The Biglaw Investor http://www.biglawinvestor.com Fri, 16 Jun 2017 10:00:00 +0000 en-US hourly 1 https://wordpress.org/?v=4.8 http://www.biglawinvestor.com/wp-content/uploads/2017/01/favicon.png The Biglaw Investor http://www.biglawinvestor.com 32 32 111859200 You Want to Be a Capitalist http://www.biglawinvestor.com/you-want-to-be-a-capitalist/ http://www.biglawinvestor.com/you-want-to-be-a-capitalist/#comments Fri, 16 Jun 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=3124 Check out The Biglaw Investor or read You Want to Be a Capitalist

Let’s put aside the politically-loaded terms of communism and capitalism and think about the general difference between capital and labor. For basically all of history, you needed both capital and labor to produce anything of value. The capitalist owned the factory and the laborers produced the goods. For a long time the capitalists had the […]

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Let’s put aside the politically-loaded terms of communism and capitalism and think about the general difference between capital and labor. For basically all of history, you needed both capital and labor to produce anything of value. The capitalist owned the factory and the laborers produced the goods. For a long time the capitalists had the upper hand and kept most of the generated wealth for themselves.

Once labor organized into a meaningful collective, it began to bargain for a better deal and the middle class was born. No longer could the capitalist dictate the entire terms of the arrangement. Without labor, the factory sat empty and the capitalist suffered. While capitalist still retained the majority of the generated profit, the inequality lessoned.

Fast forward to 2017 and labor is again on the defensive thanks to the Automation Revolution (I’m pretty sure I made up that term, but stay with me). Like the Industrial Revolution, which replaced manual labor with machine labor, the Automation Revolution is seemingly replacing human labor with computer labor (don’t believe me? Watch these robots automate this Amazon Fulfillment Center).

With the Automation Revolution, the owners of capital are doing even better than ever before. For the price of a few robots and some electricity capitalists have an army of labor working 24 hours a day. This labor doesn’t require benefits, lunch breaks or ever quit. It’s the a 19th century robber barron’s dream!

Which is why this is fundamentally true for you:

All decisions you make should help move you from being a laborer to being a capitalist.

As a laborer, you trade time for money. It doesn’t matter whether you have a high income or a low income. Even professional NFL athletes are part of the labor class. They’re simply paid a wage for doing some form of work.

As a capitalist, you are not paid for your time. You’re paid for the use of your capital. The payment can come in the form of interest, dividends or capital appreciation but you can rest assured that by allowing other people to use your money, you will get paid.

If you hope to retire some day, you will need to become a capitalist. There is no other way.

Most lawyers start out in the labor force. It’s the only way to generate income when you don’t have any capital. Slowly you save a portion of your income every year which develops into investment capital. For many lawyers it will take 40 years between the ages of 30 and 70 to become a capitalist.

However long that takes for you, when you become a capitalist you’ve reached financial independence. No longer do you need to trade labor for money.

If you’re interested in getting to the point where you no longer have to trade labor for money, your savings rate is the most important factor. Your savings rate is simply the amount you’re saving divided by your gross income.

But when you look under the hood, your savings rate is the amount of your labor you’re converting into capital. The better you are at converting labor into capital, the faster you’ll become a capitalist.

How much should you be saving? Thanks to the late start in life, most lawyers need to be saving much more than the standard 5% or 10% and more like 20 or 25%. Unfortunately, there’s no one specific rate for you. You should be saving as much as you can while balancing all the competing demands on your money.

The important part is that every dollar that comes in should push you forward on the path to becoming a capitalist. Once you get on that path you can tweak the amount going forward but many people neglect to even start down the path.

Let’s talk about it. Are you on your way to becoming a capitalist?

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Is Happiness for Sale? http://www.biglawinvestor.com/can-money-buy-happiness/ http://www.biglawinvestor.com/can-money-buy-happiness/#respond Wed, 14 Jun 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=3121 Check out The Biglaw Investor or read Is Happiness for Sale?

In the past I’ve written about spending money on the things that truly make you happy. Budgeting is one way to make sure you’re conscious of each dollar spent. Another is simply to ask yourself before any purchase whether what you’re about to buy will make you happy. But what’s the psychology behind spending? We […]

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In the past I’ve written about spending money on the things that truly make you happy. Budgeting is one way to make sure you’re conscious of each dollar spent. Another is simply to ask yourself before any purchase whether what you’re about to buy will make you happy. But what’s the psychology behind spending? We all know that spending money gives you an instant (if short-lived) feeling of happiness. Have you ever wondered what kind of spending brings on long term happiness?

There’s been many studies on this throughout the years. I’ve put together eight strategies to make sure your spending aligns with creating the maximum happiness in your life.

Purchase Experiences Instead of Things

The studies overwhelming suggest that you’ll derive more happiness if you focus on buying experiences rather than things. It turns out that humans are remarkably good at hedonistic adaptation. In other words, if you purchase a physical item it should only take you a few weeks or months before you’ve adapted to life with the physical item.

On the other hand, you’re likely to remember experiences for years to years to come. These studies are quite common, so perhaps you’ve already heard this before. Yet, as I type these words I am reminded that I have strong fun memories of a trip to Argentina. How do I feel about the 5-year old Macbook Air that I’m typing on? I enjoyed it a lot when I bought it, but now it’s feeling a bit sluggish. Maybe you should take that Bar Trip after all.

Buy Variable Pleasures Rather Than Predictable Ones

Following along the lines of human adaptation, one way to trick the psyche is to make variable purchases that bring you happiness rather than consistent ones. It turns out that it’s not so much the intensity of people’s positive experiences that matter as much as it’s novelty, uncertainty and surprise.

For example, rather than having a massage once a month on the 1st, you might find more happiness to schedule two within a month, skip a couple of months and then start again. Or, rather than taking an annual big vacation in January, you may find it more exciting to skip the big vacation and instead take four “weekend trips” over the course of a couple of months.

Pay Now and Consume Later (Increase Anticipation)

Saving up for a big purchase has always been good financial advice. You avoid debt, interest and, you know, actually have the money to afford the purchase. Perhaps overlooked is the psychological thrill of saving up for something and anticipating the purchase.

One way to do this is to purchase things well in advance (you’ll get a good deal too). For example, booking a winter trip in summer will give you six months of anticipation leading up to the trip. If you’re like me, anticipating the trip is half the fun.

Aside from the benefit of anticipating the future consumption, you’re likely to make better consumption choices when you make a purchase in advance. In other words, nobody purchases donuts for themselves to eat in six months. By scheduling your purchases in advance you’re much less likely to make an impulse buy.

