If you have recently been named a partner at your law firm, or you’re in another industry with varied income, you know it can be hard to plan ahead. We help clients navigate complicated compensation every day. Below are some common financial planning mistakes we see along with some general advice on how to look at and adjust for variable income. Once you’ve assessed your new financial situation, the idea is to get on the right track to meet your savings and life goals.
- Cash Flow: Almost all of us struggle with budgeting and cash flow. However, when the significant portion of your income comes in the form of law partnership distributions that can vary greatly in both amount and timing, it takes discipline or a cash flow system to ensure that you allocate that income appropriately to current needs and/or long-term goals. Oftentimes, this money can disappear without an appropriate budget or system.
- Taxes: Not planning for taxes is often a pain point we see, particularly with new partners. When associates become partners, the type of income they receive most likely changes from W2 wages to K1 distributions and taxes are no longer withheld regularly. This means they may need to make estimated tax payments quarterly. If not, they can encounter a surprising large tax bill when they file in April. Some law firms provide a lot of guidance and assistance with new partners as they make this transition and even will make distributions quarterly that are meant specifically for tax payments, but some do not.
I think it’s important for anyone who is facing an income transition to have a plan as well as trusted partners they can lean on for help. Before your first distributions arrive, ask yourself (and answer) the following questions. This will help you start to outline a plan.
- How much needs to be set aside for taxes?
- How much should I save to long-term goals like retirement or college funding?
- How much can be allocated to short-term goals like a new car or home remodel?
- How much do I need to help support my daily lifestyle until we get another distribution?
- Lastly, how much can I use to treat myself and my family?
It’s also key to find a great support system. Lawyers are unique in that they know exactly what their time is worth. Spending time determining how much they need to set aside for taxes or save for college could be outsourced to someone else. Partners who are experts in your field that clearly understand your personal situation and goals can provide tremendous value.