Why Should You Consider Asset Protection?
Imagine this. Joe got into an unfortunate car accident on his way to work. He was held liable for the damages. We all have car insurance to safeguard against events like this. So did Joe! To Joe’s dismay, his car insurance limit for liability claim was only $100,000. While the liability claim against Joe was $200,000. So now, Joe will be responsible for the rest of $100,000 out of his pocket! What are the odds of getting into a car accident with a large amount of potential liability claim? Probably low. But what if it happens? How do you protect your hard earned money in that event? That’s why you should consider asset protection.
Most of us have standard insurance policies such as homeowners, car, and life insurance to protect our family and assets. These standard policies have certain limits depending on your insurance. What if the liability claim is higher than the coverage amount like in Joe’s example? How do you protect your assets such as your home, investment accounts, or your future earnings? That’s right! Even the future earnings are considered your asset in the event of a liability claim.
One of the most affordable types of insurance for asset protection is the personal umbrella policy. In Joe’s example, the personal umbrella policy would have covered the $100,000 beyond his car insurance liability claim.
The first step in assessing the need for personal umbrella policy is to determine your “built-in” asset protection.
Step One – “Built-In” Asset Protection
Every state is different when it comes to “built-in” asset protection. In my state, Texas, there are several “built-in” protections. Texas law’s one of the most generous “built-in” protections is the homestead exemption. It protects up to 10 acres of an urban home plus improvements and up to 100 acres in rural areas (for single adults, 200 acres for couples) regardless of its worth per Section 41 of Texas Property Code. In addition, the law also protects personal properties up to $50,000 for a single adult and $100,000 for a family per Section 42 of Texas Property Code. The personal properties include furniture, vehicles for each family member, tools, equipment, books, family heirlooms, two firearms, jewelry (not to exceed 25% of the limit), and some of the agricultural and ranching properties.
Besides homestead exemption, following assets are also protected from creditors.
- Employee Retirement Income Security Act (ERISA) qualified retirement accounts such as 401(k), deferred compensation plans, pensions and profit sharing plans
- Life Insurance Proceeds
- College Savings Accounts such as 529
- Traditional and Roth IRAs
Every state is different when it comes to “built-in” protection. For example, Unlike Texas where the amount of homestead exemption is unlimited, California homestead exemption varies from $75,000 to $175,000 depending on age and other requirements. So review your state specific law to determine the “built-in” protection.
The second step is to determine non-qualified assets (if any) beyond the “built-in” protection. To do so, you will need to take inventory of your assets.
Step 2 – Asset Inventory
For example, let’s say you are living in a home worth $500,000 in Texas with a $200,000 mortgage. So your equity is $300,000 which adds to your net worth. Since you live in Texas, your primary residence is protected under homestead exemption regardless of its worth or equity built. This may not be the case for your state.
So you do not have any exposure from primary residence.
Next, let’s say you have $1 million dollar in stocks, bonds and cash distributed as follows.
- Individual Retirement Accounts 401(k): $600,000
- Roth IRAs: $100,000
- Taxable Account: $300,000
Since the asset held in 401(k) and IRAs are protected against potential liability claims, you do not have any exposure. However, the assets outside of retirement accounts are exposed to potential liability claims.
So your exposure here is $300,000 in a taxable account.
Let’s say you have a fully paid rental property worth $250,000. Rental properties are not protected under homestead exemptions.
So your rental properties are fully exposed.
Based on the asset inventory, here is the list of non-qualified assets exposed to potential liability claims.
- Taxable Account: $300,000
- Retinal Properties: $250,000
- Total: $550,000
Step 3 – Determine Your Need
Typical umbrella policies start at $1 million. So I would start with $1 million coverage if your exposed assets are less than $1 million dollars. As your exposed assets grow, you may have to increase your coverage. Many insurance companies offer up to $5 million personal umbrella policy.
Asset Protection – Is It Worth It?
In general a $1 million umbrella policy cost around $150 to $250 per year. The premium depends on several factors such as your age, household members, driving records, lifestyle, credit score, etc. If you decide to purchase a personal umbrella policy, most insurance companies will require you to increase your liability coverage on auto and home insurance policies as well. For instance, $250,000 minimum liability coverage on auto and $300,000 to $500,000 minimum liability coverage on home insurance. So beyond the personal umbrella policy premium, there will be an incremental increase in cost on your auto and home insurance policies.
Is $150 to $250 a year to protect your nonqualified assets worth it? Absolutely. In Joe’s case at the beginning of the article, $150 to $250 a year would have helped Joe keep his hard earned $100,000.
As the saying goes, you hope for the best but prepare for the worst.
Mind the Gap
If you already have a personal umbrella policy, consider reviewing the coverage period and compare it with your auto and home insurance policy. The different expiration dates between personal umbrella policy and auto/home policy may create a gap in the coverage. Therefore, it is usually best to use one insurance agency for all your insurance needs. Using one insurance agency may also reduce your overall premiums with a multi-policy discount.
We have worked hard for years to accumulate our assets. It is our responsibility to protect it from potential liability claims. So consider protecting your assets with personal umbrella policy, which is one of the most affordable types of insurance policy in terms of asset protection. Most of us need a $1 million to $5 million dollars personal umbrella policy to protect our assets. However, if you are trying to protect a significant amount of current assets and/or potential future earnings, there are many other ways such as irrevocable trusts and annuities which we will explore in future posts.
So how are you protecting your assets? Have you considered Personal Umbrella Policy or other type of asset protection strategy?