Congratulations! You’ve made it through law school, summer internships, the bar exam and an interview process culminating in a coveted Big Law associate position.
With a starting salary and possible bonuses totaling over $200,000 and typically increasing quickly thereafter, you’ll have some decisions to make when it comes to managing your monthly cash flow, paying off hefty student loans and setting yourself up for the future with an investing strategy.
It’s natural for someone who is suddenly making more money to almost subconsciously adjust their lifestyle to match their increased spending ability – usually called ‘lifestyle creep’. In the case of new associates making BigLaw starting salaries right out of law school, there’s the potential for more of a lifestyle surge. Suppressing the surge by extending your ability to live comfortably on just a percentage of what you make can leave you a sizable chunk of cash to work with.
If you want to pay off student loans as fast as possible and begin building your wealth by investing for retirement, the good news is that you may have the money to accomplish these goals simultaneously, with a few simple moves.
Invest for retirement in a tax-advantaged way
You can reduce your taxable income by investing in your firm’s 401(k) by making traditional, pre-tax contributions, up to the current annual amount of $22,500, with a catch-up contribution of $7,500 for those age 50 and older. For those younger than 50, that’s about $1,875 a month to reach that limit if you’re working it into your budget. Money invested inside a 401(k) grows tax-deferred and you pay taxes on what you withdraw in retirement.
Another popular tax-deductible investment account is a Health Savings Account (HSA) – an account for those with high deductible health plans to contribute and invest money for future qualified health expenses, up to an annual limit.
If you’d prefer to forgo the tax deduction now for tax-free income in retirement, then Roth (post-tax) contributions are now also an option in most 401(k) plans. Money invested in Roth accounts grows tax-deferred and you don’t have to pay taxes on qualified withdrawals in retirement – including on any growth on your investments!
Another strategy that most high-income earners have on their radar at some level is a “backdoor” Roth IRA. IRAs are individual retirement accounts with their own annual limits, currently $6,500 for those under 50 years old. A “backdoor” Roth is a process for those who exceed Roth IRA contribution income limits to make non-deductible Traditional IRA contributions and subsequently roll them into an existing Roth IRA or convert the account altogether. Do your homework if you’re exploring this strategy or talk to a financial professional before jumping in to make sure you understand the process and the tax implications of converting any current pre-tax IRA funds.
Remember, Roth options will not reduce your taxable income now if that’s your main goal.
If your goal is early retirement, remember that you can’t withdraw funds from your 401(k) or IRAs without penalty before age 59 ½, with few exceptions. You’re filling up your retirement accounts for life after 59 ½ but if you want to retire any time before then, you’ll need another bucket to pull from. For that, you can open a personal brokerage account and start investing in a tax-efficient index fund, ETF or any other fund you choose. There are no income or contribution limits for brokerage accounts but no tax advantages, either.
Pay off student loans in ten years or less
With average law school and undergrad student loan debt loads spanning $100,000 to $200,000 or more, new BigLaw associates see their salary as a golden opportunity to rid themselves of this burden quickly. That said, many transitions out of their firms by year five due to burnout or other reasons and may even factor this possibility into their plan – entering BigLaw jobs with the intention of paying off debt, accruing savings and moving to another field they are passionate about, after a few years, if they find working in BigLaw unsustainable. The risk of course is that you don’t crunch the numbers and pay enough each month to clear the loans and end up burnt out and still carrying high levels of debt.
Even if making a partner is your goal, it can take anywhere between five to 15 years depending on the firm. Paying down debt quickly will only free up more discretionary funds you can use to invest or use in other more fruitful ways and help reduce your stress as you pursue a partnership.
So how can associates approach paying off student loans? Since income-driven repayment plans for federal loans may not lower the payments much (if at all) for high-income earners when compared to standard 10-year plans, many borrowers opt to just enter repayment on the 10-year plan and make extra payments on principal directly with servicers to accelerate payoff.
For example, say you have $200,000 in federal loans at an average 6% interest rate. The 10-year standard payment would be $2,220 a month but you’d have to pay an additional $1,647 a month to cut that time in half to five years. Remember, you can also make lump-sum payments on your loans with bonuses to stay on track.
Another option you’ll run into here is refinancing your federal student loans to a private product. If you have good credit, this can lower your interest rate and save you some money over the few years you’re paying off your loans. The drawback is that you will lose the ability to use income-driven repayment plans should you change careers or move to a smaller firm with a lower salary before the debt is paid off. Weigh the pros and cons carefully before refinancing.
A balanced approach
How you prioritize your daily lifestyle choices, debt elimination strategy and investing plan is up to you – and these certainly won’t be the only financial factors at play throughout life. Ensuring you are properly insured, eventually owning real estate if you choose, starting or growing a family and legacy planning will all demand your time and attention at some point. The first few years of a BigLaw career can help you lay the foundation in an accelerated way, so take advantage of the opportunity!
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.
