Specializing On Specialists: Financial Planning For Lawyers

As appeared in Financial Advisor Magazine

Planning for a person’s financial future without accounting for their individual profession is like planning to perform surgery without first taking the patient’s medical history. Well, maybe that’s a bit dramatic, as the dangers of failure are probably greater for the surgeon and the patient, but the point remains the same. Financial planning for any person will have the best-intended outcome only if performed and applied with reference to the variables that differentiate that person’s life.

In this sense, financial planning for members of any profession should be approached as a specialty, specifically targeting the distinct, comprehensive needs that come with membership in that profession. Lawyers particularly require financial expertise and experience focused on the unique parameters created by practicing law. They may, in a sense, be like owners or executives of a business; yet, they are also quite different in many respects, particularly when they practice at a firm, and not in-house at a company.

Income Generation And Management
Lawyers can earn a wide range of compensation for their services, but their earnings are almost invariably tied to their ability to perform services. This simple reality has vital planning implications:

•    There is a limit to the number of hours that a lawyer can work, meaning that there typically is a limit (no matter how high that limit may be) on how much a lawyer can be projected to earn over time.

•    A lawyer’s income can vary directly and substantially with his or her production and, in cases of contingency billing, can vary wildly, putting pressure on the lawyer’s cash-flow planning and his or her possible need to structure credit relationships.

•    Many law firms distribute compensation and profits conservatively throughout the year, holding back large sums until the quarter or year is completed and necessitating comprehensive cash-flow planning.

•    There are financial and lifestyle incentives to create leverage in a law practice, often requiring an entirely new level of business planning.

•    If a lawyer becomes disabled, there obviously could be a substantial limit on the lawyer’s ability to continue producing income. Further, upon death, the long-term capital requirements for the lawyer’s family could be significant.

A financial planner must consider all of these realities when advising a lawyer and take special consideration of cash-flow and disaster planning. Many firms, especially larger firms, will proactively address these issues; but supplemental planning and measures are often required.

Key Implications For The Wealth Management Process
1.  Retirement Planning
Retirement planning can be highly complex for lawyers. In addition to traditional defined contribution plans, many law firms and companies that employ lawyers offer defined benefit plans and even non-qualified deferred compensation plans for their lawyers. Participation in these myriad plans must be carefully coordinated, but the relevant calculus is often complicated by tax implications, cash-flow constraints and the potential need to make commensurately larger contributions on behalf of staff.

Additionally, lawyers must consider how long they can and will work, particularly given the rigors of their practice and the increasing prevalence of mandatory retirement provisions imposed by some firms. These considerations, in turn, raise questions about contribution rates, capital market assumptions, asset allocation decisions, profit-sharing contributions for staff and, increasingly, whether to make pre- or post-tax contributions.

Finally, lawyers, like financial advisors, must consider the distinct matter of succession planning alongside retirement planning. Particularly in the context of a firm, a lawyer must ensure not only that appropriate agreements are in place to return his or her capital investments, but also that, upon retirement, his or her clients will be successfully transitioned to others, likely necessitating even further strategic planning.

2.  Asset Allocation And Investment Planning
Because most lawyers cannot accurately predict the amount of their earnings in any year, a planner may be required to place an added emphasis on the need for building and maintaining a current reserve of cash-based investments necessary to withstand periods of reduced income. These current reserves will require a responsible, short-term asset management strategy.

The need to build short-term reserve funds, however, may consequently limit a lawyer’s ability to save for retirement, thereby requiring a more aggressive asset allocation strategy for the lawyer’s retirement funds. These asset allocation decisions may be even more complicated by the fact that the lawyer may have little or no control over the asset allocation strategies used or offered in any supplemental retirement plans offered by the firm or employer.

Lawyers sometimes present another unique set of challenges and opportunities in the area of investing—they may be afforded the opportunity to invest alongside their clients in the clients’ businesses. While these opportunities may be quite attractive, they may also be quite risky, and a good planner will ensure the proper level of diligence, discipline and balance in approaching them.

