The Biglaw Investor http://www.biglawinvestor.com Mon, 24 Apr 2017 10:00:00 +0000 en-US hourly 1 https://wordpress.org/?v=4.7.4 http://www.biglawinvestor.com/wp-content/uploads/2017/01/favicon.png The Biglaw Investor http://www.biglawinvestor.com 32 32 111859200 News Flash: Social Security Exists! http://www.biglawinvestor.com/social-security-benefits/ http://www.biglawinvestor.com/social-security-benefits/#comments Mon, 24 Apr 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=2953 Check out The Biglaw Investor or read News Flash: Social Security Exists!

Part of every good investment plan is making sure you’re covered in situation involving disability or death. After publishing an intro to disability insurance (and more specifically, why you need disability insurance), it came to my attention that most, if not all, of us are eligible for Social Security benefits. Many of the millennial generation […]

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Part of every good investment plan is making sure you’re covered in situation involving disability or death. After publishing an intro to disability insurance (and more specifically, why you need disability insurance), it came to my attention that most, if not all, of us are eligible for Social Security benefits.

Many of the millennial generation have written off Social Security. It’s not uncommon to leave Social Security out of any retirement or insurance plan. This strikes me as shortsighted. While it’s hard to gauge how much you can expect to receive in benefits in 30 years, Social Security is a wildly popular program that seems very like to continue to exist when you reach retirement.

Plus, as we’ll see in a few paragraphs, there are certain benefits which you may be eligible to receive now, such as disability and survivor benefits.

There are three main components to Social Security benefits: retirement, disability and survivor.

Setting Up Your Social Security Account

First, if you haven’t already, now would be a good time to set up your account with the Social Security Administration.

You want to set up this account as soon as possible to prevent the possibility of identity theft where someone else creates an account using your social security number and fraudulently applies for benefits on your behalf.

To create an account, go to https://secure.ssa.gov/RIL/SiView.do and click on “Create An Account”.

The Social Security Administration will send you a written letter with a unique code that allow you to set up two-factor authentication. Once you receive that letter, set up two-factor authentication (that’s where you use your password and a text message received by your cell phone to log in).

Once your account is set up, the first thing to check is your Earnings Record to make sure it’s accurate. You’ve probably been receiving these letters annually from the Social Security administration but, if not, check and make sure the information looks accurate.

Each year will show your Taxed Social Security Earnings (currently capped a $118,500) and your uncapped Taxed Medicare Earnings.

At the bottom there’s also an interesting box that tells you your estimated total taxes paid (both employee and employer) for Social Security and Medicare. Some people consider Social Security less as a tax and more as a forced retirement plan, so I find it interesting to see how much I’ve contributed (over $100K to Social Security).

In order to qualify for Social Security benefits, you must accumulate at least 40 credits in the Social Security system. In 2017, you receive one credit for each $1,300 of earnings, up to the maximum of four credits per year. Therefore, you’re probably earning 4 credits per year, which means you need 10 years of working to fully qualify for all Social Security benefits (keep in mind that your earnings from summer / school jobs count as well).

There are special circumstances where you can qualify for disability and survivor benefits with less than 40 credits (which makes sense, otherwise these benefits would leave a gap in coverage). See the full explanation from the Social Security Administration in Publication EN-05-10072.

Example. Larry started his first job ever at a law firm at the age of 26. He becomes disabled at the age of 32 after working for six years and earning 24 credits. According to SSA Publication EN-05-10072, Larry should generally be eligible for disability benefits.

Social Security Benefits

Retirement Benefits

Once your account is set up and you’ve verified that your earnings record is accurate, there are three main benefits to explore.

Your Social Security retirement benefits aren’t going to be that helpful, but it’s worth taking a look. Here’s what mine looks like.

As you can see from the above, the Social Security Administration assumes that you’ll earn a certain amount each year from now until retirement. I suppose this is as good of a way to do it as any other way but for those of you thinking of financial independence, you might not be working up until you turn 62.

Still, at least you now have a rough guide as to what retirement benefits you might expect to receive. I don’t include any of these numbers in my own retirement planning (for now) since the benefits are too far into the future to accurately calculate. But I still think that I will receive them at some point (much like my pension that kicks in when I turn 65).

Between Social Security retirement benefits and the pension, hopefully I’ll be at the point that in a worst case scenario I won’t be stuck living in a cardboard box at the age of 65.

If you’re considering early retirement, here’s a calculator from the SSA page that can help you calculate your benefits assuming that you aren’t going to work up until age 67.

Disability Benefits

Perhaps more relevant to today’s planning, the Social Security Administration also provides you with a calculation of the monthly payment you could expect to receive should you become disabled right now. Here’s what mine looks like.

It’s beyond the scope of this article to discuss what it means to be “disabled” under Social Security Administration standards, but if you’re looking to understand that better, here’s the link to the SSA’s Disability Evaluation.

Suffice to say that being disabled is 50 shades of gray as opposed to the black and white of whether you’re dead or alive, which is why the definition of disability is so important in your group or individual disability insurance.

Knowing that if I became disabled that I would be entitled to receive $2,456 a month is worth tracking. I’ve included that information in my Investment Policy Statement. While not an “investment”, my IPS also includes a handy cheat sheet with insurance coverage so I can see at a glance how I’m protected (health, disability, life, renter’s, liability, etc.). Social Security Disability Insurance is simply one more piece of the foundation should I ever need to use it.

Survivor Benefits

The third and final benefit to track is the survivor benefit should you die this year. It covers three scenarios: (1) benefits for your child; (2) benefits for a spouse caring for a child and (3) benefits for your spouse as full retirement age. Here’s what mine looks like.

I keep track of the survivor benefits in the life insurance section of my Investment Policy Statement since these payments would act like a payment during an early death.

Note that the total family benefits is capped at $4,944, which would apply if I had multiple children (I don’t).

$4,944 for my wife and kids is a huge amount of money ($59,328 a year) which could quite possibly cover annual expenditures for a family of 3.

The survivors benefits only extend to age 18 (up to age 19 if attending elementary or secondary school full time). That seems reasonable to me. So it’s not a total replacement for life insurance (which would protect your spouse going forward) but it’s a nice benefit to include in your calculations of how much life insurance you need.

Medicare

It’s also worth mentioning that your account will let you know if you’ve worked enough to qualify for Medicare, which currently kicks in at age 65. It’s good to know that you only have to solve for the health insurance problem from now until 65.

The New New Deal

I’m optimistic that the federal government will figure out a way to keep the Social Security program solvent going forward. I didn’t pay attention to survivor benefits or disability benefits until I started to think about having a family and whether or not I needed disability insurance outside of my group plan. It’s good to include these numbers in your own calculation.

If you haven’t already created an account, go to https://secure.ssa.gov/RIL/SiView.do, sign up and check out your specific benefits.

Let’s talk about it. Did you know about Social Security disability and survivor benefits? If so, did you realize the survivor benefits could be so high?

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A Tax Delayed Is a Tax Not Paid http://www.biglawinvestor.com/tax-delayed-is-a-tax-not-paid/ http://www.biglawinvestor.com/tax-delayed-is-a-tax-not-paid/#comments Fri, 21 Apr 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=2941 Check out The Biglaw Investor or read A Tax Delayed Is a Tax Not Paid

A common concern when contributing to retirement accounts is that you’re not actually avoiding taxes, you’re simply deferring them to some time in the future. This confuses a lot of investors, causing them to misunderstand the value of retirement accounts. Some typical questions might be: Are you really getting a good deal if you save […]

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A common concern when contributing to retirement accounts is that you’re not actually avoiding taxes, you’re simply deferring them to some time in the future.

This confuses a lot of investors, causing them to misunderstand the value of retirement accounts.

Some typical questions might be:

Are you really getting a good deal if you save 33% on your taxes today but pay the same tax rate in the future? Seems like a wash.

Plus – what if tax rates go up dramatically? You can’t predict future tax brackets! You could be taking a tax break today at 33% but paying a tax rate of 40% in the future. Shouldn’t you take the tax hit you know today vs hoping that it’ll work out in the future?

But there are several advantages to retirement accounts that override these concerns.