Stop Comparison Shopping

Americans are obsessed with getting a good deal and making sure they pick the right product. People can spend hours finding the right item and then making sure they get the best deal (I can be guilty of this). The research shows that all this price comparison and agonizing over our options isn’t doing much for our happiness.

You know what’s easy? Walking into a store in 1955 and purchasing jam. Do you know what’s psychologically taxing? Walking into Whole Foods in 2017 and choosing between 50 types of jam. Where possible, limit your options and you’ll find yourself more satisfied with the purchase.

Spend Money on Other People

Many people assume that spending money on themselves will make them happier than spending money on other people. The literature isn’t so clear. Turns out that spending money on other people may actually make you happier than spending on yourself, particularly if those expenses are shared experiences that involve other people.

Buy Less Insurance

The pain of financial loss is much greater than the joy of financial gain. This fact has been well established by the behavioral economists. Companies have been using this psychology against consumers for years. Because people are afraid of loss, they buy an incredible amount of insurance and extended warranties that they don’t need. We think we’re insuring against future pain but in reality we’re decreasing overall consumption and ignoring the fact that humans are great at coping with tragedy and loss (what we imagine is often much worse than the reality).

Of course this doesn’t mean skipping on the necessary insurance: health, disability and term life insurance. But it does mean thinking twice about whether you need an extended warranty on your TV or phone. Chances are good that you can safely skip it.

Follow the Crowd

If you believe in market theory, then you believe the markets are basically efficient (maybe not perfectly so, but pretty darn close). Further, you’re much more likely to find happiness in something that other people have indicated they enjoyed rather than seeking a specific item that you think is perfect for you.

If you take those two statements together, it means you should probably trust those Amazon reviews. If 500 people gave that spatula 5 stars? Buy it and move on. You need never agonize over the other spatulas you didn’t purchase.

Let’s talk about it. I hope you found these behavioral ideas interesting and maybe they will influence your future decisions. While a lot of investors spend time studying the market, portfolios, etc., I’m always surprised by the lack of understanding of behavioral psychology and how it impacts (or should impact) personal finance decisions.

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Lawyers Working for the Banks http://www.biglawinvestor.com/lawyers-working-for-banks/ http://www.biglawinvestor.com/lawyers-working-for-banks/#comments Mon, 12 Jun 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=3116 Check out The Biglaw Investor or read Lawyers Working for the Banks

The other day a friend told me that he bought a house. And then he corrected himself and said, “Actually, the bank bought a house. They’re letting me live there while I slowly repay them.” It got a good laugh from the group and is right on point. It started me thinking about all the […]

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The other day a friend told me that he bought a house. And then he corrected himself and said, “Actually, the bank bought a house. They’re letting me live there while I slowly repay them.” It got a good laugh from the group and is right on point. It started me thinking about all the ways the lawyers lock themselves in to various debt that seems “normal” including debt that is much worse than a mortgage.

I spend a lot of time on financial forums and it’s not uncommon for a high earner to list their income and expenses and ask for advice. It always make me scratch my head when I see a lawyer explain that they’re making $120K a year and then list expenses like “$8K car loan” or “$2K credit card debt <—— We HATE this debt”.

Why are these lawyers choosing to essentially work for the bank? Bank shareholders grow rich each year thanks to these lawyers who are willing to spend a few extra hours at the office so they can pay unnecessary interest to a bank.

Here’s a few that come up rather frequently:

Credit Card Debt

I bet that you didn’t know that the big box on every credit card offer that comes in the mail is called the Schumer Box, named after Senator Chuck Schumer. Yet, it’s hard to miss the box because the law requires it to be in 18 point font. There’s no hiding the relevant information in small terms and conditions text when the law mandates a big box with the interest rate prominently displayed.

Assuming you’re familiar with the box, you’ve probably noticed that credit cards charge between 15% – 30% interest. Do you know of any investment return that pays a 15% – 30% return? If I did, I’d buy as much of it as I could. If you’re paying interest – even for a month – at that rate, you are someone else’s awesome investment. You are single-handedly funding their house in the Hamptons or yacht purchase.

If you’re making a decent salary, there’s absolutely no reason to carry credit card debt even for a day. If you find yourself paying interest from time to time, you have a cash flow problem that can be fixed with some simple budgeting.

Debt and an Emergency Fund

Even more perplexing, you’ll sometimes see a post that lists a small amount of credit card debt along with a $5K emergency fund. The point of an emergency fund is to keep you from going into debt (if you even need one), so it defies logic to carry high interest debt and an emergency fund at the same time. Lawyers generally have access to plenty of credit opportunities. If you have an emergency, you should be able to use a credit card (or other line of credit) to fund the emergency. If you have credit card debt, you already have an emergency. One that needs to be fixed immediately.

Car Loan

Car loans are the most likely payment to see listed on an income/expense report. If you’re grossing $10K – $15K a month, how long could it possibly take to pay off a $5K car loan? A lawyer’s status symbol shouldn’t be driving a fancy car while carrying a loan. It should be driving a paid-off car. The idea that you’re gaining some type of arbitrage by borrowing at 1.9% and investing the difference doesn’t hold water. You’re either not disciplined enough to follow through with this at the level of precision needed to make sure you don’t mess up or you’re spending way too much time trying to squeeze out a marginal return, when you should be focused on increasing your savings rate. Broke people have car loans.

Long Student Loan Repayment Terms

Whenever I talk to a lawyer about repaying their student loans, I try to convince them to pay off the debt in 5 years. It’s like ripping a band-aid, the sooner you’re out of debt the better. The student loan refinance companies know the reality on the ground though. Those of you that are refinancing law school loans are taking 10 year or 15 year terms. I’d rather that you were debt free as soon as possible but I admit it’s hard to convince a lawyer to buckle down and knock out the debt when there are a lot of competing demands for your dollars.

But if you do take a longer term loan, you’re not getting the best deal. You’ll pay a higher interest rate. And, if we’re talking about the difference between a 5% fixed and a 2.5% variable, that will be a significant amount of lost money. Worse, you’ll still be in debt 10 or 15 years later. Who wants that? I don’t know too many lawyers that are more excited to be practicing law after spending 10-12 years doing so. Do you really want to be in student loan debt at 48 if you don’t have to be?

Keep in mind that having debt for the next 10-15 years isn’t just a problem for burnout. It’s a problem because there will be so many other things going on in your life, such as kids, wanting to move to a new location, thinking about cutting back hours, etc. Will you be able to enjoy / do those things if you still owe the student loan companies?

