which is an account you can contribute part of your paycheck to in order to invest in mutual funds or target-date funds for retirement.
While matching 401(k) employer contributions are not as common at larger firms, they may be more readily available at smaller firms. If your firm offers a company match, take advantage of it as soon as possible. Matching contributions are typically capped at a percentage of your pay and can be dollar-for-dollar or a percentage of each dollar up to the limit – 3% or 5% as common examples.
These percentages may not sound like much but investing just 5% of your pay over the long-term can lead to substantial savings. The associate making $85,000 and contributing 5%, or about $354 a month to their 401(k), would end up with about $434,600 after 30 years, assuming a 7% average annual return. And that is without ever increasing contributions or assuming employer matching contributions. If your budget allows you to contribute more – say 10% – and your employer matches 5%, you could end up with around $1.3 million over the same time period.
If you’re a single tax-filer making less than $138,000 in 2023, you’ll also be able to contribute directly to a Roth IRA – an individual retirement account you set up on your own where you pay taxes on money going into the account, with all future qualified withdrawals being tax-free. In many cases, you can also code your contributions to your 401(k) as Roth if you’d like this tax treatment on that money instead of taking the up-front tax deduction. Roth is a popular strategy for those looking to pay taxes now to avoid higher taxes later.
Exploring affordable insurance options
For those working to set up their financial systems on a small to mid-sized firm salary, having a cash emergency fund for short-term, smaller-scale expenses is still a good idea. For everything else, establishing insurance that covers health (usually available and subsidized through employer benefits plans), auto, home, life, and long-term disability, provides foundational support to the rest of your plan. Lawyer professional liability insurance is another key coverage for solo practitioners and small law firms. If, and when, the time comes, the premiums for these essential coverages can add up quickly, so doing your homework on the policies and coverage amounts that fit your situation is important. A few examples include using insurance brokers to bundle home and auto coverage for discounted premiums and exploring fixed-premium term life insurance if you don’t have a compelling need for more costly permanent coverage.
Putting it all together
Of course, your ability to simultaneously juggle all these priorities comes down to how you manage the money coming in month-to-month – and the best tool for that task is a budget! Using a 50/30/20 approach to budgeting, a lawyer taking home $4,340 a month would set aside $2,170 (50%) for needs (insurance premiums fall in this category), $1,302 (30%) for wants, and $868 (20%) for saving or paying down debt. You can adjust these numbers based on your priorities or situation of course, but the main idea is to proactively build your budget and to intentionally control your cash flow, invest for the future, and protect your hard-earned savings.
Most importantly, setting up your student loan repayment strategy, and investing and insurance programs, early on will give you peace of mind to do the work you’re passionate about in private practice, which will certainly pay its own dividends for you and your clients throughout your career.
Disclaimer: Examples provided in this article are for informational purposes only and are not intended as investment, tax, or legal advice. You should consider whether the information is appropriate for your unique needs, and where applicable, seek individualized advice from a professional advisor.
