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SCHOOLS CAN DO MORE Glassman: Harvard is a pretty good law school, David. What did they do besides send you off into the world with law school debt and the ability to command a large salary? Witherspoon: I have friends who went to other law schools and they tell me pretty much the same thing. When they come out, they are ready to work, and they are ready to start careers. And part of the career-building knowledge that people need to have is the knowledge that with career choices come financial consequences. I think it is a very real need that law students have, and that is to understand that career building is not just making money. Career building is learning how to make choices that will enable you to be certain places in your life and in your career. And part of that is learning how to deal with money. Not just how to make it, but how to keep it and use it. Kuhn: That’s what I’ve heard from associates at Powell, Goldstein. They feel that they have to go to a major city, to a large law firm, to earn the huge salary and pay off the loan. And some of them would prefer to stay in a smaller city or maybe work for the government. I worked as a public sector attorney for nine years, and it is a wonderful experience. I think the rising debt loads on these top law school graduates are discouraging them from going into public sector work. And it could have a long-term effect on government service. Richard Barbieri, Legal Times: David, was part of your strict and disciplined financial planning the idea that you wanted to get the kind of job that you have now at the SEC-which is a very attractive job that I assume a lot of young lawyers would have to walk away from. Witherspoon: Oh, certainly. One of the first jobs that I had, even before I went to law school, was semi-law work in the Department of Labor, Department of Commerce, and some of the most fantastic summers I ever spent were working for the government. The problem is, though, looking down the barrel of some real money that you owe and looking down the barrel of some real money that you can make. It makes the decision kind of tough. I had good experiences in the private sector. There certainly is nothing wrong with the private sector. But I wanted to have the freedom to choose and to make decisions as to whether I wanted to do more public sector work at some point. And when you talk to other associates, they basically have come to the same conclusion that you have, so you don’t get a lot of insight from your colleagues, because they are thinking, “Well, I have a house, kids, and primary school to pay for. I am not going anywhere.” That is where I think law schools could come in and do a lot of legwork in that area, in terms of helping people to career plan and to financially plan. Students need to know that they can actually find someone at law school who can talk to them about this. Glassman: Hold that thought. Ruth, you did a survey recently of law schools. What percentage are offering financial planning education? Lammert-Reeves: Well, at the risk of sounding self-promoting, we could only find that we are doing it. For students who are getting ready to graduate, we run a program that is a series of three sessions. First of all, what are the ins and outs of loan repayment, and what is your financial plan, where we walk a student through everything: What is your gross salary, what is your net, what are your living expenses? Before they get there, they are asked to complete a sheet that asks them to identify what their goals are. And then we ask them to look at: What is the money at the end of the month that you have to reach your goals? How much is that? This one guy who was going to New York raised his hand and said, “I have a negative number. What should I do?” And the group just burst out laughing, because it’s like, let’s look and see what you were planning on spending. Glassman: And we have to realize that anyone put in the position to go from earning negative amounts of money to earning $140,000 — we would all tend to do this. Lammert-Reeves: Well, that is why I am so galvanized about doing this session I have been talking about putting together for a couple of years. When the salaries reached $125,000, I said, “Oh my God, we are going to have people like the sweepstakes winner who three years later declares bankruptcy.” Because, you know, when you are making $10,000 as a student, you have a pretty good idea of what you can and cannot afford. And you may still run up a credit card debt, but you can’t go into a car dealership and buy an $80,000 car. They can’t afford that, but they don’t have any idea that they can’t afford that. Barbieri: It sounds like they make a lot of money. Lammert-Reeves: Right. And they do. But not enough to do all that. Glassman: Let me take a step back. Of the few things that you are doing, that you wish more law schools would do, what would they be? Lammert-Reeves: Do a better job of explaining the ins and outs of the loans in general and some of the techniques to help reduce the payments. Like going