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 when it comes to figuring out how to pay for law school.
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.
Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Empower keeping track of his money and is always negotiating better student loan refinancing bonuses for readers of the site.
Great points all around. Just some thoughts with your five points:
(1) Great point about not feeling the pain. I actually remember in my second year of law school borrowing some extra money so that I could go to the Rose Bowl. It didn’t feel like anything because it was just all on paper.
(2) I do wish I had contributed to a Roth IRA (or at least knew what it was), but it’s a tough thing to do when your yearly expenses with tuition are going to be more than what you earn. Admittedly, I wasted a ton of money from my summer associate gig, but I did use at least some of it to pay for school expenses. How would you recommend law students balance Roth IRA vs. taking out debt. I’m personally on the limit your debt load and just catch up later.
(3) So many law students and lawyers don’t do any financial education. Actually, pretty much all professions with significant income seem to not do this.
(4) Love the live like a student mindset. This is huge! The only thing that changes between first year of big law and third year of law school is that suddenly, you’re making a big paycheck. But most of us are still going to be a 20-something kid making a salary most people can’t even imagine. No need to be a baller at that point.
(5) Geo-arbitrage is a good point. I know that my own cost of living here in the midwest is much less and is one of the reasons I got out with less debt and paid it off faster. I could have actually transferred to a prestigious NYC school after 1st year and probably snagged myself a big law gig on the East Coast. But it would’ve likely tripled my debt load and I’m pretty sure I wouldn’t be debt free yet (Columbia and NYU would easily be 60k in loans per year). Only downside of a mid-market is lower starting salary, but considering the fact the most rent I’ve ever paid is $600 a month ($1200 total for a 1 bedroom, split between myself and my SO), I think that’s not too bad. (Note. it’s easy to pay a lot more in rent in the midwest if you are only willing to live in luxury apartments).
Great comment Financial Panther!
(1) Yes, same for me. I remember once when my roommate bought a TV and then pitched me on the idea of buying the DVD player because “what’s another $100 when you’re about be making six figures”. There were a lot of those moments.
(2) Agreed that you can’t afford Roth IRA contributions in law school (even if you’re not wasting money from your summer associate gig, tuition and room/board are typically higher in any given year than what a summer associate makes, so you’ll finish the year in the negative). I think law students should borrow the extra money to make the Roth IRA contributions for each year that they have earned income if they’re going the PSLF route or plan to have their loans paid off in 5-8 years after law school. The reasons are that: (1) you only get one chance to contribute to the space; (2) your effective tax rate is super low; (3) even borrowing the money at 6.8%, you’re expecting 30-40 years of Roth IRA growth vs 5-8 years of interest; and (4) if you’re going PSLF, the government is paying for it anyway!
The final reason to do it is that it’s a Roth IRA contribution, so you can always withdraw it and use the money to pay off your loan if something goes wrong.
Related: Should I Borrow Money in Law School to Fund a Roth IRA?
(3) You’re right – it’s not just law students.
(4) Not only if there no need, you’re throwing away the great financial start you’ll get by not taking care of your finances first. Even if your goal is to maximize personal consumption, your best bet is to contribute to retirement accounts and pay off the debt, thus giving your money money in the long run to consume as much as possible.
(5) I think the cost-of-living balance is well in your favor. People are willing to work for less effective money in SF and NYC for the privilege of living in those locations.
I’ve only had 1 friend who went to law school, so I got the feeling that most of the law kids came from wealthy families. A lot of these guys cruised through their undergrad and still somehow got into prestigious law schools.