30 Year Mortgage

Have you ever wondered where the 30 year fixed mortgage came from? Why 30 years? It didn’t always use to be that way.

Mortgages used to be short-term loans from banks to buy houses. But after the Great Depression and WWII, the government stepped in and started buying mortgages from banks to facilitate lending to returning vets. The government assumed those vets would work for about 30 years after which they’d retire and own their home outright.

The banks wanted nothing to do with such a long long term loan as it ties up capital for nearly a third of a century. You need investors that are willing to buy these loans so that banks can return the capital to the market and lend it again. But investors didn’t want to buy 30 year paper either unless the government guaranteed repayment, which is why we have Fannie Mae and Freddie Mac.

In most other developed countries, borrowers use mortgages with 10 or 15 year terms and likely have a variable rate as well. Turns out the 30-year fixed mortgage is an outlier. Because payment is stretched out over 30 years, you’ll pay a lot more interest than you would with a 15 year mortgage. But Americans – and particularly lawyers – love the certainty of the fixed interest rate and so it remains a popular product.

I don’t buy the flexibility argument (“I’m going to pay it off in 15 years but am taking the 30 year mortgage just in case.”) If your mortgage payment is so high that you value the flexibility of “just in case”, you’re very likely buying more house than you can afford.

Worse, you’re ignoring all the evidence of behavioral economics that strongly suggest you’re more likely to start off making the minimum payments (“because I’m just getting started, my income will go up over time”) and then make a few 15-year payments but drop down to somewhere in between those numbers (“Rough month, unexpected expenses, Christmas is so expensive!”). Eventually you’ll sell the house after 8 years anyway and never think about it again, except that if you did the math you’d realize you that you paid a higher interest rate than you needed to and made substantially smaller payments toward principal than you would have had you just taken out the 15 year mortgage in the first place.

Want to be rich? Take out a 15 year mortgage and pay it off in 10 years.

Stupid Debts and Lawyers

Of course there’s plenty of other short-term finance charges, unnecessary insurance and warranties and other debt that lawyers take on. But if that’s you, think about who is making money off of what you view as a conservative approach to finances because of a misguided desire to hoard cash? It’s not you. You’re working for the banks! They purchased your car, your house, your iPhone and are letting you use it because you’re their awesome investment.

Don’t be their awesome investment.

Your creditors thank you for working so hard.

Let’s talk about it. What did you think of the article?

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Gaining Accredited Investor Status http://www.biglawinvestor.com/what-is-an-accredited-investor/ http://www.biglawinvestor.com/what-is-an-accredited-investor/#comments Wed, 07 Jun 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=3108 Check out The Biglaw Investor or read Gaining Accredited Investor Status

From time to time, I come across investment opportunities that are only available to accredited investors. It’s often enough that I think it warrants today’s article explaining accredited investor status, since you’ll need to be an accredited investor before you can invest in some of these alternative platforms. What’s an accredited investor? Essentially, it’s someone […]

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From time to time, I come across investment opportunities that are only available to accredited investors. It’s often enough that I think it warrants today’s article explaining accredited investor status, since you’ll need to be an accredited investor before you can invest in some of these alternative platforms.

What’s an accredited investor?

Essentially, it’s someone the SEC believes is rich enough that they can lose significant amounts of money investing in platforms or securities that are less-regulated and require less disclosure than an investment found on the public stock markets.

Lawyers are often targets for private investments because they may qualify as an accredited investor.

Accredited Investor Requirements

  1. A bank, insurance company or registered investment company.
  2. An ERISA employee benefit plan with total assets in excess of $5 million.
  3. A charity, corporation or partnership with assets exceeding $5 million.
  4. A director, executive officer or general partner of the company selling the securities.
  5. Any business entity in which all of the individual equity owners are themselves accredited investors.
  6. A natural person with a new worth in excess of $1 million, excluding the value of the individual’s primary residence.
  7. A natural person with income exceeding $200,000 in each of the two most recent years (or joint income with a spouse exceeding $300,000 of those years) and a reasonable expectation of exceeding the same amount in the current year; or
  8. A trust with assets in excess of $5 million.

As you can imagine, lawyers mainly qualify under the income qualification, although many lawyers won’t qualify at all unless it’s later in their investment career and they’ve achieved a net worth of over $1 million, excluding the value of their primary residence.

Why Do We Have Accredited Investor Status?

The SEC was formed to protect investors. Interesting sidenote: The first SEC commissioner, Joseph P. Kennedy, wrote regulations that outlawed insider trading, a method he used to generate an immense amount of wealth in the 1920s.

I suppose the thinking is that if you’re an accredited investor, you don’t need the same level of protection as a non-accredited investor. Given that you can be an accredited investor and lose your entire investment, I’m not sure this makes a lot of sense, but presumably some lobbying was involved in setting the thresholds and the wealthier class of investors didn’t want these restrictions to apply.

Rest assured that you can go your entire life without purchasing an investment that requires you to be an accredited investor.

However, if you invest in something that does require accredited investor status, there will be very few regulations that protect you. You’ll need to do your own due diligence on the investment and could potentially need the expertise of advisors (lawyers, accountants, etc.) that may eat up some of the investment returns.

Qualified Purchaser vs Accredited Investors

Occasionally there is some confusion over the difference between a qualified purchaser and an accredited investor, mainly because people will use the term “qualified investor” which isn’t an actual SEC term.

While you may be an accredited investor, you are almost certainly not a qualified purchaser. To be a qualified purchaser, you’d need at least $5,000,000 in investments or to be an investment manager (or company) with at least $25,000,000 in investments.

In other words, qualified purchasers are super accredited investors. If you’re a qualified purchaser, the SEC things you’re sophisticated enough to be making all kinds of your own investments without SEC oversight. Note that there is no income requirement to be a qualified purchaser. Having a high income is no longer enough, you actually need to be wealthy.

Investment Opportunities for Accredited Investors

It’s beyond the scope of this article to talk about all the types of investments that open up to accredited investors, but here’s a few that become available:

  1. Private Equity. Private equity includes the entire investment sphere of non-public investments. Private equity typically raise money from institutional and non-institutional investors.
  2. Start-ups. Accredited investors can be angel investors that directly invest in start-ups and private companies.
  3. Hedge Funds. You’re not getting into a hedge fund unless you’re an accredited investor. But then again, why would you?
  4. Real Estate Crowdfunding. Most of the real estate platforms are only available to accredited investors.