into the payment within the grace period, if they are going to consolidate, so they can get the lowest interest rates. Two is to recognize that they can pay earlier in the month, for example, and reduce their interest. There are these techniques that can help a student use their money more effectively even if they are not paying more money. Say you owe $300 a month. Well, if you get your payment in a week ahead of time, you’ve saved yourself interest. So it’s that whole thing of helping students think more strategically about their loan payments in general, and then moving from there to say, “OK, you have this income. What is important to you besides work, and how are you going to help yourself get there?” People start thinking, and they start coming up with alternatives for themselves. For example, I had an e-mail from a student yesterday who said, “I went to your session two weeks ago. My wife and I have figured out we are going to move into an apartment so we can take a look around at what the real estate is. We are not going to buy a second car. I am so much better prepared than I was a month ago for starting work than when I went into this whole thing.” I didn’t stand there and say to students, “Here is what you should do.” They start thinking, “OK, how does this apply in my life, and let me make better choices as a result of the information that I am getting.” And the whole thing of explaining to students why they need to fund retirement now, what saving $200 a month for eight years does versus waiting until they are 45 to start. That is something that students really grab onto. So if we could help students understand, give them the information, they start making the connections. Scherschel: I’ve done some exit counseling on consolidation, and this newly minted lawyer asked me, well she’d like to come pay her loan but she is going to have to pay off all the interest that would accrue, had she actually consolidated 30 years’ worth of interest. I said, no you can’t pay interest that hasn’t accrued. There’s a lack of basic knowledge about how loan repayment works. That one hit me really hard. I thought, “You don’t know that? Hopefully you will pass the bar.” I didn’t say that. Glassman: That’s why education is crucial. Scherschel: They are so focused on their law studies. We see this with medical school students, too. They are so focused on their studies because they have to be, and it is not that they can’t understand this information, they just aren’t exposed to it. Lammert-Reeves: Well, you take these different classes, but there isn’t an opportunity where there is a synthesis of the information on how it applies to me as an individual. So that is what our advanced exit program does. LAW FIRMS AS EDUCATORS Glassman: I was asking a partner of a big firm in D.C. about educating their associates on financial planning matters, and the quote I got was, “We are giving our associates help with their finances — $135,000 worth.” A lot of law firms nowadays have the belief that associates are financially secure because they are earning such great incomes. While it’s hard to disagree with that assessment, it’s also apparent that financial pressures create a need for education in these areas. Kuhn: I think what you’ll find, though, is that the cost of education has gone up substantially in the last five to 10 years, and so the amount of debt that the new associates are carrying has really increased an incredible amount. And so, from their perspective, the salaries haven’t really kept up with the amount of debt that they are carrying. Glassman: Good point. Kuhn: And so they are not feeling as well off as you think they would be feeling with that kind of salary. Glassman: So what should law firms be doing? Kuhn: I think they should focus more on helping new associates with their debt load, rather than just handing over a paycheck every month. They should focus on counseling the new associates on the value of investing in the 401(k). On the tax benefits of home ownership. That you can buy a home, appreciate some value — around here, it will — a few years later, take out a home equity loan, use the proceeds of that loan to pay off your student loan, and then you’re able to deduct the interest. I don’t know that too many people think about that and know that that option is out there. And that does take a few years of planning, because it is not going to happen immediately. Glassman: But that type of strategic planning might become more common if first- or second-year associates could learn about it sooner. Kuhn: They could start that earlier. And they should also look at the after-tax cost of investing in a 401(k). They see a dollar amount disappearing from their paycheck, but they don’t see that their taxes will be affected, and that their employer may match a portion of that investment, and in fact increase their salary. Glassman: We use the phrase a lot: the shoe cobbler whose kids are walking around without shoes. I am used to seeing attorneys without estate plans. I am used to seeing business lawyers, first-year, second-year, third-year associates