(1) The 401(k) Match

If your employer offers you a match, you should take it. For example, you might have a deal where your employer contributes 100% of the amount you contribute up to a certain ceiling. Let’s imagine that’s $3,000. You put in $3,000 and your employer puts in $3,000. That’s a 100% return. You will never see that kind of return anywhere else. Take it.

But many lawyers don’t get any kind of match (or are partners and are matching with their own money anyway), so let’s forget about the match even if it is an obvious advantage for certain people.

(2) Time Value of Money

There’s a common phrase that you’ll do well to remember: a tax delayed is a tax not paid.

Is it strictly true? Of course not! You’re simply deferring taxes into the future.

But is it effectively true? Absolutely. A tax delayed is a tax that you’re not paying today.

The future is uncertain and that uncertainty cuts both ways.

Will you pay that tax in the years ahead? You might. Or you might not. Maybe there will be future tax breaks or other ways to minimize or eliminate the tax. Who can say?

But even if you do pay the tax in the future, you will be paying the tax with cheaper dollars. That’s because a dollar today is worth more than a dollar in the future. That’s the time value of money. A simple example will help explain it.

Example 1. Larry has to pay a 10% tax on $1,000 of income, meaning he owes the IRS $100. The IRS gives him two options: Pay the $100 today or pay the $100 in three decades. Thanks to inflation, we can calculate that the present value of $100 in 30 years is approximately $41.20 today (assuming 3% inflation). In other words, you could set aside $41.20 today earning 3% and have $100 in 30 years to pay the tax bill. The decision between paying the IRS $100 today or setting aside $41.20 and paying the IRS in 30 years is obvious.

So, a tax delayed is definitely worth something just by itself even if the tax rates stay the same. If you’re really rich, you probably have a whole team of accountants and lawyers trying to figure out ways to delay your tax payments. You might even be able to delay it indefinitely if you delay the tax payment until your death and leave your assets to your heirs with a step up in basis. In that case, the tax is never paid.

(3) Marginal vs Effective Tax Rate

The slightly more complicated point to understand (although it makes obvious sense once you get it) is that when you defer taxes through a contribution to a retirement account you save on your marginal taxes today and you pay at your effective tax rate in the future.

Let’s run through another quick example.

Example 2. Larry has a marginal tax rate of 45.6% (federal, state and city taxes). He contributes $10,000 to a retirement account and saves $4,560 today ($10,000 x 45.6%). Let’s assume he withdraws the money in 30 years and it didn’t earn a dime. Will he have to pay 45.6% on the $4,560 in his retirement account? Highly unlikely. His first $10,350 is tax-free thanks to the personal exemption and standard deduction. The next $18,550 are taxed at 10%. It would be very difficult for Larry to pay 45.6% tax on the money withdrawn in retirement. He’d need a huge income in retirement pushing his retirement tax rate all the way up to 45.6%. We should all be so lucky to retire with such problems!

If Larry saves money at 45.6% and then withdraws it in the future at a blended effective tax rate of 24%, he ends up saving about 21.6% (45.6% – 24%) on his contribution or about $2,160 of the original $10,000 contribution. That’s equivalent to a 21.6% immediate return on your money.

Where else are you going to find a return like that?

You can’t.

Of course the numbers I used in the calculation might be different from your numbers. They’re also probably different from future tax rates. So what? Even if the numbers are off by half, you’ve still got an automatic return of 10.8%.

The benefits of retirement accounts are too good to pass up.

This is even magnified if you end up earning money in a high-tax location/state and then retiring to a low or zero income-tax state.

What kind of people work in urban centers in high growth states with high tax rates? Why, lawyers of course!

Where do those lawyers like to go when they retire? To warm weather locations with low or zero taxes like Arizona and Florida!

If that’s you, you’ll be able to skip paying the city and state taxes entirely on the money in your retirement account.

(4) Tax-Free Growth

As if the benefits of saving taxes at your marginal rate and paying them at your effective rate weren’t good enough, there’s also the benefit of having your investment grow tax-free during your earning years.

Every time an investment is sold in a taxable account you have to pay capital gains taxes on the sale. The capital gain taxes apply to your dividends and capital gain distributions too, causing a drag on your portfolio, so even if you’re in a low-drag investment like an index fund you’ll still see a lower growth rate.

Example 3. Larry has $10,000 invested earning 8% a year in the market but 2% of his return is attributable to dividends which are taxed at 15%. That means Larry’s actual return, after taxes, is 7.7% (2% x 15% = 0.3% which is paid to the IRS).

The 0.3% paid in taxes may not sound like much but over 30 years it will result in tens of thousands of dollars that are lost.

Compare this to a 401(k) account where the money would grow tax-free (at the full 8% in our hypothetical) and you’ll see that going with the 401(k) is a clear winner over the taxable account. Sure, you won’t get all of that 0.3% for yourself, since you’ll eventually have to pay taxes on it, but you’ll keep the lion’s share of those gains  and only a relatively small percentage will go to the government.

The Downsides of Retirement Accounts

There are a few downsides of retirement accounts that worth mentioning. Many 401(k) accounts, for example, are often loaded down with unnecessary high fees and expenses. You can select low-cost index funds to reduce those fees but there usually isn’t much you can do to reduce the bottom line fees charged by the 401(k) administrator.

These costs and fees add up over time, unless you change jobs and roll that money into a low-cost institution like Vanguard. But either way, 401(k) costs and fees take a toll on your investment return. Even someone who is paying attention to the fees might end up spending 0.5% per year in 401(k) administration fees.

While these fees are unfortunate, they are dwarfed by the savings that we’ve calculated above. The only time the math starts to work out poorly is if you’re 401(k) is charging 1.5-2% annual fees. Even really bad 401(k) plans have options for low-fee investors and based on what I’ve seen in my review of law firm 401(k) plans, you are likely to find low cost options that can keep your total fees well below that threshold.

Finally, I’ve heard some people complain that you can’t take advantage of tax-loss harvesting inside a retirement account. That’s true. So what? You should max out retirement accounts first anyway before you start filling your taxable account. Contributing to taxable accounts as a priority over retirement accounts just to be able to take advantage of tax-loss harvesting strikes me as a pretty foolish move.

Let’s talk about it. Are you convinced that retirement accounts save you money on your taxes? I hope so, otherwise my writing and persuasion skills need a lot of work! These things should sell themselves! Leave a comment below.

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Wealthy Lawyers Found: Next Door! http://www.biglawinvestor.com/wealthy-lawyers-found-next-door/ http://www.biglawinvestor.com/wealthy-lawyers-found-next-door/#respond Wed, 19 Apr 2017 10:00:00 +0000 http://www.biglawinvestor.com/?p=2934 Check out The Biglaw Investor or read Wealthy Lawyers Found: Next Door!

Today’s post comes via an article I wrote for Law Practice Today about the problems with lawyers and the under accumulation of wealth. Here’s an excerpt from the article: If you’re at all familiar with The Millionaire Next Door: The Surprising Secrets of America’s Wealthy, you’re probably aware that the authors found a disproportionate number […]

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Today’s post comes via an article I wrote for Law Practice Today about the problems with lawyers and the under accumulation of wealth. Here’s an excerpt from the article:

If you’re at all familiar with The Millionaire Next Door: The Surprising Secrets of America’s Wealthy, you’re probably aware that the authors found a disproportionate number of millionaires clustered in middle-class and blue-collar neighborhoods and not in the more affluent or white-collar communities.

The reason? High-income white-collar professionals were more likely to allocate income to consumption items and to forgo savings and investments.

Lawyers fit firmly into what the authors described as UAWs (Under Accumulators of Wealth), which is particularly troublesome given the advantage of having a higher income than the nation’s average.

If you’re a young lawyer just starting out (or an older lawyer taking a fresh look at your finances), what steps can you take to accumulate wealth and build a solid financial future?

You can read the rest of the post here: The Millionaire Lawyer Next Door and then come back and leave a comment below.

Let’s talk about it. What’s the number one reason why lawyers are UAWs (under accumulators of wealth)?

