Tax/Investment Advice Before Starting BigLaw Forum

[Anonymous User]

Hi all. I'm heading into BigLaw coming off a couple clerkships this fall, and I'm hoping to get some advice on how to handle the investment/tax implications of the signing bonus and higher salary.

People on these boards talk about investment/loan repayment strategies in a lot of detail, so I figured you all might have some tips on how to get your head around the major budgeting/tax changes that come with entering BigLaw. Did you folks walk into an H&R Block, consult with a CPA/investment adviser, or what?

Edit: Couple additional details---my spouse makes about 50k a year, I'll be entering the firm at a second year salary (170k) in October and graduating to third year salary (185k) in December (I think that's how two years of class credit for clerkships works). Signing bonus will be about 65k. My current salary for this year is ~80k. I owe 55k in refinanced student loans and my only investment is a $5,500 ROTH IRA. My safety net is pathetically small--about 3k---because I'm lucky enough to have family that could help me for a short time if I got hit by a bus.

I'm curious if the portion of my 80k salary for this year, combined with my signing bonus and stub year salary, will put me over the income limit for maxing out my ROTH IRA again this year, and whether I should do a conversion from a traditional IRA to a ROTH IRA to if I'm no longer eligible.

Also, for the people recommend maxing out my 401(k), you would all really put the first 18k into a retirement account over paying down debt or saving for a downpayment on a home? This may be shortsighted/stupid, but it's hard for my to justify tying up that huge a chunk of money when I have pressing debt and need to drastically increase my safety net now.

[nealric]

Did you folks walk into an H&R Block, consult with a CPA/investment adviser, or what?

Whatever you do, don't do this. H&R block is absolutely not set up to offer any useful advice for someone in your situation. There's frankly not that much tax planning to do for most young biglaw types. All your income is from a W-2 and you probably aren't buying property or making investments in taxable accounts yet.

My advice? First get an emergency fund saved of a few months living expenses, then max out your 401k putting most of it in a low cost total market index fund, then pay off your student loans as aggressively as possible. Once the loans are gone and you have a decent chunk of change saved up, you can start looking into fancier investment ideas.

By the way, most "investment advisers" are really sales people trying to dupe you into paying commissions out the wazoo for actively managed funds that as a whole generally won't beat a low-cost index fund.

Mods- sorry, accidental anon. You can un-anon if you wish.

[Anonymous User]

Was in the same situation last year. Biglaw makes your tax situation much less complicated because the typical white collar entry level worker deductions phase out at a biglaw salary - no IRA or student loan interest deduction for you. If you are getting a 75 or 50k clerkship bonus on top of your regular bonus you will get hit with AMT, which gets rid of the state and local tax deduction as well, and you will probably owe money to the government during the next tax year. Boy was that a surprise given all I'd paid already in taxes or loans. I'm basically a Republican now.

In terms of investments, my firm requires preapproval to trade any equities other that ETFs and mutual funds and discourages short-term trading. I use ETFs anyway so this doesn't matter to me but if you like to gamble in the market you probably won't be able to.

The bigger issue for me has been keeping control of expenses. The job slowly incentivizes you to trade money for time and you wind up with expenditures you wouldnt otherwise have.

[patentlitigatrix]

If you are married and if your spouse is also high income, it is probably worth talking to a professional tax accountant (not H&R block) re: how best to deal with your taxes to minimize the tax penalty you are going to have/avoid AMT if at all possible. Being married/having kids does not have the impact a sane person would expect on taxes in this situation. But that won't really come into play after until your first full year.

[unlicensedpotato]

Assuming you're single, pay at least $2500 in student loan interest in your stub year because that's the only year you can get a tax break for it.

[Anonymous User]

Couple other details---my spouse makes about 50k a year, I'll be entering the firm at a second year salary (170k) in October and graduating to third year salary (185k) in December (I think that's how two years of class credit for clerkships works). Signing bonus will be about 65k. My current salary for this year is ~80k. I owe 55k in refinanced student loans and my only investment is a $5,500 ROTH IRA. My safety net is pathetically small--about 3k---because I'm lucky enough to have family that could help me for a short time if I got hit by a bus.

I'm curious if the portion of clerk salary that I earned this year, combined with my signing bonus and stub year salary, will put me over the income limit for maxing out my ROTH IRA again this year, and whether I should do a conversion from a traditional IRA to a ROTH IRA if I'm no longer eligible.