who aren’t saving in their 401(k)s because the options are too confusing. I gave a seminar once to associates in one of the larger firms here in D.C., and five out of the 30 — some new associates came up to me afterward with their 401(k) choices — which were a good 110 fund options — and said, “This is why I am not participating. I understand why I should be. It’s just too confusing.” And the person who gave them the forms and whatnot from the brokerage firm didn’t explain the options available or didn’t tie plan participation into the associate’s own personal situation, as far as debt, repaying debt, and so forth. My feeling is, it is actually up to law firms not only to educate them on the new computer system and their library and all of the important things when they first come in, but also to teach them how to start building their own personal nest egg, if you will. Law firms are providing careers to associates, and I believe that they should be providing livelihood, which combines not only the career and the partnership track, but also the future, if not current, level of comfort. Lammert-Reeves: What I think happens is, law firms say, “Well, if we give them too much money, or if we give them too much information — we’ll keep them a little off balance so they always feel like they need to come to us for money.” They can’t leave because they can’t afford to leave. What they really should be doing is helping people figure out, how can this money get me to where I want to go, and then the person approaches it with a level of enthusiasm to say, “OK, I may not like what I am doing, but if I am here eight years, I’ll get to the next step.” You’ll have a whole lot more motivated employee than a person who feels like they have no choices. They are stuck. I think, in terms of outlook and interest in the kind of job that they are doing, you could really turn that around. Unfortunately, law firms don’t seem to be thinking about that. Barbieri: Well, a lot of firms are stuck in that sort of conundrum. They put a lot of investment and anxiety into recruiting and retention – Lammert-Reeves: But they aren’t doing the retention part. I mean, that’s – Barbieri: Well, they think they are by throwing a lot of money at them, but whether they do anything else about it is another thing. Scherschel: I also think that it’s not really all that complicated to provide some basic good financial advice that has stood the test of time. One of the key things is to make sure that debt-service ratios do not go above a certain level because lenders underwrite the key loan in your life, which is your mortgage. Most people want to be able to get that mortgage, and mortgage underwriting standards are pretty tight. You need to not be exceeding a certain ratio or the capital committee, the loan committee of the bank, isn’t going to approve your loan. If you want to get a competitive mortgage, you need to make sure that you don’t spend more than 28 to 30 percent of your pre-tax income on your mortgage payment, including your interest and taxes and property taxes and the basic housing expense. And then 38 to 40 percent, maybe 42 percent, of your total income is devoted to all your debt service, including your mortgage, car payment, credit card bills, and student loans. Because lenders have typically said to make sure that your student loan payments aren’t more than 8 to 10 percent of your income — maybe 12 to 15 percent if you are in a professional group and you have a higher income that could sustain a higher monthly payment as a percentage of your income. Kuhn: But those are monthly payments, not a lifetime debt. Scherschel: Right, but the thing is, it gives at least some basic idea, like, “If my debt payments are going to take me out there, maybe I can’t afford as much house as I want right now because my student loan debt is so high.” And if they make more practical decisions, then they have some guideposts to understand, “Maybe I am going to be in trouble here.” Every person’s situation is different. Some people can’t afford those optimum ratios at that level. They need lower ratios because they have other expenses — a child who has special education needs, or a child who is a prodigy and you want to give him those piano lessons. Everyone’s circumstances are different, but at least it gives them some basic idea. TAX INCENTIVES Glassman: Let’s talk about some of the other hints that we would give to associates, or the education that we would give to associates, as far as taxes go. We’ve talked about the importance of or the use of deductibility of mortgage interest. We’ve talked about the importance of 401(k)s, and the fact that contributions are made from pre-tax dollars. I am assuming that most associates know that it grows tax-deferred. Nancy, if you would comment on using tax credits and tax deductions, a lot of first-, second-, third-year associates don’t necessarily know or take advantage of these things, but there are thousands of dollars of tax incentives. Kuhn: Right, there are tax incentives. Not everyone goes out the first year out of law school and earns $125,000. So for those people who don’t, there are tax incentives that they can take advantage of. One that most new graduates should be able to take advantage of is the lifetime learning credit, and it is a credit against your tax liability of up to $1,000 per family. So for the new graduate who has paid tuition or had education expenses for part of the year, and then earned income for the second part of the year, or really any time, this lifetime learning credit is available. But it is only for expenses incurred during the taxable year, which includes loan proceeds. You can take loan proceeds as money you would spend, whether it is your own or not, and that is up to $1,000 per family. There is no lifetime cap on that, but it does phase out. For 2001, it’s $40,000 to $50,000 if you are filing as a single person. If you are married filing separately, you can’t claim it at all. It’s $80,000 to $100,000 if you are married filing jointly. Glassman: So for a single taxpayer who graduates law school and gets a $100,000 job — let’s say they work for four months — they earn $40,000. They’ll get a $1,000 tax credit. Kuhn: A $1,000 tax credit, which comes off the amount of tax liabilities. That is not just a deduction. Glassman: It’s actually $1,000 in their pocket. And for associates who are reading this who are second- or third-years and didn’t know about this two years ago, could they refile? Kuhn: They could file an amended return. Sure. Glassman: They could file an amended return and get their $1,000 check from the government. Kuhn: Right. The other fairly new provision is the student loan interest deduction, and this is up to $2,000 a year. It applies to the first five years you are out of school. And it phases out also. For single taxpayers, it is $40,000 to $50,000 of income, and for married filing jointly, it is $60,000 to $75,000. So for the new graduate that goes to the public sectors, this credit and student loan interest deduction will be a benefit to them. [Glassman update: As a result of the Economic and Tax Relief Act of 2001, the 60-month limit for student loan interest deductibility has been eliminated, effective Jan. 1, 2002. The new law also raises the income-eligibility limits with phase-outs beginning at $50,000 to $65,000 for single taxpayers and $100,000 to $130,000 on joint returns. Please see your tax adviser for a complete list of applicable provisions to be phased in under the new law.] Glassman: And you can take both? Kuhn: You can take both. Lammert-Reeves: For most people, though, unless they take advantage of the consolidation, where they start repayment sooner, they probably would not be able to get both because they might have a month’s worth of payment on the separate student loan payments. Glassman: Right, because they defer. Kuhn: A lot of times, credits can only be used for their first year. Lammert-Reeves: So it is for their last semester’s work for tuition. Glassman: Right. Scherschel: The interest deduction is supposed to start indexing the income against inflation, I think, within the next couple of years. Kuhn: Yes, I mean, those phase-outs will change. Glassman: Yes, but those, we’ll put it on record, are for 2001. Scherschel: And it’s a limited population that can benefit from that, but someone who takes the job as a public defender or the local attorneys can. Glassman: Well, the first year, more can, but in following years, certainly there is a limited number, especially in a major city like Washington. And then, Nancy, if you could also comment on, let’s say somebody does go through law school, works as an attorney, and goes back for that L.L.M. Kuhn: If you are an attorney in business, you’ve graduated from law school, taken the bar exam, and are a practicing attorney, and you then decide to go back and get an L.L.M. — in the tax area, especially, it is very common for people to have an L.L.M. — you can deduct the full expense of that tuition and educational expense as a business expense, but it is very factually sensitive. I mean, you really have to jump through all the hoops to be able to take that deduction. So the key is that you pass the bar and you practice as an attorney for at least a couple of months. There’s a tax court case in which a law student clerked at a law firm, passed the bar, worked the rest of the summer at this law firm as an attorney, then took a leave of absence, got his L.L.M., came back, and he was able to deduct all of his educational expenses as a business expense. That also includes loan repayment in future years for that educational expense. Glassman: And that means actually passing the bar? Kuhn: Passing the bar and working as an attorney. Scherschel: Because it is not for training in a new area. It is for an enhancement in a current job. Kuhn: For example, if a paralegal goes back to school to become a lawyer, that doesn’t work, because the only goal is qualifying himself or herself for a new trade or business. So those expenses would not be deductible as a business expense. Continued: Having it All — Later, Part IV

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