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5 Big Money Items For Law Students http://www.biglawinvestor.com/five-big-money-items-for-law-students/ http://www.biglawinvestor.com/five-big-money-items-for-law-students/#comments Mon, 17 Apr 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=2897 Check out The Biglaw Investor or read 5 Big Money Items For Law Students

During law school it’s easy to feel like your personal finances are out of control. If you’re taking on student loans, it quickly starts to feel like Monopoly money and it’s difficult to budget when you receive a lump sum every semester. However, the truth is that your law school years are dramatically influential on […]

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During law school it’s easy to feel like your personal finances are out of control. If you’re taking on student loans, it quickly starts to feel like Monopoly money and it’s difficult to budget when you receive a lump sum every semester. However, the truth is that your law school years are dramatically influential on the life you’ll live once you graduate and start your first job. Here are the five big ticket items every law student should be thinking about.

Limit Law School Loan Borrowing

Your number one goal in law school should be leaving with the smallest amount of loans possible. While this may seem like obvious advice, many law students (myself included) start to treat law school loans as funny money. Think you’re immune? Walk through this thought experiment with me. What’s the difference between student loan debt in the following scenarios: (A) $0 and $10,000 of debt; and (B) $130,000 and $140,000 of debt?

Duke University professor Dan Ariely wanted to know how people related to the value of free (or, in our example, zero debt). He conducted an experiment where he offered college students a choice between Lindt truffles (fancy chocolate) priced at 15 cents or Hershey Kisses (standard chocolate) at 1 cent. The college students split with 73% choosing the Lindt and 23% choosing the Hersheys.

Ariely then adjusted the price of both chocolates downward by one cent, such that the Lindt cost 14 cents and the Hershey Kisses was free (but the difference between the two remained the same at 14 cents). If people are purchasing the Lindt chocolate because of it’s value relative to the Hershey Kisses chocolate, you wouldn’t expect a change in the preferences of the college students since the price difference held steady at 14 cents between the two chocolates.

Yet, when Ariely conducted the second experiment, 69% of the college students chose the Hershey Kisses while only 31% wanted the Lindt.

What this teaches us about human psychology is that zero means a lot to us.

Applying this to your law school loans, it’s helpful to understand that at a certain point you may not feel the pain of borrowing an additional $10,000. This type of thinking does the most damage in your second and third year of law school when the expenses keep adding up. To remain vigilante, you should challenge your spending during law school to keep those loans as low as possible.

One way to keep expenses low is to use a tool like Mint and YNAB (You Need A Budget) that can help you keep track of spending even if budgeting isn’t your thing. YNAB is especially helpful in allowing you to portion your student loan money into monthly amounts, something that is hard to do when you often receive a lump sum at the beginning of the semester.

The second obvious way to limit your law school expenses is to find part-time employment (in addition to any summer jobs). In 2011, the American Bar Association recommended removing from its standards the previous requirement that a law student must not be employed more than 20 hours per week because of the unprecedented financial strain on law students. Freed from these requirements, there should no longer be a stigma associated with working while you are in law school. This is particularly true during your second and third year of law school when your grades and outside activities may be less relevant to you post-law school career.

Law School is a Great Time to Start a Roth IRA

There are two major types of retirement accounts. The first type is funded with pre-tax dollars and includes accounts like the 401(k), 457(b) and Traditional IRA. These accounts allow you to save on your tax bill today and let the money grow tax free, but you will eventually pay income tax when you make withdrawals in the future. The second type is funded with post-tax dollars (Roth 401(k) and Roth IRA). You pay taxes on the income upfront, but the funds grow tax free and are tax free when you make qualified withdrawals in the future.

You may not have thought about retirement accounts much yet, but they are a great vehicle for building wealth. In particular, the Roth IRA offers a lot of advantages during years when you have a low income. Since you pay taxes upfront, any money funded in your Roth IRA account during a low income year is likely to be taxed at a 10% or 15% rate. Since you’ll never have to pay taxes on Roth money again, it’s to your advantage to contribute as much as possible during low tax years.

Another great benefit of the Roth IRA is that you are allowed to withdraw your contributions at any time without needing to pay any penalties or tax. This is because the contributions are made with post-tax money. That means a Roth IRA can double as an emergency fund when you’re getting started. If an emergency never happens (a much more likely scenario), you’ll be glad that the you took advantage and contributed the money to a Roth IRA account.

When I was in law school, I actually borrowed more money than I needed to fund my Roth IRA. Don’t forget that you still need to have earned income in order to be able to contribute to a Roth IRA (you can’t just use your loan money).

Begin Your Financial Education

Law school is a great time to begin your financial education. While many lawyers joke that they went to law school “to avoid math”, managing your personal finances and student loans is a part-time second job that you have (whether you know it or not). Many lawyers will seek assistance from financial planners to help manage their money. There’s nothing wrong with this, but you’ll want to make sure that you’re getting good advice and that you’re paying a fair price for the advice. In order to make sure you’re getting good advice, you need to understand the difference between a commissioned salesperson and someone who has owes you a fiduciary obligation.

At a minimum, you need to understand the vocabulary of personal finance in order to speak intelligently with your financial advisor. That means knowing the basics of tax-protected accounts like 401(k)s, Roth IRAs, Health Savings Accounts and the basics of investing like index funds, the S&P 500, etc.

The good news is that you can learn the basics pretty quickly by reading 1-2 books a year or following a personal finance blog. Similar to learning the law, a lot of the work is just becoming familiar with the concepts themselves, so don’t be concerned about a need to develop a deep mastery of personal finance. Think of it as the different between being fluent or conversational in a foreign language. You must at least be “conversational” in personal finance.

Now is a Great Time to Be Poor

People tend to move one way in lifestyle inflation – up! And you rarely, if ever, move backwards.

As a law student, the lifestyle you choose to live today sets the foundation for your lifestyle inflation going forward. If you start out at the bottom, you have a lot more room to experience lifestyle inflation than if you start your legal career living an upper middle-class lifestyle.

One of the great things about law school is that it’s a perfect time to be poor because everyone around you is poor. It’s easy to fly home on a Wednesday (or whenever happens to be cheapest) and fun to gather with your friends for $1 beer nights. This will change as your peers get older and particularly when they start making money. Before you know it you will find yourself at fancy bars and restaurants, spending considerable amount of money to hang out with friends. Take advantage of the fact that your peers are poor to be poor yourself. You won’t miss spending the extra money in law school.

The real takeaway here is that if you can stretch out the law school years for the first 3-5 years of your career, you’ll be setting yourself up for great financial success in the future. It shouldn’t be that hard to “live like a law student” at first since almost any amount of money you’ll make during your first year of working will be substantially more money than you’ve ever received in the past. Living like a law student for the first 3-5 years gives you the opportunity to contribute to retirement accounts, knock out student debt and start saving for a down payment.

Consider Financial Implications of Where You’ll Practice Law

The cost of living varies greatly in the United States. The biglaw lawyers in Houston are making the same salaries as those in San Francisco, but with a vastly different quality of life. And that’s not to say whether living in San Francisco or Houston is better or worse, but that it’s a good idea to think about the geographical arbitrage available to you when you’re planning your future. It’s much harder to move around later in life.

Apartments in Chicago might cost you 2/3 of the price of a one bedroom in Manhattan. If your goal is to accumulate money quickly once you graduate, you stand to have a better chance of doing so if your living expenses are reduced. This matters because your debt dollars don’t discriminate as to cost of living. Your law school loans will be the same no matter which market you work in.

Considering these five items as a law student will put you in good standing to begin your career on the right financial foot.

Let’s talk about it. For the lawyers, what mistakes did you make in law school? What are some other things law students should be thinking about?

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How Much Did I Pay? 2017 Tax Report http://www.biglawinvestor.com/2017-tax-report/ http://www.biglawinvestor.com/2017-tax-report/#comments Fri, 14 Apr 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=2913 Check out The Biglaw Investor or read How Much Did I Pay? 2017 Tax Report

Taxes are one of the reasons I started The Biglaw Investor. I have no problem paying them, I just didn’t realize how big of an impact they’d have on building wealth when I was back in law school. For many years now I’ve done my own tax preparation. I’m sure this saves a little money […]

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Taxes are one of the reasons I started The Biglaw Investor. I have no problem paying them, I just didn’t realize how big of an impact they’d have on building wealth when I was back in law school.

For many years now I’ve done my own tax preparation. I’m sure this saves a little money but I mostly do it to learn the tax code.

Ever since I started working in Biglaw my knowledge of the tax code has skyrocketed and continues to grow. I learn something new each year. Yet, I still consider myself an amateur. Tax knowledge is the area where I’d like to improve the most and I think doing a post like this year each year will help.

