Essential wealth planning for new law firm partners
In a recent post we considered what graduates who are beginning a budding career in law need to know about managing their finances. Now it’s time to focus on the higher rungs of the law firm ladder with our wealth management planning advice for new and prospective partners.
You may have dreamt for many years of being a law firm partner, but now you’ve made the grade what’s in store for you financially? In many cases it’s the promise of immediately bigger income. As with the top rung of many professions your future earning potential will also be greater.
But that isn’t the whole story. Your changing circumstances as a ‘partner in waiting’ – where you’ve had the nod but still have targets to achieve – or a newly appointed partner will also give rise to new financial requirements.
ADL helps many legal professionals just like you, who are making the step up to partner, with wealth management planning. In this article, we consider what partners need to know about financial management, and why you should start planning as soon as possible.
What your new pay package will look like
First, let’s look at how law firm partners can expect to be compensated for their dedication and expertise.
While not all partner roles are the same, there are three general classifications of partner remuneration:
Equity partner – Where the partner’s income depends on the law firm’s profits. Profit share agreements can either be based on individual partners’ levels of seniority at their firm; or a mixture of that plus an additional annual performance-based share. As covered later, equity partners are required to invest capital in the business; again, the details of this will vary by firm e.g. cash contribution or loan.
Fixed share partner – This arrangement is a reduced form of equity partner (see above), with the partner’s income usually determined on a profit share basis, but at a lower percentage than full equity partners. Fixed share partners are often contracted to guaranteed minimum payments even in a year of poor profit. Bonuses/commission can also be part of their remuneration.
Salaried or Income partner – Unlike the two partner types above salaried/income partners remain on PAYE. They receive a contractual amount that doesn’t take into account the firm’s profits, which are not part of their income. That said, bonuses and commissions may still be paid.
There’s a lot to get to grips with. At a time when you might also be taking on bigger or more complex cases that would positively impact your and the firm’s reputation, it’s also important to consider how your financial compensation package could affect any wealth management planning.
Understanding financial risk and reward as a partner
Broadly speaking the issues below are the main financial considerations at this point of your legal career. Here’s a closer look at the issues you might encounter and our initial advice on how to approach them:
From safety net to self-employment – If you’re becoming an equity or fixed share partner the law firm will require you to switch to self-employment for tax purposes. If this is the first time you’ve moved away from PAYE you’ll need to get used to setting money aside to pay tax every January and July.
When you come off payroll you’ll also lose access to the firm’s employee benefits package. Removal of death in service and critical illness benefits is especially important, particularly for new partners who have a mortgage and/or a family to maintain.
Solution: Not all law firms automatically stop employee benefits: we work with some that are still entitled to a lump sum payout should the partner die, for example. But more often than not you’ll need to think seriously about replacing insurance policies to make sure you are appropriately covered in case the worst happens. The key word here is “appropriately”; this means more than having an equivalent sum being paid out by the insurer, but rather also being set up under trust, and then paid out of the trust correctly – especially where it’s covering a mortgage.
We helped a newly appointed partner who lost access to payroll benefits, recommending income protection to cover essential outgoings and a decreasing term assurance policy for their mortgage.
Off the payroll, out of the pension scheme – Closely linked to the point above is another common problem to solve: leaving your firm’s pension scheme if you’re a self-employed partner. That means you’ll need to start funding your future retirement yourself – and without the right advice pensions can be a minefield.
Solution: We recommend transferring the pension you’ve accrued at the law firm into a private scheme. From there, you’ll need to restart the regular contributions you were already making and review the level when your income begins to rise, for example through a greater share of profit-related bonuses. This is something we handled for a newly promoted partner; it’s important to review your contributions after 6 or 12 months, when you’d normally receive your first bonus.
It’s all about maximising pension allowances. However, partners are likely to use carry forward quickly. At this point you’ll want to make the most of ISAs and – once those are maxed out – alternative options such as Venture Capital Trusts.
As explained in our recent blog High Earner, High Pressure?, which considers investment options for people on bigger incomes, VCTs are tax-efficient collective investment schemes. They are designed to boost UK start-ups and scale-ups while providing income and capital gains for investors, in exchange for the increased risk you’re taking on.
An increase in personal financial risk – Depending on the structure of your law firm you may be exposed to a much higher level of financial risk which can even include assets such as your family home.
In a limited company or limited liability partnership exposure levels are lower. Partners are required to invest up front – typically through capital or current accounts, directors’ loan accounts or existing profits. Typically, risk matches the level of initial investment made.
But risk is higher at firms with a traditional partnership that becomes insolvent if, for instance, the partnership performs badly or suffers a negligence claim that exceeds professional indemnity cover. In some cases, the creditor might even choose to pursue a specific partner further putting their personal assets at risk.
Solution: It’s a counterpoint to your success as a legal professional that financial risk increases even as you begin to earn more money as a partner. You might also need to take out a loan to buy into the partnership. This is often the case at smaller law firms where finance is required to ensure cashflow is not disrupted. Financing in this way can be structured as a capital account, paid down over time when you generate fees as a partner.
Partners in time: get wealth planning advice early
Whatever the issues presented as you step up to be a law firm partner getting the right advice and wealth management planning in advance are key. If you engage an adviser prior to becoming a partner you’ll be in a better position to navigate the financial opportunities and risks that will inevitably come your way.
According to Glassdoor the average partner starting salary in a UK firm tops £88,000 and this annual figure can rise dramatically over time. Add almost £20,000 in bonuses – sometimes far more – on top of this and you can clearly see why financial management advice is a must.
ADL is home to extensive expertise and experience under one roof, relating to all of the aspects outlined above and more including:
- Insurance: critical illness, income protection and more
- Pensions planning and ongoing management
- Employee benefits
- Intergenerational wealth transfer
Our mission is to provide bespoke wealth management planning that suits your specific circumstances, and support you to make sure the devil in the financial detail doesn’t undermine your progress as a law firm partner.
For more information or to book a free introductory consultation, contact our team today.