Partners in law, accounting and other professional firms are among the best-paid people in the country and among the least well planned. The reasons are structural, not personal. Income arrives as K-1 distributions rather than a salary, the biggest asset is an interest in the firm that cannot be sold, and the retirement depends on a buyout formula written by other partners. Here is how we read a partner’s balance sheet, and the questions we ask first.
Income that is not a salary
A partner’s draw is a share of profits, paid as the firm earns them and taxed as self-employment income. That has three consequences. Cash flow is lumpy, so the personal reserve needs to be larger than an employee’s. Taxes are paid in estimates, so a plan that does not set money aside each quarter ends in a scramble every April. And there is no employer match: every dollar of retirement saving is the partner’s own decision, which is why so many partners reach fifty with far less saved than their income would suggest.
The capital account
Most partners have money tied up in the firm as a capital contribution, often borrowed. It earns whatever the partnership agreement says, it is returned on terms the agreement sets, and it is exposed to the firm’s fortunes along with the partner’s income. We treat it as a concentrated, illiquid position, because that is what it is, and we size everything else around it.
The plans that work hardest
Professional firms can sponsor retirement plans that allow far larger contributions than an ordinary 401(k): a cash-balance plan layered on a profit-sharing plan can let a partner in their fifties shelter well into six figures a year, deductible to the firm. Whether the firm’s plan is designed that way, whether the partner is using the room, and whether the plan’s investments have been reviewed in the last few years are the first three questions we ask. The answers are often no, no and no.
The buyout
A partner’s retirement is usually funded partly by the firm: a return of capital, a share of unbilled work, sometimes a formula payment over several years. It depends on the agreement, on the firm still being there, and on the partners who remain being willing to pay it. We read the agreement, model the payments, and plan on the assumption that they could be smaller or later than the formula says.
The order of work
- Build the reserve: enough to cover the lumpy months and the tax estimates without touching investments.
- Use the plan room: the firm’s retirement plan is the highest-value saving a partner can do, and the deduction is the firm’s as well.
- Diversify away from the firm: everything outside the capital account should look nothing like the firm’s own risk.
- Write the estate plan around the partnership interest, because the agreement, not the will, decides what happens to it.
None of this is advice for any particular partner; firms and agreements differ, and the right order depends on the person. It is the map we start from. If you are a partner and have never seen your own version of it, that is the first conversation to have.
This material is for informational purposes only and is not a recommendation to buy or sell any security. All investing involves risk, including loss of principal.