Despite my amateur tax status, the biggest lesson I’ve learned is that the big boost to savings money on taxes comes in tax planning for the next year. If you’re trying to save money when you’re filing your taxes, you’re probably too late.

So, without further ado, here’s how I did this year on my taxes and what I’m planning on doing for the coming year.

What Did I Pay In Taxes?

Living in a high cost-of-living city means I’m subject to substantial taxes at all angles. This means it takes a little extra work to figure out my effective tax rates each year. I don’t just want to trust the number from Turbotax.

To figure out my effective tax rate, I use my gross income as the denominator (i.e. line 22, plus 401(k) contributions, plus all of the exempt wages and section 125 wages). Those additional exempt wages are things like healthcare insurance premiums, HSA contributions and qualified transportation expenses that come out of your income and are not reported on Box 1 of your W-2. My W-2 statement has a handy box at the end detailing my “gross wages”. See if yours does too. The numerator is simply the amount of taxes I paid.

2016 Effective Tax Rates

  • Federal: 22.53%
  • Payroll: 4.22%
  • Obamacare: 0.3%
  • State + City: 9.25%
  • Total: 36.00%

There’s a few things that jump at me when I do this analysis:

(1) My doctor friends taking advantage of geographic arbitrage by earning high salaries in low cost-of-living places are making out like bandits. It’s not cheap to live in NYC and I paid 9.25% of my gross income to New York State and City as a privilege. Shout out to my Texas Biglaw lawyers earning the same salary but paying zero in state and city income taxes. That’s a significant amount of extra cash you’re keeping.

(2) The percentage paid to the federal government seems lower than you’d expect if you just looked at the tax brackets. Yet, I’m still paying a higher federal rate than I would like to be. I need to keep making decisions that open up more and more tax-advantaged accounts so that I can shelter more income in the future.

(3) The overall effective rate at 36.00% is still pretty high. It’s a privilege to live in the United States, so I don’t mind paying it, but I’m still happy to modify my behavior as it suits the government so that I can effectively pay less taxes. That’s the point of paying attention to your taxes each year and making additional tweaks as time goes on (ironically, I’m paying about the same percentage of my income in taxes today as I did when I was a first-year associate, so that’s a pretty good win in my book).

(4) The Obamacare additional Medicare tax is pretty small.

(5) Total taxes paid were nearly 4 times my entire salary at my first full-time job.

2016 Marginal Tax Rate

Tax software is a great way to figure out your marginal tax rate each year. You can just add $1000 to your earned income and then see how much additional federal and state taxes you have to pay. For me, my federal tax + payroll goes up by $350 and my state and city taxes go up by $106 for a total additional tax due of $456.

Therefore, my marginal rate is 45.6%.

That means each additional dollar earned will see 46 cents paid in taxes. The flip side is also true – each dollar saved in a pre-tax retirement account will reduce my tax bill by the same amount.

Here’s Why I Paid What I Did

People want to know what they can do to reduce taxes and drive down their effective tax rate. I’m all about figuring that out too.

One thing to keep in mind is that my actual effective tax rate is even lower than the number above because a lot of income is now being generated in retirement accounts. The interest, dividends and capital gains in those accounts do not show up as income on my tax return and I plan on keeping it that way.

So, what can you do to lower your taxes?

1) Retirement Account Contributions

Retirement accounts take a little bit of effort to set up. But once you start building up cash in tax-advantaged space, it becomes obvious pretty quickly that they are good for your finances. Generally, I’m always looking for more tax-advantaged space and making decisions that lead to more retirement accounts being available to me. It first started with the 401(k) followed quickly by the Backdoor Roth IRA. Once I switched to a firm that offered a High-Deductible Health Plan, the Health Savings Account became the next retirement account available to me. There are more accounts on the horizon.

But for 2016, I made the following contributions:

  • 401(k) – $18,000
  • Backdoor Roth IRA – $5,500
  • Health Savings Account (aka Stealth IRA) – $3,350
  • Total: $26,850
  • Total Deductible: $21,350

If you also want to pay less taxes, you should figure out a way to avoid paying taxes on $21,350 of your income.

While I will eventually have to pay taxes on the amount in the retirement accounts, I am very confident that I’ll be able to access it at an effective rate that is significantly lower than my current 45.6% marginal tax rate. Saving taxes at 45.6% and then paying them later at something like 20% is a winning proposition every time.

2) Losses and Tax-Loss Harvesting

Nobody likes losing money, but when you do the government and taxpayers are willing to share in your loss. Thanks to a few times where I swung for the fences early in my career, I have carry-forward capital losses that I can apply against my current income. I also have taken advantage of tax-loss harvesting to generate additional paper losses. This allowed me to deduct $3,000 against my income this year and I have capital losses that will carry forward for the next few years.

3) Maximizing Other Tax-Free Benefits

My W-2 has a handy table on the last page that shows me my “gross wages” which includes not only the compensation reported on Box 1 of my W-2 but things like HSA contributions, health insurance premiums and qualified transportation expenses (i.e. monthly commuter card). Excluding 401(k) and HSA contributions, I was able to shelter another 1.4% of my income through participation in the various benefits offered by my firm. That may not seem like much but it resulted in over $1,000 added to my bottom line.

4) Charitable Contributions

While charitable giving was lower this year than I would have liked, if you’re itemizing your deduction (most of you in Biglaw), don’t forget that all of your charitable contributions are tax free.

Most people remember this for things like $50 and $100 checks you write to support a favorite cause, but did you also remember that all of your donations to the Salvation Army are also deductible?

If you live in a big city like us, I bet you’re always putting together a bag or two for donations. I lay everything out before I donate it and take a picture which is then saved in my taxes folder for the current year. You could also use ItsDeductible.com in connection with Turbotax to keep track throughout the year.

Not Everything Was Good …

Part of doing my taxes each year is learning what didn’t help, even if it seemed like a good decision at the time. Here’s what didn’t help lower my tax bill.

1) Paying Taxes

Typically, you can add your state and city tax payments to Schedule A as part of your itemized deductions. This is helpful since it prevents you from paying federal taxes on the money that you pay to state and city governments. So, one would think that living in a high state and city location has at least some benefits.

Of course, you’d be wrong to make that assumption, since the Alternative Minimum Tax effectively eliminates a taxpayer’s ability to claim state and local tax deductions. In order to see if you’re subject to AMT, you run your taxes through two parallel tax systems (ordinary taxes and AMT). You pay the higher of the two taxes.

I continue to be subject to AMT, which means that my high state and local taxes are worthless when it comes to catching a tax break (although they do help me cross the threshold for itemizing deductions, therefore making other Schedule A deductions more valuable than they would be if I were taking the standard deduction).

2) Capital Gains and Dividends

It seems like a great thing when your taxable investment account is spitting off capital gains and dividends. You’ve invested in many companies. Those companies are doing well, making money, and they’re sharing part of that profit with you, the owner. The problem is that you really don’t need this income during the accumulation phase of your life when you’re in the highest bracket you’ll ever be in. But you don’t really get a choice in the matter as the dividends keep coming and you’re forced to pay taxes on the income.

Here’s one example of an income-generating asset I liquidated this year:

  • Sold off shares in British Petroleum. I haven’t been immune from trying to pick stock winners and have been slowly unwinding my positions (this was the last individual stock I owned). BP paid pretty handsome dividends to me year after year, including $1,200 worth in 2016. While I was happy to receive the income each year, I’ve known for awhile now that earning $1,200 in dividends and then paying 15% capital gains on the dividends wasn’t the best deal. Instead, I’d rather lock that money up in an index fund that mostly grows through capital appreciation. With capital appreciation, I get to decide when to sell the shares and therefore when to trigger the taxes (if you’re interested in more about this, see the book review of The Overtaxed Investor).

3) Other Reasons I Paid Higher Taxes

At my income level, your deductions start to phase out thanks to Donald Pease and the phase out. This is really just an extra 3% tax on high-earners and there’s nothing I can do to avoid it.

The AMT is a similar problem that continues to keep me within its grip. This year the AMT amounted to 8.7% of my total Federal income tax. There’s not much you can do about AMT besides increasing your income so that eventually you accelerate out of it.

