How much coverage do you need?

In assessing the level of coverage that may be appropriate, the following factors should be considered:

1. The total value of all assets to be protected. All other things equal, the higher the asset value, the higher the amount of umbrella policy coverage that may be appropriate.
2. The perceived scope of the risks that are faced. This requires a thorough, objective analysis of:
   
   •     Risks arising from being a homeowner or a renter
   •     The risk of causing an accident—one potential factor may include the length and nature of a commute to work
   •     Any potentially dangerous activities one undertakes that could put others at risk
3. The potential loss of future income. As mentioned earlier, future potential income could be considered an asset, or a source of wealth, in its own right. Liability lawsuits can stake a claim on both assets and future potential income.

Umbrella coverage should generally cover the value of the taxable assets owned, as well as that of any homes beyond the primary residence. (Again, however, one's actual need could be higher or lower.) Assets held in employer-sponsored retirement accounts (e.g., 401(k) or 403(b) accounts) are generally protected from exposure to civil liability under the provisions of the Employee Retirement Income Security Act of 1974 (ERISA). The same protection generally also applies to up to $1 million worth of assets held in individual retirement accounts (IRAs). So, in assessing your needs for umbrella coverage, in general only nonqualified assets, along with assets in excess of $1 million in IRAs, need to be considered.

With respect to your primary residence, it's possible that at least part of this component of your net wealth need not be included when determining an appropriate level of umbrella coverage. This depends on the degree of protection under the homestead exemption2 for a given state of residence (intended to prevent the forced sale of a home to meet the demands of creditors).

For example, if you live in a state where the homestead exemption threshold is $1 million, and the value of your equity in the home is lower than $1 million, there is typically no need for umbrella liability protection on your home equity. Note, however, that for the homestead exemption to apply, a homeowner generally must record a Homestead Declaration with the local registry of deeds.