Yet another complexity that some lawyers may introduce relates to the possession of inside information. Many lawyers, by virtue of their advice to public or pre-public clients, will be deemed to possess inside information, necessitating additional precautions on the part of their financial advisors.

3.  Tax Planning
Depending on the nature of a lawyer’s employment arrangement, he or she may be self-employed or an employee for tax purposes. Moreover, depending on the form of legal entity for which he or she works, a lawyer may receive some income in exchange for services and some income as a distribution of profit or other payment.

These considerations are integral to advising a lawyer in the area of tax planning. Particularly as income and employment tax rates have risen in recent years, a failure to understand these subtleties can be quite costly to a practicing lawyer.

Furthermore, one of the single most important functions of any financial advisor to lawyers is to understand and plan for the lawyer’s estimated tax obligations. These obligations are likely to be substantial, especially for self-employed partners in a law firm, and can dramatically impact a lawyer’s liquidity throughout the year. A failure to plan properly can lead to substantial penalties and burdensome budgetary constraints.

4.  Estate Planning
While many of the estate planning issues applicable to lawyers are equally pertinent to others, such as the preparation of estate planning documents, the titling of assets, beneficiary designations and family and charitable gifting, a few are especially relevant to the legal profession. Questions may arise specifically as to how much, if any, value can be attributed to a legal practice. Regardless of that answer, as lawyers are less likely to own appreciating interests in their practices, their estate plans typically must be focused around dispositive provisions, asset accumulation, capital preservation, asset protection and life insurance.

Particular care should be exercised when developing income replacement strategies in a lawyer’s estate plan. Careful consideration should be given to plan design (e.g., how much, product type, etc.), but ownership and beneficiary decisions will also be critical.

5.  Risk Management
Responsible financial planning for any individual involves an assessment of the individual’s assets and liabilities—outstanding, contingent and hypothetical. Traditionally, while insurance can be an effective tool in protecting the assets of an individual from risks, the individual may also benefit from the strategic use of limited liability vehicles both inside and outside of the individual’s business or other income-generating activities.

Lawyers, however, require special concentration on risk management. While an in-house lawyer generally should be able to rely upon a “corporate shield” for protection against claims arising from the ordinary-course performance of legal services, most lawyers must be prepared to practice law as part of partnerships or similar entities that cannot legally offer a liability shield. These lawyers must rely increasingly on firm-provided and supplemental malpractice and professional liability insurance policies, in addition to their personal umbrella, automobile, homeowners and other insurance policies. They may also benefit from the use of asset protection trusts and similar vehicles where the use of such vehicles is not prohibitively expensive or cumbersome.

Understanding Lawyers
Of course, financial planning for lawyers requires not only an understanding of the issues they may face but also an understanding of lawyers themselves, including how they are trained. At the risk of generalizing, for example, lawyers tend to be trained to minimize risk.  In the area of financial planning, avoiding risk can be helpful, but avoiding risk altogether can be unwise. This dynamic can be challenging, particularly in the area of long-term investment planning.

Lawyers may also be trained to be as efficient as possible with their time, particularly when they are charging clients based on billable hours. While this is again a helpful approach, it can also be short-sighted if a lawyer cannot be focused by his or her planner on spending sufficient time on the non-billable, but nonetheless critical, task of attending to his or her personal financial plan.

Finally, lawyers often are trained to analyze and even overanalyze any problem, never taking anything for granted and never relying on the opinions of others. This training is precisely what their clients pay them for, but it can create another challenging dynamic for financial planners who work with lawyers. Any such planner must be prepared to spend extra time explaining concepts and persuading their clients to act on them when those clients happen to be lawyers.

Directly addressing these dynamics with the client should lead to better, more meaningful outcomes. Ironically, what truly is needed to achieve long-term financial success is a non-legal, lawyer-advisor partnership.