Let’s talk about it. Are you an accredit investor? Have you made an investment that required accredited investor status? I’ve made one, which will be the subject of a future post.

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How to Manage a Windfall http://www.biglawinvestor.com/how-to-manage-a-windfall/ http://www.biglawinvestor.com/how-to-manage-a-windfall/#comments Mon, 05 Jun 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=3105 Check out The Biglaw Investor or read How to Manage a Windfall

I’ve never experienced a financial windfall, unless you count the various bonuses I’ve received throughout my career. And, for nearly all of those bonuses, I had plans in place well in advance of their arrival. This has always been just completely fine with me as a financial windfall often comes with personal tragedy and loss. […]

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I’ve never experienced a financial windfall, unless you count the various bonuses I’ve received throughout my career. And, for nearly all of those bonuses, I had plans in place well in advance of their arrival. This has always been just completely fine with me as a financial windfall often comes with personal tragedy and loss.

Yet, a lot of people will receive a financial windfall at some point in their life. A financial windfall is any money that a person gets unexpectedly. It could come in the form of a (1) legal settlement; (2) inheritance; (3) gift; (4) insurance payment; (5) bonuses / sudden increase in income; or (6) the lottery (one can dream).

While not a new source of money, the same physiological effects of a windfall might occur if you have a big real estate sale, sell a business (cash out stock options) or go through a divorce or death of a spouse.

Since a financial windfall almost by definition means a huge change in the recipient’s life, it’s not surprising that managing the psychological and emotional factors associated with the windfall are probably more important than managing the money itself.

“Most financial practitioners agree that well over 50 percent (of windfalls) are lost in a relatively short period of time. NBC News reported that more than 70 percent of lottery winners exhaust their fortunes within three years.” – The Bogleheads’ Guide to Investing. Chapter 15, p.180.

If you’ve never received a windfall, those numbers might catch your attention. If you’re like me, you probably think that, of course, that wouldn’t be you. You live in a town where all the men are good looking and all the children are above average.

However, I’ve read enough forum posts from people with unexpected windfalls to know that the emotional struggle is real. Guilt, excitement, fear (of screwing it up), sadness, lost sense of purpose, fear (of succeeding), responsibility, anxiety, distrust, isolation, etc. are all on the radar screen if (when?) you receive a financial windfall.

So, what should you do? Below are some steps for managing a windfall.

Go Slowly

The financial community is in agreement that avoiding impulse decisions is the single greatest key to managing a windfall. Do not do anything rash. Resist the feeling that you need to make a decision. It’s so important that I’m going to say it again.

–> TAKE YOUR TIME <–

Why should you take your time?

Because you’re under the sway of all the emotions I mentioned above!

Think through all the possible mistakes someone could make by acting quickly after a financial windfall.

  • Facebook IPO cashout —> become an angel investor —> no money.
  • Insurance settlement —> buys a few “nice” things —> increased lifestyle —> no money.
  • Bonus —> new high risk investment —> no money.
  • Inheritance —> financial advisor —> subpar returns.

It’s important to recognize that you can be a target for people trying to take advantage of your new wealth, which is all the more reason why it’s better to take your time to figure out what to do next. When mistakes are made, it won’t be because you know you’re making them. It’s going to be because you actively think you’re avoiding a mistake that a mistake is made.

Here’s a few recommendations for how to go slowly:

  • Set aside nearly all the money in a separate, newly created account, holding secure low-risk options such as CDs, money market funds or treasury bills.
  • Focus entirely on beginning to resolve the emotional, family and social implications of the windfall, without regard to the money itself.
  • Update (or write) your Investment Policy Statement and incorporate the windfall into your plans.
  • Read a few general financial books covering personal investing.
  • Spend some money. But don’t spend it on anything that requires significant ongoing expenses. Take a trip but don’t buy a house.

Let this period ride for a year or as long as you think you need. Sure, you technically might be losing a little money by keeping the funds in a low-interest savings account, but your future self will thank you for preserving the capital.

Don’t forget Warren Buffett’s two rules to financial success:

Rule 1: Don’t lose money.

Rule 2: See Rule 1.

It’s also helpful here to imagine the windfall through the lens of a situation different from your own.

For example, did you receive money from an insurance settlement? Imagine you’re someone who received it through an inheritance. Would you act differently?

Or if you received it via an inheritance, imagine that you’re an entrepreneur that cashed out stock options on a lucrative exit.

Figure Out the Taxes and Insurance

Before you deploy the windfall, while you’ve got it safely tucked away in a savings account, spend some time figuring out the tax implications of receiving a large sum of money.

There are often complex tax issues when you receive an inheritance from a retirement account or when you exercise stock options. If you need professional tax assistance, finding a CPA who doesn’t sell investment products might be a good idea.

I also like this idea because it gives you something to do with your time so that you can feel like you’re making progress on managing the windfall. As the ancient Greeks said, “Know thyself” first and act later.

In figuring out the tax situation, you’ll want to calculate any taxes due and explore ways to minimize those taxes. Depending on the size of the windfall, you may also need to contact an estate planning attorney for help in setting up your own estate.

Equally important, you’ll need to re-evaluate your insurance policies. Do you need more or less now? If the windfall is such that you’re financially independent, it may be time to cancel your life insurance and disability insurance policies. On the other hand, you may want to increase an umbrella policy to protect against future liability issues now that you have substantial assets at risk.

These are all steps that should be taken before the money is invested or used in any capacity, plus they’ll buy you some time as you process the emotions that come with a windfall.

Formulate a Go-Forward Plan

After some time has passed and you’ve become comfortable with the new reality, the last phase should be planning what to do with the money, whether it means quitting a job, buying a vacation home, donating to charities or setting up trust funds for children or grandchildren.

An Investment Policy Statement will help guide your plans, since the windfall necessarily has to integrate with your previous financial situation, net worth, budget, etc. The windfall is also likely to be spread across many different goals, which means you’ll want one cohesive document so you can avoid inadvertently making one-off decisions without looking holistically at the windfall and its impact on your financial life.

More Resources

Here are a few more resources if you’re exploring a financial windfall:

Let’s talk about it. Have you had to manage a financial windfall? What did you do and how did you handle it?