Reminder About Form 8606

If you completed a Backdoor Roth IRA this year, here’s my annual reminder to make sure the tax software correctly filled out Form 8606. Form 8606 shows your Backdoor Roth IRA contribution and you want to make sure Line 15 (Taxable amount) shows $0.

Form 8606 - Backdoor Roth IRA

Tax Planning for 2017

As mentioned at the beginning of the post, the most important aspect of doing your taxes is planning for the next tax year. I intend to continue to save as much pre-tax as possible, which will include maxing out my individual retirement accounts:

Additionally, since I’m getting married this year, we will also take advantage of three other retirement accounts available to us:

Total: $68,400

You can save a lot of money on taxes if you’re able to shelter $68,400 from income taxes. I’m always looking for more ways to stuff money into tax-advantaged accounts and only expect this number to grow each year.

Having eliminated all my individual stock holdings, I’m now on a path to generate significantly less dividends and capital gains next year. While those seemed nice on paper, I have no need for he income right now and am happy to exchange them for capital appreciation.

Overall, I’m pleased with the progress I’ve made over the last 5 years in keeping my tax bill as low as possible. I look forward to continuing the challenge next year!

Note: There is a poll embedded within this post, please visit the site to participate in this post's poll.

What do you think? What was your effective tax rate this year? What are you doing to lower it? Comment below!

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I’m Paying $7/mo for My iPhone Plan http://www.biglawinvestor.com/cheap-iphone-cell-plan/ http://www.biglawinvestor.com/cheap-iphone-cell-plan/#comments Wed, 12 Apr 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=2889 Check out The Biglaw Investor or read I’m Paying $7/mo for My iPhone Plan

Before I launch into an extremely detailed tactical post about how and why I’m only paying $7 a month for my iPhone cell phone bill, I want you to know that I’m a pretty normal guy. It just so happens that I love efficiency and find it almost offensive when something isn’t as efficient as […]

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Check out The Biglaw Investor or read I’m Paying $7/mo for My iPhone Plan

Before I launch into an extremely detailed tactical post about how and why I’m only paying $7 a month for my iPhone cell phone bill, I want you to know that I’m a pretty normal guy. It just so happens that I love efficiency and find it almost offensive when something isn’t as efficient as possible. But other than that – normal guy.

If you’re like me, I know a couple of things about you already: (1) you have a smartphone and (2) you pay thousands of dollars for it.

And, I know that you didn’t have a smartphone 10-15 years ago.

I’ll also venture to say that you probably aren’t any happier today in any way directly because of that smartphone.

Don’t stop reading just yet!

I didn’t give up my smartphone, remember? I still love my iPhone.

I couldn’t get rid of it even if I wanted to. Being a lawyer means having to check your email constantly, since one of our biggest selling points is being always available to clients.

But just because I need to have a smartphone, I wasn’t convinced that I needed to pay so much money for it, especially the nearly $100 I typically spent each month.

After months of experimentation, I’m here to tell you that we’ve all been had. There is a better way.

Examine Your Cell Phone Bill

Background: Previous to seeing the light, I had an unlimited talk, text and 2GB plan with Verizon.

There are three main services provided by the cell phone carriers: (1) SMS; (2) Voice and (3) Data.

SMS. Each text message uses about 140 bytes of data. If you send 1000 text messages a month, you’ve used an astonishingly small amount of data (0.13MB). Even a teenage kid that texts 100,000 times a month is only burning through 13MB of data. I think we can all agree that “unlimited” texting is hardly a great value.

Voice. I don’t know about you, but I use the voice part of my phone a lot less than I did 10 years ago. Pretty much everything I need to do is coordinated over text messages (and not the SMS kind). Yet, most people would say that voice service is essential. I’m not going to dispute that, just asking you how often you really use it.

Data. Now here’s something I actually use. In fact, I use data all the time. I use it for streaming videos, checking sports score, reading the news and so much more. But the fact is that I also spend the vast majority of my time in two locations: home and work. The commonality between those locations? Tons of wifi. There’s only a few situations where I’m not on wifi: commuting (although the MTA recently added great wifi service to every train station), traveling and when I’m out and about.

So those three components make up your $100 cell phone bill. Texting, Voice and Data services.

She’s not using her phone to talk to a person (or Siri).

Now let’s look at how modern phones work.

Examine Your Office Phone

Have you looked at the backside of your desk phone recently?

Chances are pretty good that it’s missing a copper wire that connects it to the phone network.

Here’s the back of my office phone:

That’s right. No phone lines. It’s all data.

That’s right. The box in your office that is only good for the voice portion of a modern cell phone plan is entirely run over the internet.

This got me thinking – why do I need a voice plan for my cell phone? Couldn’t you just run everything over the internet the same way?

It turns out you can.

That’s what I’ve been doing for the past six months.

I’ve had countless conference calls, phone conversations with clients, partners and work-from-home days. Yet, I stopped paying for my fancy Verizon voice plan last summer.

I’ve run the iPhone solely on a data plan and I’ll show you how I did it.

I suspect the vast majority of you will reject this idea for yourself. That’s okay. There’s still something here for you too: your cell phone bill doesn’t have to be that expensive. If you’re paying $60 a month for phone service, you can easily drop that down to $20 or less without sacrificing a thing.

If you just want to keep your same level of service buy pay 1/3 the price, skip the next section.

How I Switched to a Data-Only Plan

Again, I’m guessing only a small minority of the readers will be interested in doing this. I’m not even sure I can recommend this for most people because if you’re not super comfortable with technology, this might be more trouble than it’s worth. That’s okay. I just wanted to share, particularly since it’s been working for me for six months now.

If you follow these steps, you’ll end up with your current number at Google Voice and a data-only plan from a company called Charge.co. You’ll use Google Hangouts or Facetime Audio for all of your voice calls (mostly over WiFi). You’ll also use Google Hangouts for texting. You will also still be able to use iMessages but messages will come from your email address rather than your phone number.

Step 1. Order a SIM card from a data-only provider.

I ended up using Charge.co as my data provider. They run on the Sprint network. Living in NYC I haven’t noticed a problem with the Sprint network.

Here’s a summary of their data-only plan:

If you sign up and enter this referral code, you’ll get a free 1GB of data: E7SG3PLE

Step 2. Port Your Current Number to Google Voice.

If you want to keep your current number, you’ll need to port it over to Google Voice. This will cost $20. It might take a day or two while the number is ported.

Then, you’ll need to download the Google Hangouts app and connect it to your Google Voice number (which is now your previous phone number).

After this, there’s nothing to pay for. Google Hangouts is free for unlimited texting and calls within the United States. You can make calls on Wifi or over LTE.

Step 3. Add the Data-Only SIM from Charge

Once you install the data-only SIM from Charge, you’ll be on their pay-as-you-go plan that charges $13 per GB used. Since you’re now actually paying for the data you use, you’ll probably want to take steps to reduce your data usage. That’s not too hard if you focus on using your phone when you’re in Wifi situations.

How it Works

Here’s how the following things work:

(1) Texting. This works like normal, except that I use Google Hangouts for all texting conversation. Since a lot of my friends have iPhones, most new conversations from those friends start with an incoming text message from Google Hangouts. I often reply back via iMessage and then those conversations stay in iMessage.

(2) iMessage. This is a bit unfortunate, but your iPhone will only recognize one phone number as your iMessage number and that’s the number assigned to your SIM card. Even though you only have a data-only plan through Charge, you still have a phone number tied to it. Since I wanted to keep my old number, I ported it to Google Voice and now my friends and family try to send iMessages to it. Now that it’s not associated with an iPhone, those get routed over the SMS network and end up in Google Hangouts. I wish Apple would allow you to prove ownership of a phone number other than the one assigned to your SIM card for purposes of associating that number with iMessage but until they do, this is a bit of a problem. If you are cool with switching your number entirely, you could just use the new number from the Charge SIM for iMessages going forward.

(3) Phone Calls. Most of these take place on my office phone, which I now have installed at work and at home (yes, if that sounds like cheating, it is). If I’m on a Wifi network, calls come in via Google Hangouts. I don’t always catch them, but I can either call the person back via Google Hangouts or on the office phone.

(4) Phone Calls Outside of Wifi. Turns out this barely ever happens, but when it does I can make calls over Google Hangouts (to any number in the US) over LTE. I can also call people who own iPhones by using Facetime Audio.

