Far too often our initial consultations with clients reveal that they are lacking adequate asset protection. From mistakes as simple as carrying too little car insurance to more complex ones like not utilizing asset protection trusts, safeguarding your assets is a vital part of optimal wealth management. While many people think that asset protection is only for the extremely wealthy, this is simply not the case.
In fact, if you have a household income above $100,000 and you have a net worth of $500,000 (excluding your 401(k) assets but including the equity in your home), it’s time for you to consider protecting your assets intelligently. Prudent asset protection creates a series of layers for creditors to go through so that if you do get sued, creditors are most likely going to settle for an amount that is covered by insurance instead of chasing after your personal assets. (For more, see: The Importance of Life Insurance for Lost Income.)
Where to Begin
An asset protection plan begins with the state you live in since each state has its own laws with regards to what is protected. For example, Florida and Texas both have homestead laws that exclude your primary residence from a lawsuit. From there, federal law provides some protection for qualified retirement assets, like 401(k)s. Beyond that, it’s generally up to you to place the remaining layers to protect your assets. In this article, we are going to focus on the first two layers, auto insurance and umbrella insurance. Most people have the proper amount of home insurance, so we will leave that out of our discussion. Let’s start with the first, auto insurance.
First Layer: Auto Insurance
For most people outside of highly litigious professions, auto accidents are the most threatening events to accumulated wealth. A lawsuit resulting from an auto accident can quickly send creditors chasing after your money. So how can you protect yourself? Carry the proper amount of bodily injury and uninsured motorist insurance.
How much? Enough to cover your non-federal and non-state protected assets (such as your home or 401(k) in some cases as mentioned above). For example, if you live in Florida and have taxable accounts worth $200,000 and a salary of $100,000, you have $300,000 of assets that need protecting. In order to provide protection, you would need to purchase a $100,000 to $300,000 bodily injury policy. If you have unprotected assets north of $300,000, a $250,000 to $500,000 bodily injury policy is needed. As a best practice, set your uninsured motorist limits equal to your bodily injury limits.
What does it cost? Stepping up your protection from a $100,000 to 300,000 policy to a $250,000 to $500,000 policy generally results in only an 8%-12% increase in annual premiums. (For more, see: 5 Financial Planning Decisions You Won't Regret.)
What if I have more than $500,000 in unprotected assets? Then auto insurance won’t adequately protect you because it caps out at $500,000 of protection. But don’t worry, this is where the second layer of protection, umbrella insurance, comes in.
Second Layer: Umbrella Insurance
Umbrella Insurance is simply additional coverage above any regular home, auto/motorcycle and boat insurance coverage. It is named “umbrella” because it sits on top of your other insurances and covers liability claims from all the policies underneath it.
How does it work? Umbrella Insurance will pay for medical, court or other expenses that may be required after your basic home, auto and boat policies stop. Coverage levels start at $1 million and can run beyond $10 million, depending on your needs.
How much do I need? Generally speaking, you will need enough insurance to cover all of your unprotected assets. For example, if you live in Texas and have a $1 million home, a $2 million 401(k) and $800,000 of unprotected assets, a $1 million dollar umbrella insurance policy will be adequate. The home is covered under Texas’ homestead exemption, and the 401(k) is protected by the federal government. (Note, most 401(k)s are offered full protection, but sole proprietor 401(k) protection varies state by state).
What does it cost? It’s very affordable. You can generally obtain $1 million of umbrella coverage for as little as $200-300 annually in premiums.
The Bottom Line
Carrying the proper levels of auto insurance and umbrella insurance will keep your assets properly protected, which will reduce your worries and lead to greater peace of mind. (For related reading, see: Don't Let Risk Ruin a Great Financial Plan.)