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Looking Ahead 18 Months http://www.biglawinvestor.com/looking-ahead-18-months/ http://www.biglawinvestor.com/looking-ahead-18-months/#comments Fri, 02 Jun 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=3096 Check out The Biglaw Investor or read Looking Ahead 18 Months

(Editor’s Note: Before we get to today’s post, I wanted to welcome a new sponsor to the site. You’ve probably noticed the ads on the right side of the page. Those faces and names are people and businesses that are supporting the site. I receive a ton of requests to advertise (more than I expected) […]

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(Editor’s Note: Before we get to today’s post, I wanted to welcome a new sponsor to the site. You’ve probably noticed the ads on the right side of the page. Those faces and names are people and businesses that are supporting the site. I receive a ton of requests to advertise (more than I expected) but turn away most as I only want to work with and recommend people and services that I would use myself. To that end, I vet any sponsor the best I can and have had multiple conversations with them by the time you see an ad show up on the site.

Recently I had the pleasure of bringing Pradeep Audho, the owner of PKA Insurance, onto the site as a sponsor. Pradeep focuses on disability and life insurance and is a representative of most of the major life and disability insurance carriers. You can get term life quotes in a few seconds on his website here and can also get disability insurance quotes in 24 hours here. He has experience working with lawyers and can provide insurance to you no matter where you live in the US (and in fact, for these kinds of things, it’s easier and more efficient to handle via email anyway, so you don’t need to find someone local to you). Please stop by his site and thank you to the readers who support the site’s sponsors.)

Graduating high school felt like both scary and exhilarating at the same time. Finally I left behind the rules and order of forced schooling but with great freedom came great responsibility. Where would I go to college? How would I answer the question on everyone’s lips: “What will you major in?”

And of course no sooner did you answer that question would you receive the follow up – “And what job are you going to get with that degree?”

It would have been daunting to make all of these decisions in the summer after my senior year.

Luckily for me (and most of you), most of the work setting up the future, like picking an appropriate college, had already been decided during my junior year. Like most high school kids, I spent the previous 18 months looking at various schools, applying for scholarships and financial aid and ultimately selecting a place to go to school.

In fact, from my junior year of high school onward I had a series of experiences and transitions that involved this 18-month advance look at the future.

In college, with another graduation looming in about 12-18 months, I started to think about the next step in life which led to practicing for the LSAT and looking at law schools.

I opted instead to move to Boston and spent two years working for a small law firm while I decided whether and where I wanted to attend law school.

But within about 12-18 months of moving to Boston, I began the pattern again and started applying for law schools, which would not coincidentally start in about 12-18 months.

The pattern repeated itself in law school.

Everyone is told that your 1L year is the most important year. From day one you’re focused on your grades and how they will impact your ability to find a job during the fall of your 2L year, which is about 12-18 months away.

Then you have your 2L summer which leads (you hope) to a permanent placement once you graduate law school, which is in another 12-18 months.

And then, assuming everything goes to plan, you start working.

The End of the 18-Month Cycle

Once we start working, there’s a perception that life now becomes an unimaginable stretch of time. No longer do we have the 18 month cycles to guide us forward. There’s no transition on the horizon.

It’s easy to lose sight of goals and planning once these 18-month cycles disappear. Without a transition point in the future, what exactly are you planning for anyway? Saving money for some future date in 30-40 years seems unpalatable. Paying off your loans is years away too.

Yet, those 18-month cycles propelled you forward from high school to law school to a career. If you abandon them, what becomes the driving force?

Rather than moving on to being an “adult”, I suggest that we should be embracing the 18-month cycle for planning and motivational purposes.

Twelve to 18 months is a perfect timeframe that seems reasonably close but is far enough away to allow you to accomplish quite a lot. Better yet, you’re already trained to respect this cycle. You’ve been living it for the last 10 years!

What Do Your Next 18 Months Look Like?

This article is set to publish in June, which means than in 18 months we’ll be at the end of 2018. It seems both far and near. If you’ve been working for any length of time, you’ll also recognize that it’s inevitable. Time marches forward.

If you were standing on your tiptoes peering out over the future of your financial life, where would you be in 18 months?

Would you have a higher paying job? Would you have saved up $36,000 in a 401(k) by maxing out your 2017 and 2018 contributions? Would your law school loans be under $100,000 or perhaps paid off entirely? Would you have a down payment saved for your first house? Half of a down payment?

Planning goes a long way. The great thing about looking 18 months out is that you can start adjusting behavior today to achieve those goals.

Bill Gates said, “People overestimate how much can be accomplished in a day but underestimate how much can be accomplished in a year.”

I think about that quote a lot.

Building wealth is obviously a long term goal and not something that can be accomplished in a day. And while you can get started today, it’s the power of hundreds of good days that will get you where you want to go.

Our own plan over the next 18 months is to continue integrating our finances as we get married and to hit our savings targets which we’re tracking each month. We’re already in the middle of shifting our income to take advantage of every retirement account we can. By the end of 2018 we should be a well-oiled machine with all of our excess income continuously building in retirement and taxable accounts.

Where will you be at the end of your next 12-18 month cycle and what can you do today to start?

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Revisiting Roth vs Traditional http://www.biglawinvestor.com/revisiting-roth-contributions/ http://www.biglawinvestor.com/revisiting-roth-contributions/#comments Wed, 31 May 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=3075 Check out The Biglaw Investor or read Revisiting Roth vs Traditional

I’m pretty busy these days trying to stuff as much money into pre-tax retirement accounts as possible. Living in a high tax environment with a triple combo of federal, city and state taxes makes me fairly confident that the taxes I’m paying today will be higher than the taxes I pay in the future. But can […]

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Check out The Biglaw Investor or read Revisiting Roth vs Traditional

I’m pretty busy these days trying to stuff as much money into pre-tax retirement accounts as possible. Living in a high tax environment with a triple combo of federal, city and state taxes makes me fairly confident that the taxes I’m paying today will be higher than the taxes I pay in the future. But can I be sure? Of course not.

But if I’m right, by taking advantage of the tax arbitrage of saving money today at my marginal rate (by contributing to a Traditional 401(k)) but paying it in the future at a lower effective rate (by withdrawing from a Traditional 401(k)), I’m effectively getting a free 401(k) government match.

If you’re still unsure over whether Roth or Traditional 401(k) contributions are right for you, one thing you may have considered is that you can effectively contribute more money to a Roth 401(k) than you can to a Traditional 401(k). Won’t that additional money result in greater savings over time? Should you take advantage of the loophole to save more money into a Roth 401(k) account?

Well, first, let’s discuss why you can contribute more money to a Roth 401(k) than a Traditional 401(k).

It’s because by making contributions with after-tax dollars to a Roth 401(k), those dollars are “worth” more than the money that you’re putting into a  pre-tax Traditional 401(k) since those pre-tax dollars by definition have not yet been taxed.