(5) Data. Works just like it always did.

(6) Cost. I am spending about $7 a month on this plan, which includes the $3 monthly fee and then about $4 worth of data (about 1/3 of a GB a month).

Here’s a photo of me in action:

Funny, right? Double-breasted suit with peak lapels. So 1992.

Other Ways to Save Money on Mobile Phone Plans

Okay, so you’re not crazy and you have no interest in going through all the complicated steps above.

I completely get it. I almost didn’t publish this post but the reality is that I learned a lot of things through the process that I think you might find helpful.

The first is that there’s this whole world of MVNOs out there (it stands for Mobile Virtual Network Operator). Essentially, these companies rent network space from the only four companies that actually have towers: Verizon, AT&T, Spring and T-Mobile.

The MVNOs provide the service for much cheaper than the big four carriers using the exact same towers.

So, what’s not to love? Same service. Cheaper price. The only difference is that you might not be able to run the latest phone.

I tried a bunch of different MVNOs during this experiment. I couldn’t tell a difference between the service they provided and Verizon, except that they typically have low-tech websites. It was universally pretty easy to switch back and forth between the MVNOs. You just pop in and pop out the SIM cards.

I tried about four or five different MVNOs during this experiment. All worked great and I’d happily switch back to them, except that I ended up on this data only plan which is working fine.

Here’s a few that are worth looking into (keep in mind that MVNOs seem to come and go, so if you transfer your number to them you run the risk that they’ll close up shop one day and it’ll be a pain to transfer your number out. I think they try to avoid this at all cost, but this is the wild west so proceed with caution):

I know I tried more MVNOs but waiting six months to write the post has dulled my memory. Here’s a huge list of MVNOs from Wikipedia. I also found this guide pretty helpful.

Will I Keep This Crazy Experiment Going Forever?

I have no idea if I’ll continue with my data-only cell phone plan. I’ve been pleasantly surprised by the lack of hassle, so I’ll be sticking with it as long as it works.

I do know that if/when I switch back to a regular phone plan, I will definitely go with a MVNO. I couldn’t tell a different in service between an MVNO and my plan from Verizon, so why pay $100 a month when you get the same thing for $40?

Happy to answer questions below or over email. We’ll be back to our regularly scheduled personal finance posts this Friday.

Update 1 (9:34am): I completely forgot to mention VPN and using public Wifi. I am also concerned enough about using public wifi that I bought a cheap subscription to Cloak (only $2.99/mo for 5GB of data, scroll down for “Mini Plan”). You tell it which networks you trust (like home and work) and then it automatically starts using VPN if you connect to any other network. Here’s a photo of my iPhone connected to the MTA subway. I haven’t noticed any type of performance issues using Cloak. Of course this means you need to trust Cloak with your data but I find this a better option than connecting to public Wifi without a VPN service. Thanks to Franklin for reminding me about VPNs in the comment section below.

Let’s talk about it. Is this crazy? Too much work? How much are you paying for your cell phone and does it seem worth it?

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Ugh, Your Spouse Has Debt Too? http://www.biglawinvestor.com/ugh-your-spouse-has-debt-too/ http://www.biglawinvestor.com/ugh-your-spouse-has-debt-too/#comments Mon, 10 Apr 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=2867 Check out The Biglaw Investor or read Ugh, Your Spouse Has Debt Too?

One of the benefits of running this site has been getting to know you and the many other regular readers. I’ve learned that everyone’s situation is unique, even if the general principles of good financial health apply across the board. One common theme I’ve seen is that people start thinking about finances at different points in […]

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One of the benefits of running this site has been getting to know you and the many other regular readers. I’ve learned that everyone’s situation is unique, even if the general principles of good financial health apply across the board.

One common theme I’ve seen is that people start thinking about finances at different points in their lives. Some start during law school, while others have been practicing for several years before they decide to get everything in order.

It seems the ones that are forced to confront money issues sooner rather than later are those married to a spouse that also has debt. Sometimes we think that only lawyers are struggling with the student loan debt monster, but it’s a rare modern couple that isn’t battling debt on two fronts.

So, if you think $200K of student loan debt is bad, how about $350K in combined debt? What about $450K? Or $600K?

I recently corresponded with one such reader from the Pacific Northwest that has a combined debt load of about $350K between the two (one is a lawyer the other is not).

They have a healthy combined income of about $125K but with a debt balance of nearly 3x their income and interest rates in the 6.8% range, it’s difficult to make progress (interest at that level is about $24K/year or $2K a month even before you touch the principal balance).

So what is a couple like this to do? Here are a few of my ideas.

It’s Time to Think Different

Remember the Think Different Apple campaign from the late 90s?

Yes, if you have $350K in student loan debt, it’s time for you to think different too. And thinking about buying Apple products is probably not the way to go here.

Not only are you broke, you’re $350K away from broke. This is a huge problem that will take you years to get back to zero. Yet, getting back to zero you must, whether that’s repayment or forgiveness.

Realizing that you owe so much doesn’t have to be a depressing experience (although it usually is). It just means acknowledging the facts of the situation and deciding to take action.

Because once you start to conceptualize that you’re absolutely broke, you’ll also realize that you’re in no position to do a lot of things like (1) buy a house; (2) help out family members; (3) live in a high cost-of-living location or (4) live in a certain way because “you’re at that stage in life”.

All of those things go out the window when you decide you want to solve this problem as soon as possible.

The good news is that if you’re reading this post, your mindset is probably 95% of the way there. It’s just the unpleasant thought of paying off the debt that lingers (don’t worry, we’ve all been there).

Now is the time to develop a plan.

The plan is to pay off your student loan debt.

Public Student Loan Forgiveness

PSLF is getting a lot of press lately, with many wondering if they qualify for PSLF or whether PSLF will go away. Despite the concern over the program, it would be silly not to consider PSLF as a possible solution to the debt.

If one or the other has the opportunity to work for the government or a 501(c)(3) organization, PSLF could provide non-taxable forgiveness in 10 years. If one spouse has the bulk of the debt, it may be beneficial for that spouse to find work that qualifies for PSLF while refinancing the other portion to pay it off quickly.

I like to use a back-of-the-envelope calculation to consider whether a PSLF-eligible job is “worth it”. Let’s say one spouse has $200K in student loan debt and is considering taking a paycut to work at a PSLF-eligible job.

Since the $200K will be forgiven in 10 years, one way to compare the PSLF-eligible job with a non-PSLF job would be to divided $200K by 10 years to get the roughly $20K in “benefit” you’ll receive annually from the PSLF-eligible job.

Of course that money essentially comes to you tax free, so you’d probably need closer to $30K in extra pre-tax income to equal the $20K in benefit you receive from the PSLF program.

So with $200K of debt, 10 years left on the program and deciding between two jobs where the PSLF-eligible job pays $70K and the non-PSLF job pays $100K, you might roughly consider them equal. Of course, there are better tools out there to compare the value of PSLF, such as this calculator. (Ed Note: The creator of that calculator, Travis at Student Loan Planner, is a paid sponsor of the site but his spreadsheet is free and a truly helpful tool for comparing the different repayment options.)

The point is that it’s absolutely possible to quantify the value of PSLF so that you can make good decisions about whether the PSLF job is “worth it”, particularly if you’ll take a salary cut.

Increase Income

If counting on a government program to perform as expected isn’t your preferred approach, there’s always the possibility of taking control of the situation yourself.

To do that, there’s only so much defense you can accomplish by reducing expenses. You’ll probably get a lot more value out of working to increase your income.

Thankfully, there’s a lot you can do. Some of the ways to boost income are short term (like renting a room on AirBnB or starting a side hustle). Just look at what this lawyer has accomplished by picking up a few side hustles. Could you do that? Of course you could!

Some of the ways to boost income take more time, like switching jobs or finding a more lucrative practice area. It’s still a great idea to plant these seeds today because tomorrow will come sooner than you think.

Sometimes the best way to increase your income is to switch jobs. Don’t be afraid of sending out your resume and going on a few interviews to test the market and see what else is out there. You can get all the way up to the point of receiving a job offer and still say no. There’s no harm in exploring.

All-Out Warfare

The great thing about $125K in income and $350K in debt is that it’s not an insurmountable problem.

What if they wanted to get rid of the debt in 4-5 years. Could they do it?

If you said “NO!”, that’s the wrong attitude! You may not want to give up the creature comforts (who would?), but don’t forget that all-out warfare on the student loan debt is perfectly possible.

This doesn’t mean a gradual adjustment where you slowly reduce expenses and throw an extra $1000/month towards the debt. All-out warfare is a radical lifestyle change.

A couple with this much debt could:

  • Refinance their student loans
  • Move back in with parents
  • Pick up side income (adjunct teaching, Uber, Postmates, etc.)
  • Cut expenses to the bone (goodbye eating out, smartphones, traveling)

With TWO people working together to eliminate the debt, there are a lot of options to make serious headway on the debt while keeping each other motivated.

You wouldn’t be alone either. There are couples living on $14,000 a year. I certainly would find that too extreme, but sometimes people forget that all-out warfare is an option. If you really want to get out of debt, what’s a couple of years of living on the bare minimum? You might even find that you like it when you get rid of your stuff.

And what happens if after 18 months you decide you’re tired of this approach and need to change up your strategy? Well, maybe you’ve paid off $150K and are now only staring down $200K of debt. That’s hardly a bad position to be in.

Let’s talk about it. What would you do if you had $350K in student loan debt? Any advice you’d give this couple?

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Does Anyone Know If They Qualify for PSLF? http://www.biglawinvestor.com/do-you-qualify-for-pslf/ http://www.biglawinvestor.com/do-you-qualify-for-pslf/#comments Fri, 07 Apr 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=2849 Check out The Biglaw Investor or read Does Anyone Know If They Qualify for PSLF?

Many of you have written to me or tweeted about the recent development in the ongoing lawsuit between the American Bar Association and the Department of Education over whether the American Bar Association is a “qualifying employer” for purposes of the Public Service Loan Forgiveness Program. The ABA sued the Department of Education on December […]

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Many of you have written to me or tweeted about the recent development in the ongoing lawsuit between the American Bar Association and the Department of Education over whether the American Bar Association is a “qualifying employer” for purposes of the Public Service Loan Forgiveness Program.

The ABA sued the Department of Education on December 20, 2016 after being unable to resolve a dispute in which several of its employees, who had previously been told by FedLoan Servicing that their employment with the ABA “counted” toward the PSLF program, were retroactively denied certification.

The ABA’s complaint set forth the facts of the lawsuit, argues that the ABA is a “qualifying employer” and that the courts should force the Department of Education to recognize the ABA accordingly. Further, the ABA argues that by first approving the ABA as a “qualifying employer” there are now individuals who have spent years working in public service with the understanding that those years would count towards PSLF forgiveness.

The Department of Education responded on March 23, answering the ABA’s complaint. I’m not a litigator, but in what I believe is a typical response, the ABA went through each complaint and either admitted, denied or stated that they had a lack of knowledge or information sufficient to either confirm or deny the particular allegation.

The part of the Department of Education’s response that sent a chill through the air came when the DOE answered complaint 58. In complaint 58, the ABA alleged that “borrowers are encouraged to file an ECF each year. This is a way for an employee to verify that her employment qualifies for PSLF …”

The Department of Education agreed that FedLoan Servicing encourages borrowers to submit an ECF annually but disagreed that employees can verify that their employment qualifies for PSLF through the ECF.

That’s worth repeating: FedLoan Servicing’s response to an ECF doesn’t mean anything. The agency is saying it can change its mind.

This is a problem. Does the Department of Education really believe that people should work for 10 years in a “public interest” job and then figure out whether their work qualifies for forgiveness?

And that ties into the lawyer who dutifully filed an ECF each year and received confirmation that his employer counted as a “qualifying employer”. What did the Department of Education say with respect to each time FedLoan Servicing told him his payments counted towards PSLF?

They admitted that it was a “tentative” acceptance. What else could they say, I guess?

How Do You Know If You Qualify?

As of now, there is NO WAY to know whether your employment officially counts in the PSLF program but it’s important to understand that we’re only talking about a sliver of the prong and not the whole program in general.

Here’s what we do know:

You must work for a qualifying employer.

Here’s the definition of qualifying employment:

Qualifying employment includes employment by the government, employment by a not-for-profit organization that is tax-exempt under Section 501(c)(3) of the Internal Revenue Code, AmeriCorps position, a Peace Corps position, or employment at a public service organization.

Everything but the “public service organization” is pretty clear.

What’s a public service organization?

A public service organization is a private not-for-profit organization that is not a labor union or a partisan political organization and that provides at least one of the following public services: (1) emergency management, (2) military service, (3) public safety, (4) law enforcement, (5) public interest legal services, (6) early childhood education, (7) public service for individuals with disabilities and the elderly, (8) public health, (9) public education, (10) public library services, (11) school library services, or (12) other school-based services.

It’s here that there is confusion and I’m willing to bet it extends far beyond the American Bar Association.

My theory (completely unverified) is that the Department of Education is looking for ways to push certain organizations out of the PSLF program and narrow the scope of who is eligible for forgiveness.

In order to do so, they started with the ABA knowing full well that a bunch of lawyers would sue them. This has the benefit of getting the issue quickly in front of the court system. Once the courts rule on this lawsuit (and once the Department of Education begins forgiving loans in October 2017) we’ll have a better understanding of the contours of the actual forgiveness program.

I wouldn’t worry too much if you work for a government or 501(c)(3) organization (it’s not like PSLF is going away). However, if you’re relying on PSLF forgiveness because you work for a public service organization that you believe qualifies based on the fact that it provides “other school-based services” (and is not a 501(c)(3) organization), I would highly recommend paying attention to this lawsuit.

Let’s talk about it. Do you think the ABA qualifies? Let us know your thoughts on the latest round of the lawsuit in the comments below.

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Lawyer Salaries Are Weird http://www.biglawinvestor.com/bimodal-salary-distribution-curve/ http://www.biglawinvestor.com/bimodal-salary-distribution-curve/#comments Wed, 05 Apr 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=2833 Check out The Biglaw Investor or read Lawyer Salaries Are Weird

Lawyers may belong to the only industry in the world where starting salaries cluster at two peaks along the landscape of income a junior lawyer can expect to receive out of law school. For those that aren’t familiar with the Bimodal Salary Distribution Curve, above is the latest chart from National Association for Law Placement, […]

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Check out The Biglaw Investor or read Lawyer Salaries Are Weird

Lawyers may belong to the only industry in the world where starting salaries cluster at two peaks along the landscape of income a junior lawyer can expect to receive out of law school.

For those that aren’t familiar with the Bimodal Salary Distribution Curve, above is the latest chart from National Association for Law Placement, showing the starting salaries from the Class of 2014.

The chart is probably the single most important marker when discussing lawyers and personal finance since lawyers start at such dramatically different points of income.

But before we talk too much about what you can do with the income you have, I did some digging and thought it would be interesting to write a little about the history of that curve.

Looking Back: Has It Always Been This Way?

Twenty-five years ago the legal industry had a much different distribution of starting salaries. Those salaries followed a typical mountain peak followed by a sloping curve, which is generally what you’d expect to see for starting salaries (i.e. almost everyone is clustered at the lower end of the range with a few all-stars finding a higher salary).

The 1991 chart looks like a normal salary distribution with the median slightly ahead of the largest peak thanks to some lawyers that managed to command salaries in the $70-$90K range upon graduation.

By 1996, there really hadn’t been much of a change except to note that a slightly lower percentage is clustered at the beginning (i.e. smaller mountain peak) which suggests that more lawyers were finding higher paying jobs.

But only four years later, we have the fully developed twin mountain system that we live in today.

What caused the shift?

According to William D. Henderson, it was two factors: (1) the growth of the corporate legal services market and (2) the adherence to the “Cravath” system which aims to hire the top graduates from the top schools to create an elite law firm.

Ironically, Cravath’s “system” for getting the best and brightest has now been adopted by every large law firm that provides full-service highly-specialized legal services, with the result being that all law firms follow Cravath when it comes to salary.

On one hand, you could argue that Cravath gave up on the idea of differentiating itself from its peers or, on the other hand, you could argue that every other major law firm has adopted the model without truly understanding its intent.