Also, for the people recommending I max out my 401(k), would you really put the first 18k into a retirement account over paying down debt or increasing nest egg savings? This may be shortsighted/stupid, but it's hard for me to justify tying up that huge a chunk of money when I have pressing debt and need to dramatically increase my safety net.

[Aeon]

I'm curious if the portion of clerk salary that I earned thiss year, combined with my signing bonus and stub year salary, will put me over the income limit for maxing out my ROTH IRA again this year, and whether I should do a conversion from a traditional IRA to a ROTH IRA to if I'm no longer eligible.

Also, for the people recommending I max out my 401(k), would you really put the first 18k into a retirement account over paying down debt or increasing nest egg savings? This may be shortsighted/stupid, but it's hard for me to justify tying up that huge a chunk of money when I have pressing debt and need to drastically increase my safety net now.

It's hard to say whether you will exceed the threshold, because a lot of it will depend on your and your spouse's AGI, filing status (jointly or separately), deductions, etc. You might just take the safe route and contribute to a non-deductible traditional IRA and then immediately convert to Roth. There are no income phase-outs on this, and at most you might have to pay a few additional dollars of tax if your investment appreciates in the interim.

Again, you'd have to run your specific numbers and estimated return on your 401(k) versus your loan interest rate. If your firm is one of those rare ones that matches contributions, you should definitely contribute enough to get the maximum match offered. Otherwise, if you have competing demands on funds, you should just make the judgment call about how to allocate your income.

[Anonymous User]

Did you folks walk into an H&R Block, consult with a CPA/investment adviser, or what?

Whatever you do, don't do this. H&R block is absolutely not set up to offer any useful advice for someone in your situation. There's frankly not that much tax planning to do for most young biglaw types. All your income is from a W-2 and you probably aren't buying property or making investments in taxable accounts yet.

My advice? First get an emergency fund saved of a few months living expenses, then max out your 401k putting most of it in a low cost total market index fund, then pay off your student loans as aggressively as possible. Once the loans are gone and you have a decent chunk of change saved up, you can start looking into fancier investment ideas.

By the way, most "investment advisers" are really sales people trying to dupe you into paying commissions out the wazoo for actively managed funds that as a whole generally won't beat a low-cost index fund.

Mods- sorry, accidental anon. You can un-anon if you wish.

That's very helpful, thanks. I imagine most people could figure this out on their own, but I just have no idea whether the signing bonus has tax withheld at disbursement, and if not, how much money I would need to set aside in anticipation of my higher tax bracket/bill after my income shoots up (and again, whether I'm ROTH IRA eligible or whether I need to do a conversion). Would you find a CPA to answer those questions for you over H&R block? Or just get out a calculator and figure it out yourself.

[hoorahray]

Did you folks walk into an H&R Block, consult with a CPA/investment adviser, or what?

Whatever you do, don't do this. H&R block is absolutely not set up to offer any useful advice for someone in your situation. There's frankly not that much tax planning to do for most young biglaw types. All your income is from a W-2 and you probably aren't buying property or making investments in taxable accounts yet.

My advice? First get an emergency fund saved of a few months living expenses, then max out your 401k putting most of it in a low cost total market index fund, then pay off your student loans as aggressively as possible. Once the loans are gone and you have a decent chunk of change saved up, you can start looking into fancier investment ideas.

By the way, most "investment advisers" are really sales people trying to dupe you into paying commissions out the wazoo for actively managed funds that as a whole generally won't beat a low-cost index fund.

Mods- sorry, accidental anon. You can un-anon if you wish.

That's very helpful, thanks. I imagine most people could figure this out on their own, but I just have no idea whether the signing bonus has tax withheld at disbursement, and if not, how much money I would need to set aside in anticipation of my higher tax bracket/bill after my income shoots up (and again, whether I'm ROTH IRA eligible or whether I need to do a conversion). Would you find a CPA to answer those questions for you over H&R block? Or just get out a calculator and figure it out yourself.