Every dollar that you contribute to a Roth 401(k) account is yours to keep forever. That’s not the case with your pre-tax contributions to a Traditional 401(k). You get to keep most of each dollar but some part of that dollar is earmarked for the federal government.

I made a little chart to illustrate this concept below:

Another way to internalize the concept is to think of the Roth 401(k) as an account you own entirely. Meanwhile, the Traditional 401(k) is really two accounts: (1) an account you own and (2) an account you’re managing on behalf of the government. The government account may fluctuate in size depending on your taxes in retirement but it’s likely that you’ll have to turn over some part of the investment to the government at some point.

When making the decision between Roth or Traditional contributions, you’d gloss over this difference in contribution amounts at your own peril. It really does matter that you’re contributing more “real” dollars to a Roth account than you can to a pre-tax account.

There are also several reasons (both behavioral and economic) for why you might prefer to max out a Roth 401(k) account.

(1) More Savings. As outlined above, you can effectively contribute more money into a Roth 401(k) than you can a Traditional 401(k).

(2) Human Behavior. In order to save a comparable amount in a pre-tax account, you must invest your tax savings in a taxable account. In other words, let’s say you save $7,000 in taxes each year by contributing to a Traditional 401(k). If you spend that $7,000 on cocaine and flights to the Caribbean, despite the additional fun, you’re definitely not saving the same amount of overall money as you would in a Roth 401(k) account. You have to be disciplined to save the additional tax savings each year. If you’re setting your own salary and banking the rest, this shouldn’t be much of a problem but it is easy to let money slip through your fingers. You need to be confident that you’re saving 100% of the tax savings.

(3) High Taxes in Retirement. If your tax rate in retirement is going to be the same (or higher) as your tax rate during your working years, the Roth makes more sense. In those scenarios, you aren’t taking advantage of any tax arbitrage. That’s why for some very high earners a Roth account makes the most sense. Imagine for example that you’re earning $3,000,000 a year and saving $1,000,000. By the time you reach retirement you’ll be forced by the RMDs to withdraw so much money that you’ll end up in the highest tax bracket anyway. It makes more sense to pay taxes today and withdraw is tax-free in the future than it does to take the chance on future tax rates (not to mention your Roth growth is entirely tax-free as well, whereas you’ll pay ordinary income tax on the growth in your Traditional 401(k)).

Tax Arbitrage Advantages of Roth vs Traditional 401(k)

I’m not going to spend much time going over the benefit of saving taxes at around 40% and paying them later in the future at 20%. Clearly that’s a winning proposition you should take every chance you get and the reason why the Traditional 401(k) is going to be the right answer for most lawyers. The reality is that most lawyers won’t be making enough money to make a Roth 401(k) the better choice.

It’d be great if you could figure out how much the extra space in the Roth 401(k) is worth vis-a-vis the benefits of taking advantage of the tax arbitrage of saving today at your marginal rate vs paying tomorrow at a lower effective rate.

Luckily for us, The Finance Buff has done the math and put together a spreadsheet to help you make the decision.

Based on his calculations, the higher effective contribution limit of the Roth 401(k) is worth about 7 percentage points.

In other words, if you expect your marginal tax rate at retirement to be around 7% (or more) less than your marginal tax rate today, the Traditional 401(k) is going to perform better.

Today my marginal tax rate is 45.6%. If my marginal rate in retirement is 38.9% or less, the Traditional 401(k) should be the better choice.

Don’t forget that we’re still talking about the marginal dollar too. I’m ignoring the fact that I will have to fill up the lower tax brackets before I even approach a marginal rate of 38.9%.

I feel confident that I’ll be withdrawing funds in the future at a rate of 38.9% or less. For one, I probably won’t still be living in NYC when I retire (instead, I’d prefer to be living in a sunny climate with no income tax like Texas or Florida). Second, if I didn’t have any state income tax to pay, I’d need an income of over $418,400 to hit the marginal federal tax rate of 39.60%. If my income is less than that in retirement I would be taxed below 38.9%.

Now don’t get me wrong. I’m not ruling out an income of $418,400+ in retirement. I’m just saying that should that happen, life went extremely well. Paying higher taxes would be a good problem to have. One that I would be happy to accept.

It’s much more likely that my retirement income will be substantially below the top tax bracket, which will move upward from today’s number with inflation anyway. If I play my cards right, I’ll be using tax diversification in retirement to reduce my overall federal income tax burden. For those reasons, I think it’s obvious the best path is to save money today at a high tax rate and pay it tomorrow at a much lower one.

Let’s talk about it. Are you contributing to a Roth 401(k) or a Traditional 401(k)? It’s important to see that there isn’t necessarily a clear answer, although for most lawyers earning a high (but not astronomically high) salary, saving in a pre-tax account is likely the way to go.

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Money Before 59½: 72(t) Distributions http://www.biglawinvestor.com/72t-distributions/ http://www.biglawinvestor.com/72t-distributions/#comments Mon, 29 May 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=3079 Check out The Biglaw Investor or read Money Before 59½: 72(t) Distributions

Sometimes it feels good knowing you can withdraw money from a retirement account before age 59½ without having to pay the pesky 10% penalty. I’d wager to guess that most people would contribute more money to retirement accounts if they knew there were ways to get access to the money early. One of the ways to […]

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Sometimes it feels good knowing you can withdraw money from a retirement account before age 59½ without having to pay the pesky 10% penalty. I’d wager to guess that most people would contribute more money to retirement accounts if they knew there were ways to get access to the money early.

One of the ways to access money early is setting up a Roth IRA Conversion Ladder. To briefly recap, to set up a Roth IRA Conversion Ladder you slowly convert a Traditional IRA (the kind of account you’d have after you quit a job and rolled your work’s 401(k) over to personal account) into a Roth IRA. If you do the conversions during a period of low income you can skip or reduce the amount of taxes you’ll pay too. Once you convert, you’ll wait five years and then be able to withdraw the converted amount without penalty from your Roth IRA.

Another “hidden” way to access money from a retirement account without paying the 10% penalty is through 26 U.S. Code §72(t). This method is a little more complicated but with the help of qualified professional tax/financial advisor should be pretty easy.

What is the 72(t) Rule?

First, let’s look at the IRS FAQ on §72(t):

An additional 10% tax applies to early distributions (before the participant reaches age 59½) from a retirement plan or IRA under Code §72(t)(1). Section 72(t)(2) lists exceptions to this tax, including distributions received in substantially equal periodic payments.