Regardless of how we got here, the dual track system for lawyers seems here to stay. Even the salary increases from mid-2016 did little to differentiate the law firms since almost all adopted the higher “Cravath” salary.

Law Students and the Bimodal Salary Distribution

What does this mean if you’re in law school?

It means you better understand the bimodal salary distribution curve is going to apply to you too, which means you might end up with the high paying job or you might not.

More importantly, look at how many jobs there are in the middle. Almost none. This is lost on a lot of law students who think they may not end up with a high paying “biglaw salary” but also assume they won’t end up with a low paying salary either. The real glut in legal salaries is everything between $65,000 and Biglaw.

Lawyers have been cramming this information down the throats of law students and pre-law students for the past few years (decade?), so you would think that everyone is aware of the potentially bleak financial outlook for some lawyers but I still run across pre-law students all the time that think all lawyers are rich.

Regardless, if you’re in law school, you need to buckle down on law school expenses in a big way. Forget about taking the bar trip. While law school can be a lot of fun (well – you’re not working) you’re risking a world of financial pain if you don’t develop a financial plan. Don’t think that your loans will eventually be forgiven either. The government is step ahead of you on that one and it’s not at all clear that following the IBR/REPAYE path is a great deal.

Bimodal Salary Distribution for Practicing Lawyers

How does the salary distribution curve effect you if you’re a practicing lawyer?

Well, for one, it’s only a representation of starting salaries. Many lawyers that start on the lower end of the cluster end up growing their salaries over time. As a whole lawyers earned a median salary of $115,820 in 2015, which means that incomes will likely go up over time.

Planning for a gradual increase in your income is important because it may change your income-driven repayment plan calculations when you stop assuming that you’ll be making $50,000 for the foreseeable future.

Update: As pointed out in the comments, I left out the part that high earners also need to be planning for a decrease in their salary (duh!). Neither end of the spectrum lasts forever, so planning your financial future on an income of $65,000 or $180,000 has some serious flaws.

Let’s talk about it. What are your thoughts on the bimodal salary distribution curve? Let us know in the comments below!

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How to Know if You’re Saving Enough http://www.biglawinvestor.com/am-i-saving-enough/ http://www.biglawinvestor.com/am-i-saving-enough/#comments Mon, 03 Apr 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=2824 Check out The Biglaw Investor or read How to Know if You’re Saving Enough

Many lawyers want to know if they’re saving enough money. Should it be 10% of their income? 20%? 30%? Or maybe, is it better to focus on specific dollar amounts like $1,000/mo, $2000/mo, etc? It’s one of the most difficult questions to answer because “as much as possible” isn’t actionable advice. It’s like making a […]

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Many lawyers want to know if they’re saving enough money.

Should it be 10% of their income? 20%? 30%?

Or maybe, is it better to focus on specific dollar amounts like $1,000/mo, $2000/mo, etc?

It’s one of the most difficult questions to answer because “as much as possible” isn’t actionable advice.

It’s like making a New Year’s resolution to lose weight. You can’t do anything with such a vague goal, which is why it’s doomed to fail.

Yet, your savings rate is the single most important factor in building wealth. It’s way more important for a “young” investor than worrying about what return you’ll get in the market.

Rather than focusing on how to eke out a few more percentage points of return, he would be much better off focusing on how to increase his savings rate, whether that’s increasing income or decreasing expenses.

Example 1. Larry has $50,000 saved and is adding $10,000 a year. In 15 years, assuming an inflation-adjusted return of 6.55%, Larry will end up with $372,250. If he managed to earn an additional 2% return, he’d increase the size of his stash to $454,595.

Getting an extra 2% obviously isn’t a bad outcome, but it didn’t move the needle very much.

Example 2. Larry has $50,000 saved and is adding $30,000 a year. In 15 years, assuming an inflation-adjusted return of 6.55%, Larry will end up with a staggering $857,750.

Clearly it’s a better result if Larry focuses on finding out how to save an extra $20,000 a year.

The opposite is true for an “older” investor (i.e. someone who has saved up a significant nest egg). Let’s run through the same examples assuming someone with a $1,000,000 nest egg.

Example 3. Larry has $1,000,000 saved and is adding $10,000 a year. In 15 years, assuming an inflation-adjusted return of 6.55%, Larry will end up with $2,832,762. If he managed to earn an additional 2% return, he’d increase the size of his stash to $3,706,748, for a gain of almost an extra $1 million.

But what if millionaire Larry increased his savings rate to $30,000. Would he do significantly better?

Example 4. Larry has $1,000,000 saved and is adding $30,000 a year. In 15 years, assuming an inflation-adjusted return of 6.55%, Larry will end up with $3,318,262. Definitely better than if he had only saved $10,000 annually, but much less than if he had been able to eke out an extra 2% return.

Through those four examples, the results should be clear. When you’re at the beginning stages of building wealth, it’s all about increasing the savings rate. Once you have $1 million (or maybe $500,000, you can allow yourself to start getting into the nitty gritty of getting the best return possible).

How to Calculate a Savings Rate?

If you’re trying to save a percentage of your income, use the amount saved as the numerator and use your entire gross income as the denominator.

This means you’re going to get a lower percentage than if you only used “take home” pay as the denominator.

The debate between whether you should use your “gross income” or “take home” pay in the denominator is the source of a ton of confusion when it comes to savings rate because just about every article you read that discusses saving as a percentage will use a different denominator.

Here’s why I use gross income as the denominator: you’ll be forced to include your taxes as expenses. By including taxes as part of your expenses, you’re acknowledging that actions you take to reduce your taxes also increase your savings rate.

Many lawyers aren’t familiar with the true percentage of their income that goes to taxes, so it’s a good idea to calculate a savings rate using gross income as a denominator so that you’ll become more familiar with the role that taxes play.

But saving a percentage of your income is only so helpful. It doesn’t really tell you anything about whether you’re saving enough dollars (and, as we all know, retirement must be paid for in dollars, not in percentages).

For that reason, I rarely concern myself with my percentage savings rate. Instead, each year we set goals at the beginning of the year for the total dollar amount that we want to save. I track savings each month and we measure whether we’re on target to save the dollar amount that we wanted to save.

This is a personal decision but I suggest you play around with both and figure out what works best for you.

How to Increase Your Savings Rate?

Here’s a few steps you can take to increase your savings rate:

(1) Save the Raises. Almost all jobs have cost of living or standard raises over time. While there are times when you need to use the extra money to maintain your standard of living, most of the time the extra money isn’t needed. If you can restrict yourself to living on your income today and save the raises, you’ll find that over time your savings rate increases substantially.

(2) Make More Money. It seems obvious but it’s a heck of a lot easier to save 25% of $300,000 than it is to save 25% of $50,000, even with the higher taxes you’ll pay on a $300K salary. If you can change jobs when there’s an opportunity to make more money, you’ll be doing yourself a much greater service than just about anything else you can do, so long as you …

(3) Keep Your Fixed Expenses Low. It’s not just about overall spending, there’s something special about keeping the fixed expenses low. If you’re not obligated to spend money, you have the option to save more money. This allows you to bounce around between saving and spending each month, making a conscious decision along the way. Try to rent your lifestyle wherever possible. There’s a reason why Felix Dennis said, “If it flies, floats or fornicates, rent it.

(4) Cars and Houses. If you’re looking for the two big ticket items where you can do the most damage, it’s your housing and transportation expenses. Many people budget for a mortgage by calculating the monthly payment to the bank. They forget to add in taxes, utilities, repairs, HOA fees, landscaping expenses, furnishings and any additional upgrades that come with the bigger and nicer house. To make matter worse, the house is a fixed expense so you’re much less financially nimble once you own one. It’s the same with cars, since you can easily lose a great deal of money buying (or financing) a depreciating asset.

(5) Be a Conscious Spender. Many people are surprisingly good at self-regulating spending once they take the time to review their spending or budget accordingly. In other words, I highly doubt you want to waste money. It just happens to all of us, mostly because we’re all busy doing a lot of other things in our lives. If you want to increase your savings rate, set time at the 1st of each month to review the previous month’s expenses and project what you want to spend for the upcoming month. Chances are high you’ll notice a few things that really aren’t bringing you any happiness. Cut those out.

Let’s talk about it. Join us over at Lawyer Slack and let us know what you think. How do you calculate your savings rate and what can you do to increase it? Comment below!

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