Umbrella insurance: Protection for that nest egg

A retirement nest egg may make you feel like you've locked down your financial future, but don't get too comfortable. Getting hit with a liability lawsuit in your retirement years could turn your life upside down.

While your insurance may cover some damages or legal fees, an umbrella insurance plan goes further. It protects you and your assets if you are held liable for a claim exceeding the coverage of your other insurance policies. Without such coverage, your assets could be in trouble.

Say, for example, you're five years into retirement and you get into an auto accident. Your car is just a little banged up, but the other driver and his passengers are seriously injured. You're hit with a claim of $1.5 million, but your liability auto insurance only covers $100,000.

If you don't have an umbrella policy extending your coverage, you'll be responsible for $1.4 million. If you don't have that kind of cash on hand, your assets will be seized.

One soon-to-be retiree's plan

Jack Fisher, one of three winners of a Financial Makeover Contest hosted by NerdWallet and the National Association of Personal Financial Advisors, was nearing retirement age and entered the contest hoping for an evaluation of the retirement savings plan he and his wife had established.

Fisher was paired with Delia Fernandez, a financial planner based in Los Alamitos, Calif. She identified Jack's lack of an umbrella policy as an area to address. Jack's retirement plans, she says, were more focused on investment and ensuring long-term care than on protecting his assets for the long haul.

"He didn't think why he should have umbrella insurance, and actually gave a bit of pushback because he wasn't clear what role it played in his protection," says Fernandez.

Fernandez recommends umbrella insurance in particular for those with a higher net worth, as it offers more complete asset protection than regular insurance. But she says it's also important for middle-income earners. "Most of us are not wealthy. … We can't afford to rebuild this," she says. "Whether you're approaching retirement or getting ready to send your kids to college, how could you rebuild what you've already done?"

Unfortunately, umbrella insurance is one of the least known and most underused types of liability coverage.

What is an umbrella policy?

Umbrella insurance is liability coverage that goes above and beyond what your homeowners, renters and auto insurance policies provide. Umbrella coverage has higher limits with a broader range of coverage, including claims involving bodily injury, property damage and issues such as libel, slander and defamation of character.

If you're sued or found liable for damages, umbrella policies will pay not only the monetary damage costs, but also attorney fees and other court costs. Having such coverage can prevent another party from going after your assets if damages and legal costs exceed the limits of your regular policy.

"You're basically hiring some really good legal defense to protect your assets as you get ready for retirement," says Fernandez.

It's important to note that employee retirement accounts and IRAs are usually protected under federal laws even if you don't have umbrella coverage, so your retirement account will likely remain safe even if a legal case were to bankrupt you. But as for the rest of your assets? Not so much.

In Jack's case, "He doesn't want to file bankruptcy just to protect his [six-figure] retirement fund," Fernandez says — meaning "he's still more than a million at risk."

How much should I get?

Typical umbrella policies start at $1 million in coverage and are sold in million-dollar coverage increments. You'll usually need to carry minimum underlying liability coverage on your homeowners or renters policy before you can buy umbrella insurance.

Fernandez says she often meets clients who simply want to find the cheapest rates. "It's the equivalent of going out in the middle of traffic and running around without any clothes on," she says. "You need to protect what you've built and what you're going to have."

In general, you'll want enough coverage to at least cover your net worth, says Fernandez. Calculate the value of your retirement and other assets you have vs. your debt to determine your net worth. For most, $1 million in liability coverage will be enough; if your net worth is higher, consider bumping up your coverage accordingly.

Before choosing a plan, it's a good idea to sit down with your property and casualty agency to make sure you will be adequately insured in case of a liability lawsuit. "If you have any doubts," says Fernandez, "get a second opinion."
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