Thanks, I appreciate this post. As a new associate, it's good to be scared straight every now and then. This is high octane nightmare fuel. I cannot imagine earning biglaw money for five years and not managing to pay off my student loans and maximize 401(k) contributions.First, congratulations to the associate on being employed in this tough job market! You are no doubt a very smart and on-the-ball person - it further shows in that you are seeking financial advice early in the game. Second, the sentiment that the associate mentions - that they can't imagine not paying off the student loans and maxing their 401k - is a pretty common sentiment. However, as associates find out, it is all too easy to fail to accomplish this. We will discuss some of the reasons why associates fail to accomplish this and what they can do to help themelves after the break.
First, with regard to earning biglaw money and not having enough to get by, associates almost always over-estimate just how far a biglaw salary goes, especially compared to their loans. Here's an example. Let's assume that the new associate starts out making $145K, which seems to be what many biglaw firms are going towards.
- Using this tax calculator, we find that the associate will owe $31,702 in federal tax.
- Social Security and Medicare (FICA) tax is 7.65% on the first $106,800 for a total of $8170.
- Health Insurance payments are going to be much bigger than you expect. Although most corporations subsidize a significant fraction of employee health insurance payments, most law firms only subsidize a little or do not subsidize at all. I pay around $10K/year for health insurace on a family plan. For an individual, it would cost around $5K.
- Don't forget state income taxes - that's 3% in Illinois, but ranges from zero in some states to as high as 12% in other states. Let's use 4% as a national average. That yields $5,800. Additionally, if you work in New York or some other cities, you will have to pay municipal income tax in addition to federal and state.
Now that we have a better idea of how much money is really coming in, let's take a look at four aspects of money going out:
- Living Expenses
- 401k max
- Loan Payments
- Extras/fun stuff
Let's assume that our associate is going to live a reasonable, professional lifestyle in Chicago. Rent a reasonably priced apartment in a professional area. Wear reasonable professional clothes, not $2000 suits. Have the occasional Starbucks, etc. A lifestyle where the associate is not really trying to to be especially careful with their money, but is overall pretty conscious about keeping the spending down - and is certainly not buying anything big. Living this lifestyle in Chicago is probably going to cost around $3500/month. You will be spending about $1500 on rent and the remaining $2000 on bills/food/clothes/entertainment, etc. That's a total of $42,000/year.
In comparison, in New York, as you can see from the Bankrate cost of living comparison tool, you will be spending aroud $3500 in rent and probably about $2000 for other costs for a total monthly cost of $5500/month. That's $66,000/year.
Subtracting our living expenses from the $94,300 that we has coming in leaves us with $52,570 to spend in Chicago and $28,300 to spend in New York.
Second, let's talk about maxing out the 401k. There are two types of 401k, the traditional, pre-tax one and the Roth 401k which uses after tax income. The benefit to the Roth 401k is that the income withdrawn from the Roth 401k will never be taxed again. Consequently, the Roth 401k is probably the way for our associate to go. The maximum contribution to the 401k in 2009 is $16,000. Let's apply that to our numbers above and see how much we have left.
For Chicago, that leaves us with 36,570. For New York, that leaves us with $12,300. Uh Oh. These balances are starting to get pretty low!
Third, now let's talk loan payments - we can use this calculator to estimate the student loan payments. First, however, we have to know what our outstanding loan balance is going to be. As we discussed in my earlier post here, the total loan balance might be as high as $267,000. The actual numbers that the law schools put out with regard to loan debt at graduation are ususally laughably low. They also often present the number as "average loan debt per student" where a number of students (sometimes as high as 25%) are trust-fund kids that have their tuition paid for. Consequently, their "zero" of accumulated debt skews the average to an unrealistic number.
In today's day and age, even if you are going to a reasonably priced law school, if you are paying the full freight with loans then you are not going to graduate with less than $150K in debt, $200K is a more reasonable number, and $250K in debt is a real possibility. Even in the mid-1990s when I went to law school, even with good paying summer jobs at law firms after my 1L and 2L years, I still had about $120K in debt when I got out. Also, recognize that not all of the debt is going to have the low interest rates offered to federal student loans (6.8%) - private loans can be much higher, and you will need to take out plenty of private loans to get through.
