Congratulations you’ve made Partner!

You’ve reached the level that most solicitors strive for when they start out on their career journey but what does that mean for your personal finances and what should you do about it?

When you become a partner, your employment status will most likely change from employed to self-employed and this can have a number of implications which you need to consider.

1.    Profit sharing
If you are joining as a fixed share or salaried partner, as opposed to an equity partner, this means you will normally be entitled to a fixed amount by way of a profit share. Equity partners don’t normally get a fixed amount and instead take a percentage of the profits of the firm. Even for a fixed share partner, the profit share can fluctuate.

2.    Drawings
Drawings are essentially the income that is paid to partners based on their share which, with a fixed share partner will normally be one twelfth of your annual profit share. With equity partners, normally a monthly amount is paid but with an amendment at the end of the year dependent upon the profits of the firm. If this is less than expected, you may be expected to pay some of the received drawings back.

3.    Paying tax
As you are now self-employed you will be expected to pay your own tax and national insurance to HMRC at the end of the tax year. Some firms pay your income gross and you need to save your own tax and national insurance so remember to save this up! Other firms will hold some income back on your behalf to cover the tax and national insurance that will become due. You need to check if the firm keeps your tax savings separate from the rest of the firms cashflow and therefore cannot be used in times when cashflow is tight.

4.    Capital
You may be asked to contribute capital to the firm, and this can be arranged via the firm’s bank. This capital is used by the firm so can be at risk in tough times. They may pay you interest on the loan and you may get it back when you leave but check the terms of the contract on this.

5.    Benefits and Employment Rights
You are now self-employed which means that you have most likely lost all of your benefits. This may include death in service benefits, income protection, healthcare and pension contributions. As well as this you have lost your employment rights, for example the right to bring an unfair dismissal.

What do you need to consider?
If you are on the road to Partner you should start to put the plans in place to minimise the impact on your personal position sooner rather than later so that when the change occurs you are not left in a position with no life cover or income protection. It would be sod’s law that the time you are trying to sort your own arrangements out, is the time you need the cover.

1.    Death in Service Benefits
When you were an employee you may have had benefits equating to a multiple of your salary, typically four times your salary in life cover. As this was part of a group scheme, the likelihood is that there was no medical requirements or underwriting when the plan was taken out. This is not the case for personal policies.

When you take a personal life cover plan out, medical underwriting which is based on your lifestyle and medical history has to be undertaken to ensure the provider wants to take you on as a risk. In practice what this means is that you may not be able to get cover if you have conditions in your medical history.

2.    Income Protection and Critical Illness Cover
It is very common for law firms to offer some form of full sick pay which is paid for the first few weeks of being off with an illness followed by a reduced benefit, typically 75% for the remainder of the term which is normally to age 65. Some firms also offer a critical illness package. Again, these are normally part of a group scheme which means the situation is the same as with a death in service benefit above and you will need to look into setting up your own arrangements and be medical underwritten.

How much cover should you have?
With group benefits, the amount of cover you get is prescribed by the scheme, unless you have the option to change your benefits at an additional cost. When you are looking at ensuring you have your own protection policies in place, the ‘need’ is based on your personal circumstances.

The first thing to consider is your mortgage and it is advisable to ensure your mortgage would be paid off in the event of death or critical illness.

You then need to consider if you have any financial dependents and ensure there is enough life cover to provide for partners and children so that they can live the lifestyle you would wish them to in the event of your death.

For the critical illness cover, you need to consider whether you personally would need an additional lump sum in the event of being diagnosed with something like cancer and therefore how much that would be.

Life cover and critical illness plans normally pay a one-off lump sum, tax free and they pay out to either you (in the event of a critical illness) or to your beneficiaries (sometimes via a trust) in the event of death.

Income Protection pays a tax-free monthly income subject to a maximum percentage of your income and pays out after an initial deferred period (waiting period). This can vary from 1 week to 24 months depending on how long you can support yourself at the start. The longer the deferred period the lower the cost. Income protection is based on the ability to perform your job (own occupation) or any job (any occupation) and it would pay out until you go back to work, the specified retirement age or in the event of death.

3.    Private Medical Care
If your firm has provided private medical care and you wish to continue with this, the first thing to do would be to speak to the existing provider to see if you can convert this to a personal policy.

Assuming this is not the case, you will need to explore the options with other providers for a personal policy. You will have to disclose pre-existing conditions which may then be excluded from the cover on the plan. You should also be able to cover other family members on the plan as well.

4.    Pensions

This is a complex area due to the changes in the Annual Allowance, Tapered Annual Allowance amongst other things. Essentially you are now in a position where you have to provide for your own retirement. It is likely that when you become a partner your income will increase. A pension is a tax vehicle that means for a higher rate taxpayer every £10 you put into a pension only costs you £6 and the government put in the other £4 in the form of tax relief. That is a 40% uplift before any fund performance.

You need to be careful with pensions as there are complex rules around the amount you can put in each year, particularly for higher earners.

Another point to note, if your income is over £100,000 in any one tax year, you start to lose the personal allowance (the first portion of income you can earn tax free). This means that for every £2 of income over £100,000 you lose £1 of the personal allowance. In the 2019/20 tax year, this means that when your income (including bonus/profit share) reaches £125,000 you have lost the personal allowance completely. This can result in an effective rate of tax of 60% on this portion of income. By contributing into a pension to bring your income back to the £100,000 level, you maintain your personal allowance meaning you make 60% in tax relief on this portion of income.

Remember as a self-employed person paying your own pension contributions, only 20% tax relief is given at source and you need to claim the remainder using your Self-Assessment form at the end of the tax year.

How can a Financial Planner help?
Working with a financial planner prior to becoming a self-employed partner should help you to see the cost implication alongside the benefits of the change. They should be able to forecast what you need to spend on the benefits you are losing and what you will need to put aside into a pension or other vehicle to ensure your retirement stays on track.

In conclusion, becoming a Partner in a Firm is a great achievement and something you should be immensely proud of. Make sure you are ahead of the curve by preparing for it and putting the policies in place before you lose your other benefits. Plan for what you will need to put aside ensuring that your future self will thank you and that as well as you having made partner, you ensure it doesn’t put your financial future, yourself, your house and your family at risk.

To speak to a proactive firm that specialises in dealing with clients in this situation contact KBA on 01942 889883.

HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen