Retirement Savings for Lawyers… A New Meaning to Diversification

January 24, 2017

Lawyers are generally good at saving for retirement.  Case in point: The Economic Policy Institute (EPI) estimates that the mean average retirement savings in the US is $95,776. According to a source from ABA Retirement, the average law firm 401(k) account balance is more than double that.  Many seasoned law firm partners have even built seven-figure retirement savings accounts.

Clearly, lawyers are making good decisions by “maxing out” their retirement plan savings.

That is great news and if that describes you, congratulations… you’ve done well.

The question now becomes, “what else can you be doing to thoughtfully save for life after law?”

Tax Diversification

Diversification is a term that gets thrown around all the time in the investment world.  The concept is simple… don’t put all your eggs in one basket.  Usually, the idea of diversification is in the context of spreading your money across different types of assets – i.e. US stocks, international stocks, bonds, cash and real estate.

Another type of diversification that we talk about with clients is the idea of “tax diversification.”  The idea here is building pools of assets that have different tax characteristics.

For lawyers, who often have so much of their investments in tax-deferred retirement accounts this means starting to build wealth in after-tax or “non-qualified” investment accounts.  These accounts are titled as individual, joint or revocable living trusts.

There are a number of advantages to building up “after-tax” wealth, including:

  • Tax rate arbitrage – Assets in 401(k)’s and other retirement accounts are eventually taxed at ordinary income tax rates. Once you reach age 70 ½ Uncle Sam requires you to start pulling money from these accounts and those proceeds are taxed as ordinary income.  By contrast, assets in after-tax, non-qualified accounts enjoy a more favorable capital gains tax rate on realized gains, provided you’ve held the asset for over one year.  The difference can be significant with the maximum ordinary income rate around 40% and the long-term capital gain rate at 20% (or lower depending on your income level).
  • No required distributions – As mentioned above, the IRS requires you to start taking distributions at age 70 ½ from retirement accounts like 401(k)’s, Profit Sharing and IRAs. After-tax accounts have no such requirements and give you more planning flexibility.
  • Accessibility – After-tax accounts have no rules around when and for what purpose you can access the funds. You can pull money from these accounts to cover unanticipated expenses, capitalize on an investment opportunity or renovate your master bathroom at any time without penalty.

While the concept of saving more for retirement is by no means novel, perhaps the idea of consistently building wealth outside your firm’s retirement plan is.  It’s quite common for law firm partners to wake up one day in their 50s and have little investment assets outside their 401(k).  By putting yourself on a regular after-tax savings plan you can bring more “tax balance” to your balance sheet and set yourself up for greater flexibility once you’re ready for life after law.