Law Firm Partners Face The Perfect Storm As They Consider Retirement
As appeared in Financial Advisors Magazine
As the world has grown more complex, so too have the opportunities, challenges and conditions that comprise the environment in which we live and interact with one another. A direct consequence of this ever-increasing complexity is the manner in which professional advisory firms—particularly law firms—have had to evolve into large, often international institutions with sufficient numbers of experts to meet the needs of individuals and organizations operating in and dealing with the challenges of the modern world. Ironically, the leaders and owners of these professional services firms, typically referred to as “partners,” are now themselves facing a great challenge—and many of them do not yet realize it.
The partners of the largest law firms are among the best-educated, powerful and influential members of our society. Their work is interesting; their careers are important; and their pay can be extraordinary, easily exceeding $1M per year at some of the largest firms. In turn, more junior attorneys are attracted to join these firms, supplying a continuous flow of top talent to advise future generations of clients. These junior attorneys support the partners’ work, fueled in part by good pay and the opportunity to become partners themselves—and that is the foundation of the problem.
In order to ensure that there are sufficient opportunities for the next generation of talent while simultaneously preserving the economic balance in their firms, law firm partners, especially at larger firms, frequently impose mandatory retirement requirements on themselves, typically around the age of 65. And, in recent years, the trend has been to incent or force partners to retire even earlier, sometimes as early as age 55.
A Perfect Storm
Yet, this trend of earlier retirement for law firm partners has become problematic in recent years, as the key underlying financial realities that have previously enabled early partner retirement are now under assault. Consequently, aging partners who have earned higher incomes and accumulated substantial wealth over the course of their careers may feel a false sense of security, while they actually are in grave financial danger. This danger can be summarized as a “perfect storm” of sorts, fueled by a precarious mixture of one trend, earlier retirement, with three others:
1. Life expectancies are increasing, making the retirement phase longer. As life expectancies continue to rise, responsible financial planning analyses must now assume that retiring partners may live well into their nineties. This means that the time between retirement and death may last for 30 or more years, but many partners simply do not realize the challenges inherent in ensuring that their savings can last for such a long period. These challenges relate not only to the obvious difficulty of making a pool of assets last for three or more decades but also to the fact that unexpected events—such as divorce, disability, family emergencies, health crises or others—are statistically more likely to occur during such a long period of time, placing additional stress on the partner’s assets.
While some partners do continue to work in some capacity even after their official retirements, this work is less likely to produce sufficient income to support the partner’s current lifestyle and may not adequately forestall the need to begin living on retirement-designated assets. In fact, many people who have accumulated a higher net worth during a lifetime of work actually increase their spending immediately after retirement, as they tend to travel more and spend more on their families, recreation, health care, insurance and enjoying life generally.
2. Capital markets assumptions are under downward pressure. Structural imbalances in the Unites States (e.g., the unsustainable national debt combined with ever-expanding entitlement programs) and abroad (e.g., in Europe and China) suggest that assumptions regarding long-term returns must be ratcheted downwards relative to more recent norms. In many cases, average annual long-term return expectations for certain risk-based asset classes such as equities have moved down by two or more percentage points, while annual long-term expectations for more conservative asset classes such as fixed-income have moved down by one or more percentage points. These downward revisions to long-term return expectations may seem slight, but over a period of decades, they can be dramatic. More to the point, they can lead to retirement projections that, when utilized in Monte Carlo or other planning simulations, are dangerously unsustainable when the law firm partners are assumed to be retired for a period of 30 or more years.
3. Health care, tax and other costs are increasing. Responsible retirement projections for law firm partners who retire early must also account for the likelihood of increasing health care, tax and other costs of living. Despite passage of the Affordable Care Act, health-care costs have continued to rise exponentially and are likely to continue on that trajectory. This is especially true for people who are considered wealthy and are therefore at risk of being asked to pay a larger portion of their own health-care costs when politicians, regulators, insurers and providers are finally forced to make the hard choices necessary to ensure a sustainable health-care system.
Likewise, given the fact that the debt burden facing the United States is structurally unsustainable when considered alongside the current Medicare, Social Security and other entitlement programs stressed by an aging, longer-living baby boomer generation, it is more likely that tax rates and other tax-like fees will increase, not decrease, over the coming decades. This is yet another trend that makes early retirement for law firm partners a more difficult challenge, as they need to assume that taxes will comprise an increasingly larger portion of their annual spending needs.
Given these lurking threats to the long-term feasibility of continued early retirement programs for law firm partners, it is critical that partners, either independently or in collaboration with an experienced financial counseling team, clearly define their long-term financial and life goals, accurately assess their current assets and resources and identify and implement the actions necessary to realistically bridge the financial gap between their goals and current assets. As discussed, proactive planning becomes even more critical in light of the new norms for future life expectancy, rates of return and spending assumptions. The earlier in their careers that partners begin planning under this new paradigm, the more likely they are to weather the storm effectively, as long-term and realistic planning decisions such as intelligent cash-flow management can significantly increase the likelihood of a successful early retirement. Thus, while they do face an imminent perfect storm, law firm partners are not without the prospects of safety if they plan ahead and plan prudently.