Sounds great, right? All we need to do is figure out the Section 72(t)(2) exceptions. More from the FAQ:

If distributions are made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary, the §72(t) tax does not apply. If these distributions are from a qualified plan, not an IRA, you must separate from service with the employer maintaining the plan before the payments begin for this exception to apply. If the series of substantially equal periodic payments is subsequently modified (other than by reason of death or disability) within 5 years of the date of the first payment, or, if later, age 59½, the exception to the 10% tax does not apply.

Translation: If you meet a few requirements (discussed below) you can withdraw money from a retirement account prior to age 59½ without paying the 10% penalty (of course, you’ll still have to pay ordinary income tax).

For an investor intending to retire before 59½ this could play a big role in accessing retirement funds early.

How Do You Implement the 72(t) Rule?

To avoid the 10% penalty, 72(t) requires the investor to take annual distributions from a retirement account that are “substantially equal periodic payments” (SEPPs) calculated to distribute the entire balance of your IRA over your remaining life expectancy.

After you begin taking 72(t) distribution, you must continue taking such distributions for 5 years or until you reach 59½, whichever is longer.

In other words, once you begin taking these distributions you’re locked in for several years. There’s no way to change your mind unless you are willing to pay the penalties and interest.

After you reach 59½ (and so long as you’ve been taking payments for 5 years) you can stop taking annual SEPP distributions.

By taking 72(t) distributions you’re effectively creating an annuity out of your retirement account by calculating distributions based on your life expectancy.

How Much Can You Take Out Each Year?

There are three ways to calculate your annual SEPP distribution. You can run the calculations for each method and choose the one that fits your income requirements and tax planning needs.

  1. The Required Minimum Distribution Method,
  2. The Fixed Amortization Method, and
  3. The Fixed Annuitization Method.

Here’s a simple calculator from Bankrate to show you how much you can withdraw based on a few assumptions: 72(t) Distribution Calculator.

Let’s run through an example.

Example. Larry, 42, has a portfolio of $1,500,000 in a retirement account. He wants to start taking SEPP distributions using Rule 72(t). According to the Bankrate calculator, he can withdraw $35,971 using the required minimum distribution method or up to $56,919 using the fixed amortization method.

Using the 4% Safe Withdrawal Rate on a comparable portfolio, we would expect Larry to be able to withdraw about $60,000 a year without worrying too much about depleting the portfolio. That’s pretty close to the $56,919 that he can withdraw using the 72(t) Rule!

So, as you can see, turning your retirement portfolio into an annuity with distributions over your remaining life expectancy mirrors the amount you would expect to receive using the 4% Rule.

I imagine a few lightbulbs are going off right now.

It’s further proof that the 10% penalty is irrelevant! It certainly shouldn’t keep you from shoving as much money as possible into retirement accounts.

Pitfalls and Caution

Knowing about the 72(t) Rule is helpful, particularly for those interested in early retirement, but it’s a little more complicated than the other methods I’ve written about and requires that you get a few things right. While this is not a problem for detail-oriented lawyers, I’d work with a professional tax advisor if I implemented this plan.

Here’s a few things you will require your attention:

  • Selecting the correct calculation method that makes the most sense for your tax planning (remember, you can only make it once and then you’re locked in).
  • Changing your mind after taking SEPP distributions for a few years (you can’t do this).
  • Forgetting to take a distribution on time.
  • Making sure to file all tax forms correctly to report the exception to the 10% penalty (like Form 5239).

In short, this is a great tool for the early retiree that requires a little planning and professional help but should get you comfortable that retirement money isn’t really as locked away as you might think it is.

Let’s talk about it. Can you see implementing the 72(t) Rule in your future?

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BLI’s Book Recommendations http://www.biglawinvestor.com/book-recommendations/ http://www.biglawinvestor.com/book-recommendations/#comments Fri, 26 May 2017 10:00:00 +0000 https://www.biglawinvestor.com/?p=3065 Check out The Biglaw Investor or read BLI’s Book Recommendations

From time to time I’m asked for book recommendations. It’s a great question because books are an efficient way to learn the basics or dive deep on a specific subject. The best move you can make (besides – shameless plug – following the blog or subscribing to the email list) is to pick up a […]

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Check out The Biglaw Investor or read BLI’s Book Recommendations

From time to time I’m asked for book recommendations. It’s a great question because books are an efficient way to learn the basics or dive deep on a specific subject. The best move you can make (besides – shameless plug – following the blog or subscribing to the email list) is to pick up a few good financial books to read each year.

Rather than repeating myself, below are all the books that I think are worth your time plus a short description. I’ll keep this article updated with the latest as I’m constantly reading new books. Don’t forget that you can get a lot of these at the library for free, although sometimes it’s nice to have a hard copy around to refer to when you get caught up in some financial question.

The Simple Path to Wealth by JL Collins. Jim’s book is a masterpiece of easy-to-read financial information that will have you set for life. This is a great first book if you consider yourself completely new to personal finance, yet I suspect that almost any reader will find something of value.

The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing by James Dahle. Written by a practicing emergency physician, this book is aimed at doctors and discusses a few topics that are particularly relevant to them (e.g. medical school residency and the big salary bump when you reach the attending level) however there is more than enough in here to make it valuable to any lawyer. With nearly unanimous 5-star reviews, how could you go wrong? Like The Simple Path to Wealth, this book is a perfect introduction to building wealth but would also be beneficial for an experienced investor, particularly when he covers topics such as disability insurance and other ways to protect wealth. Maybe some day I’ll contribute my own book covering situations unique to lawyers.

If You Can by William J. Bernstein. If you’re not quite ready for several hundred pages, Dr. Bernstein wrote a primer for millennials that’s only 16 pages along. It’s also free. There’s not much you have to do to build wealth, but Dr. Bernstein recognizes that it’s harder than it seems.

The Bogleheads’ Guide to Investing and Guide to Retirement are two great books written by various Bogleheads. If you’ve never heard of the Bogleheads, stop by the forum and prepare to learn. Literally the nicest place on the Internet, the Bogleheads is a multi-million dollar gift to the internet free from ads. It’s one of the few places where you’re likely to get thoughtful and helpful responses to your questions. The books are pillar editions for your financial education.

The Essays of Warren Buffett by Warren Buffett. Warren Buffett writes amazingly letters to his shareholders each year chock full of gems and good financial advice. This collection of his essays is a masterful cut and paste from those letters that ties the different sections around particular themes. If you’re looking for wisdom directly from the Oracle of Omaha, this is the place to find them.