Don't waste your money on a CPA. Seriously, your situation just isn't complex enough to merit one. This thread has given you good advice so far. Here is what I would do:

First, put half the signing bonus away in an emergency fund. This will leave you with around $35k in totally liquid savings when you add it to your $3k. This is now your multi-month (how many months depends on what your living expenses are) emergency fund. You can also dip into this if you do wind up with a tax bill next year. Put it in an online savings account earning 1%, rather than investing it. This way the money is not exposed to risk, and you have very quick access to it if you need it.

Second, take the other half and put it on your loans. You're about to have great cash flow, so just knock down the loans now, and you'll easily pay off the rest within a year, because those will be down to around $25k. Throw all your extra money at the loans and they will be done very soon.

Third, max your 401k. Beyond this, forget about IRAs. Your income is now too high to get the tax benefits of either type of IRA. To save for retirement beyond your 401k, next step is to max the wife's 401k. Once those are done, and you find yourself still wanting to put more away for retirement, open a brokerage account and create a 3 or 4 fund portfolio in it with low expense funds (Vanguard is your best bet). There are lots of places online that will tell you how to do this. If you're still thinking that you aren't saving as much as you want after this, are you planning to have kids? Open a 529. If not, do you want to buy a house? Save for a downpayment. Etc.

[Anonymous User]

Did you folks walk into an H&R Block, consult with a CPA/investment adviser, or what?

Whatever you do, don't do this. H&R block is absolutely not set up to offer any useful advice for someone in your situation. There's frankly not that much tax planning to do for most young biglaw types. All your income is from a W-2 and you probably aren't buying property or making investments in taxable accounts yet.

My advice? First get an emergency fund saved of a few months living expenses, then max out your 401k putting most of it in a low cost total market index fund, then pay off your student loans as aggressively as possible. Once the loans are gone and you have a decent chunk of change saved up, you can start looking into fancier investment ideas.

By the way, most "investment advisers" are really sales people trying to dupe you into paying commissions out the wazoo for actively managed funds that as a whole generally won't beat a low-cost index fund.

Mods- sorry, accidental anon. You can un-anon if you wish.

That's very helpful, thanks. I imagine most people could figure this out on their own, but I just have no idea whether the signing bonus has tax withheld at disbursement, and if not, how much money I would need to set aside in anticipation of my higher tax bracket/bill after my income shoots up (and again, whether I'm ROTH IRA eligible or whether I need to do a conversion). Would you find a CPA to answer those questions for you over H&R block? Or just get out a calculator and figure it out yourself.

Don't waste your money on a CPA. Seriously, your situation just isn't complex enough to merit one. This thread has given you good advice so far. Here is what I would do:

First, put half the signing bonus away in an emergency fund. This will leave you with around $35k in totally liquid savings when you add it to your $3k. This is now your multi-month (how many months depends on what your living expenses are) emergency fund. You can also dip into this if you do wind up with a tax bill next year. Put it in an online savings account earning 1%, rather than investing it. This way the money is not exposed to risk, and you have very quick access to it if you need it.

Second, take the other half and put it on your loans. You're about to have great cash flow, so just knock down the loans now, and you'll easily pay off the rest within a year, because those will be down to around $25k. Throw all your extra money at the loans and they will be done very soon.

Third, max your 401k. Beyond this, forget about IRAs. Your income is now too high to get the tax benefits of either type of IRA. To save for retirement beyond your 401k, next step is to max the wife's 401k. Once those are done, and you find yourself still wanting to put more away for retirement, open a brokerage account and create a 3 or 4 fund portfolio in it with low expense funds (Vanguard is your best bet). There are lots of places online that will tell you how to do this. If you're still thinking that you aren't saving as much as you want after this, are you planning to have kids? Open a 529. If not, do you want to buy a house? Save for a downpayment. Etc.

That makes a ton of sense, many thanks!

[Tiago Splitter]

Beyond this, forget about IRAs. Your income is now too high to get the tax benefits of either type of IRA.

The rest of this guy's advice is solid but you can get money into a Roth IRA by contributing to a traditional IRA and converting it over to a Roth. As long as you have no other pre-tax IRA money this is the equivalent of making a contribution right into a Roth.

