November 21, 2005
Retirements in Unprepared Law Firms Usually Results in Dissolution
Before the days of tax-deferred savings accounts, including Keogh plans, retiring partners depended on continuing payments from their firm for retirement income and/or they didn’t retire. Of course, not retiring didn’t prevent their contribution from declining with advancing years. In the modern law firm, that is a prescription for disaster - one that usually leads to the dissolution of the law firm.
Business continuity requires that the partnership agreement address the retirement or gradual withdrawal of the firm's senior citizen members. Seniors have to make room for the next generation of leaders and they have to do so without draining the coffers of the firm. Firms concerned with the staying power of the law practice as an institution generally take one or more of the following approaches:
- Some establish a mandatory retirement age
- Most develop a transition period for retirement - over four or five years, for example
- Capital account buyout occurs in installments spread over three to five years
- Compensation declines over a transition period, for example 80% in first year, 60% in the next, 40% in the third and 20% in the fourth year with none thereafter. The computation of the compensation base to be reduced by the percentage is usually based on the firm’s traditional formula for origination and billable hours. Of course, billable hours will decline throughout the transition period but the firm’s senior statesmen are often effective rainmakers. Some firms set a declining compensation for the transition years based on prior year averages, removing the transitional partner from the normal compensation process.
The key, of course, is that these things have to be decided well in advance of retirement years. Incoming partners need to understand that their future retirement income depends on their own accumulation of wealth, including funds in tax-deferred retirement savings accounts. Left unaddressed, the retirement issues can become irresolvable without dissolution of the firm.
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Filed under Compensation, HR, Partner Agreements, Planning by Tom Collins