For $150K in debt, assuming an average interest rate of 8% and a 10-year amortization schedule, the loan payment is $1820/month (21,840/year). For $200K, it's 2427/month (29,124/year).
Yikes! If we are in New York, we only have $12,300 left to spend after our 401k contribution. That doesn't even leave us with enough to make the payments on our $150K worth of debt - we are about $9000 short. Consequently, we are going to have to cut somewhere. We might be able to squeeze our lifestyle down, but most of our monthly cost is rent, so pretty much the most we can squeeze out would be about $1000/month or $12,000/year. Our other option is to not fund the 401k fully so that we can make our loan payments.
This is the real "rubber hits the road" situation that associates like the one that left the comment really don't fully appreciate until it hits. They see the $145K and it seems like so much money that they will be able to pay for everything that they could possibly want. In practice, however, the money really goes quick!
As opposed to living in New York, if our associate is living in Chicago they have 36,570 left to spend and can make their minimum loan payments at both $150K and $200K with some left over (either about $15K or about $7K.)
However, if you want to pay off the loans in 5 years as the associate mentioned in his comments (instead of the standard 10-year amortization), the payments are: for $150K = 3,041/month ($36,492/year) and for $200K = 4,055/month ($48,660)
Woah now! Living in New York and maxing out our 401k leaves us with only $12,300 left to spend, so there is NO WAY that we can afford either option. Further, even if we did not contribute a dime to the 401k and lived in New York, we would only have $28,300 - we would still be short by at least $8000 - or even $20,000!
Frankly, as opposed to the optimistic comments expressed by the associate that left the comment, if you are living in New York and have at least $150K in debt, there is very little possibility that you can max out your 401k and pay off your loans in 5 years. You just don't have the money.
Taking a look at Chicago, after maxing out the 401k, you would have $36,570K - that is just enough (barely) to make the payments to pay off the $150K in loans in 5 years. It's possible, but you would have to be extremely careful with your budget - and no buying extras. However, even in Chicago, if you had $200K in loans you would be about $12K short. You may be able to live more frugally and cut your living expenses, but it's likely that you are not going to have enough to both fully fund your 401k AND pay off the loans in 5 years.
Finally, let's talk about extras. Most associates run at least some of the numbers and often have some plan or goal to pay back their loans and max that 401k. However, as we have seen above, that's a really difficult goal. Further, most associates make it even more difficult on themselves by buying extras that they don't need and work against them meeting their 401k and loan goals. These extras typically include:
- Buying/renting more house than they need
- Buying/leasing more car than they need
- Taking that vacation trip
- "Rewarding themselves" - this is especially dangerous. For example, it seems like it has become fashionable for associates to "reward themselves" with an expensive vacation after taking the bar exam. That's about the worst time in your career to buy an expensive vacation.
- Clothes, watches, status items
- Paying for food or drinks when out with friend because you are the one with the "good job"
- Being vulnerable to salesmen. Did I mention that because your phone number is public and everyone knows you make a lot of money, that salesmen are going to be calling you constantly? They will try to sell you just about every service known to man. They will come to your office to fit you for shirts and pants, they will do your dry cleaning, take care of your house and errands. They will even come to your office and give you a workout during lunch - using kettle bell weights seems to be this year's fashionable workout. Always for a fee, of course.
In summary, your starting salary is really a lot less after taxes. Further, when you toss the loan payments on there and the costs just to get by, you really don't have that much left over. It is going to take a LOT of discipline and planning to be able to pay off your loans and max that 401k. Even in a fairly good scenario, you are going to have to live frugally and pass up a lot of extras - and it is by no means guaranteed that you are going to be able to do even that.
Best advice, stop looking at the 145K number and start getting real with your bottom line costs. You are going to need it to help you resist the budget-killing extras that are going to be constantly sold to you. Good luck!