Why You Need an Umbrella Policy

Adding extra liability coverage to your auto- and homeowners-insurance policies can protect your finances from expensive lawsuits.

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We have homeowners and auto insurance with $300,000 in liability coverage, but someone suggested that we get a $1-million personal-liability umbrella policy. Why would we need this much coverage?

"As long as you can earn a livelihood, you should have an umbrella liability policy,"says Mitch Freedman, a CPA and personal financial specialist in Westlake Village, Cal.

CALCULATOR: How Much Umbrella Insurance Do I Need?

He recommends that everyone have at least a $1-million umbrella policy to provide liability coverage beyond the limits of their auto- and homeowners-insurance policies -- even if they have less than $1 million in assets. That’s because in the rare event you are sued, you could be forced to pay a legal judgment from your current assets and future earnings. The policy can also pay for defense costs, which can quickly add up even if you win your case. It’s an inexpensive way to protect your finances from devastating lawsuits.

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Freedman recommends getting more than $1 million in umbrella coverage if you earn more than $100,000 per year or have more than $1 million in assets. “Our clients get liability-insurance limits that are at least as much as their net worth,” he says. Daniel Morris, a CPA in San Jose, recommends at least a $2-million umbrella policy for most people, or a policy for $3 million to $5 million if you have rental property.

The price varies by risk, but someone with one house and two cars would generally pay about $200 a year for the first $1 million in umbrella coverage and another $100 for the next $1 million, says Bill Howard, an independent insurance agent in Alexandria, Va.

Umbrella policies are inexpensive because they kick in only after you’ve exhausted your liability coverage under your auto or homeowners policy. Most insurers first require you to have $300,000 or $500,000 in liability coverage on your car and home. For example, if you have $500,000 in liability insurance on your auto policy and a $1-million umbrella policy, you’ll have a total of $1.5 million in liability coverage.

If you’re looking for extra cash to afford the umbrella policy, Howard recommends raising your auto- and homeowners-insurance deductibles. Boosting your deductible from $250 to $1,000 could reduce your annual premiums by hundreds of dollars, make you less likely to file small claims -- which could jeopardize a claims-free discount or could even get you dropped from your policy -- and still leave you with only $1,000 in out-of-pocket expenses for each claim. Then you can use the premium savings to boost your coverage by hundreds of thousands -- or millions -- of dollars.

Kimberly Lankford
Contributing Editor, Kiplinger's Personal Finance

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.