[Lexaholik]

I was in your situation a few years ago (coming off a clerkship to Biglaw, and expecting a transitional income year) but had no spouse. Assuming you're talking about 2016 income:

INCOME

Assuming you start in October, you will be spending 3/4 of the year earning your clerkship salary and 1/4 of the year earning your Biglaw salary. Your complete household income will be $223.75k = spouse (50k) + prorated clerk 80k salary (60k) + full clerkship bonus (65k) + prorated 170k biglaw salary (42.5k) + prorated second year biglaw end of year bonus (6.25k). Assuming you and spouse make max 401(k) contributions of $18k each, your AGI (adjusted gross income) will be $187.75k (223.75k - 36k). Roth limits are based on Modified AGI which has a couple more calculations based on your personal situation, but it looks like you're probably close enough to the limit that a Backdoor conversion makes sense. (Roth IRA income limit is MAGI = 183k with phaseouts until 193k.)

Links:
http://www.rothira.com/roth-ira-limits
https://www.irs.gov/publications/p590a/ ... 1000230985
http://www.investopedia.com/ask/answers ... r-magi.asp
http://abovethelaw.com/2015/12/associat ... uses/?rf=1

BACKDOOR ROTH CONVERSION

As another poster mentioned, you should do a backdoor conversion. There are no income limits for backdoor conversions. To put it simply, you contribute to a *non-deductible* traditional IRA and convert it immediately to a Roth IRA. Sounds like you already know a little bit about this but instructions are available at the links below:

Links:
http://www.investopedia.com/ask/answers ... utions.asp
https://www.bogleheads.org/wiki/Backdoor_Roth_IRA

MAXING OUT 401K

As to whether you should pay off loans or max out 401(k) / save for down payment, it depends on your loan interest rate and lifestyle. You say your loans are refinanced so I assume that your rate isn't terrible but rule of thumb is that paying off 6%+ interest rate loans is a no-brainer. The reason why I say lifestyle is that if you live a relatively frugal life, you can simultaneously max out 401(k) and pay off your debt quickly. In general it's better to max out 401(k)s when you're making a lot of money because (1) you save more in taxes because you're in a higher bracket and (2) building up your tax-deferred accounts when you're young allows gives you a lot more time to compound your investments tax-free. Obviously a match would be helpful but your firm probably won't have one. Doesn't matter--maxing out is still a good decision.

Links:
http://www.lexaholik.com/what-should-i- ... ent-loans/ (note: this is my blog!)
http://www.businessinsider.com/amazing- ... est-2014-7

As you can see from above, if both you and spouse max out 401(k) you will still take home $188k for 2016. That puts you in the 28% tax bracket. Adding in state and local taxes will put you at an overall effective (note: not marginal) tax rate of anywhere from 25% to 35% depending on your other deductions/credits. (I'm ballparking here.) That means you'll take home anywhere from $120k to 140k as a family. Of course most of that money will be backloaded in the year, when you get your biglaw salary, clerkship bonus, end of year bonus, and tax refund if you over-withheld.

Links:
http://www.bankrate.com/finance/taxes/tax-brackets.aspx
http://www.investopedia.com/terms/e/eff ... axrate.asp

EMERGENCY FUND

Other people have suggested that you build up your safety net. If what you say is true--that your family can help you out in time of need--then you don't really *need* the emergency fund. Having said that, I would never rely on family assurances but that's also my personal preference. It's not a bad idea to save up the e-fund because if you end up not needing it, it could later be part of your down payment.

Congrats--your problems are first world. You are making a lot of money now and one thing I recommend is to learn personal finance on your own. If you hire a CPA, they probably won't know as much as you unless you pay a ton of $$$ for a really good one. Google is your friend.

Edit: If your firm is like my former firm, they will withhold taxes on your clerkship bonus.

[Anonymous User]

OP again--thank you so much Lexaholic! It was incredibly kind of you to provide such detailed advice--it looks like I may not need a CPA after all. Much appreciated!

[Lexaholik]

OP again--thank you so much Lexaholic! It was incredibly kind of you to provide such detailed advice--it looks like I may not need a CPA after all. Much appreciated!

You're very welcome. Eventually it might be a good idea to hire one, but at this stage given how much money you're about to earn, you really should dedicate the next few years learning personal finance. (If things are too busy alternatively, maybe your spouse can do it, especially if he/she has a natural interest.) I didn't know anything when I first started Biglaw, but self studied over the next few years.

A lot of lawyers aren't great with personal finance so to make up for it, they tell themselves that they have to have a high income forever. That's a recipe for long term unhappiness.