J.K. Lasser’s Your Income Tax by J.K. Lasser. More of a reference book than the type of book you’ll read while curled up on the couch, each year there is a new version released which goes through your tax return in painstakingly precise detail. I have a reference copy of this on my shelf and pull it off each year when I’m preparing my taxes or if a reader asks a particularly thorny tax question. You won’t read this book from cover to cover but it’s a great collection of information on all the different tax forms.

Why Smart People Make Big Money Mistakes and How to Correct Them by Gary Belsky and Thomas Gilovich. If you’re interested in behavioral economics and why might be your own worst enemy, this is a great book on how to outsmart yourself and what pitfalls to look at for as you go through your financial life. You’re smart enough to earn a law degree but are you smart enough to realize your own limitations?

The Little Book of Common Sense Investing by John Bogle. Still not sure that indexing is the way to go? Jack Bogle, founder of Vanguard, has a little book of common sense investing that he wants to share with you. When you think about it, society as a whole earns the market return no matter what, so why do you think you’ll do better than your peers?

The Millionaire Next Door by Thomas J. Stanley. It’s a classic for a reason. The millionaires in the United States are precisely those people that don’t necessarily look like millionaires on the outside. The lessons from this book are just as relevant today as they were when it was originally published.

Your Money or Your Life by Vicki Robinson. Another classic, Your Money or Your Life is a way to transform your view of money. Think early retirement or financial independence is something that happens when you’re 65? This book will change your perspective. Until Mr. Money Moustache writes his own book, Your Money or Your Life continues to be a solid choice for thinking about money as the ability to purchase your freedom.

How to Think About Money by Jonathan Clements. Not just a behavioral finance book, How to think About Money tries to get you to worry less about money and make smarter financial decisions with the money you have. I liked it so much that I wrote my own review (see my highlighted notes here).

Let’s talk about it. Did I leave out any good reads? Let me know in the comment below and I’ll add them to my list.

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The Roth IRA Conversion Ladder http://www.biglawinvestor.com/the-roth-ira-conversion-ladder/ http://www.biglawinvestor.com/the-roth-ira-conversion-ladder/#comments Mon, 22 May 2017 10:00:00 +0000 http://www.biglawinvestor.com/?p=3056 Check out The Biglaw Investor or read The Roth IRA Conversion Ladder

Occasionally I’ll run into someone just getting started saving that is worried about putting so much money in retirement accounts because they have a vague sense that at some point they might need access to the money in the future. They couldn’t tell you specifically what they’ll need the funds for (perhaps a mortgage, emergency, […]

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Check out The Biglaw Investor or read The Roth IRA Conversion Ladder

Occasionally I’ll run into someone just getting started saving that is worried about putting so much money in retirement accounts because they have a vague sense that at some point they might need access to the money in the future.

They couldn’t tell you specifically what they’ll need the funds for (perhaps a mortgage, emergency, future living expenses, etc.) but feel more “comfortable” keeping the money in a regular taxable brokerage account rather than what they perceive as locking up the money forever until they’re 59.5.

Besides missing out on all the tax arbitrage benefits of retirement accounts, the fear of locking your money away might not be as big as you think. We’ve already run the math to show that the 10% penalty in your 401(k) account isn’t even that bad if you decide to simply pay it.

But if you’re willing to do some life planning, there are a couple of other easy ways to get access to your money before you hit 59.5.

We’re going to explore one today: The Roth IRA Conversion Ladder.

The basics of the Roth IRA Conversion Ladder are pretty simple: (1) you roll pre-tax 401(k) money to a pre-tax Traditional IRA; (2) you convert pre-tax Traditional IRA money to post-tax Roth IRA. You can then withdraw the contributed amount from a Roth IRA tax and penalty free.

The Roth IRA Conversion Ladder comes with two catches.

The first is that you need to wait five years after conversion before you can withdraw the money without penalty. The second catch is that you must pay income taxes when you convert money from a pre-tax Traditional IRA to a post-tax Roth IRA.

How would this work in practice?

You have to build a ladder.

Let’s imagine a lawyer that decides to call it quits at the age of 45 and wants to access 401(k) funds before 59.5 without paying the 10% penalty. Let’s further imagine that this lawyer wants about $50,000 in annual going forward.

Here’s how the Roth IRA Conversion Ladder would look:

In the first five years you’d be building the rungs of the ladder as you convert money from a pre-tax IRA account (formerly your 401(k)) to a post-tax Roth IRA. The conversion would generate $50,000 in taxable income each year. Paying income taxes puts you in the same position as you would be if you were withdrawing 401(k) money after age 59.5.

Because of the 5-year conversion rule you wouldn’t be able to withdraw this money immediately, otherwise you’d defeat the purpose of the 10% penalty entirely. The IRS isn’t clueless as to what you’re doing!

However, the IRS thinks making you wait 5 years is enough time to keep you from taking advantage of this path around the 10%. And while that might discourage some, all it really takes is a little advanced planning.

However, you probably noticed that for years 1 through 5 you have a problem. You can’t withdraw the $50,000 while you are waiting for the money to season thanks to the 5-year conversion rule.

To solve this problem, you have two options.

The first possible solution is to begin the Roth IRA conversion five years in advance of when you’ll need the funds. The problems with this, however, is that you’ll end up adding $50,000 to your income during years when you’re working, thus subjecting that $50,000 to a high marginal tax rate. Also, you might find it logistically difficult to get the money from a 401(k) to a Traditional IRA so that you can perform the conversion. For those two reasons, this may not be the way to go.

The second solution is to withdraw the money from some other source. Again, a little planning goes a long way.

The money needed for the first 5 years could come from (i) previous Roth IRA contributions (not the backdoor kind, but direct contributions, since direct contributions can always be withdrawn without tax or penalty; (ii) withdrawals from a 457 account; (iii) savings in a regular taxable brokerage account or (iv) income from a side hustle.

Savings in a regular taxable brokerage (or savings) account seems the most likely to me.

If you saved up $250,000 in a taxable account, you could withdraw $50,000 per year for five years before your Roth IRA Conversion Ladder kicks in.

The process sounds more complicated than it is but conversions are pretty easy (Vanguard has one button to press which gets it done in about 5 minutes). After that, all it takes is a little bit of planning for you to access these funds well before you’ve hit the age of 59.5.

Let’s talk about it. Does knowing that there are ways to access retirement funds pre-retirement make it easier to contribute and max out retirement accounts?

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