Which is best for you? LLC/Corporation Versus Umbrella Policy
Are you a real estate investor? Chances are you either use an umbrella insurance policy or an LLC to protect yourself from liabilities concerning your property. There are however, certain situations one can be more beneficial than the other.
To understand which is best for you, you need to understand how they protect you. Many real estate investors don’t fully understand the implications of using an LLC/Corporation, but this is especially true when it comes to umbrella policies.
What is an umbrella policy and what does it do for you?
An umbrella policy is an insurance which adds additional liability coverage amounts to insurance coverage you already have.
Let’s say you have pool insurance with $100K of liability coverage and business general liability insurance of $500K, then a $1M umbrella policy is going to give you $1.1M of pool liability coverage and $1.5M of general business liability coverage.
An umbrella policy doesn’t cover any additional areas of liability or risk. It only adds more coverage to your existing coverage. The umbrella policy isn’t as great of an asset protection tool as its name implies after all.
A typical umbrella policy scenario
Hypothetically speaking, let’s say you own a business that provides home appliance services to residential customers. One day a claim is made against you by a customer against your LLC for damages from a failed, and expensive, appliance repair.
Now this customer is going to file a lawsuit against your LLC. But that doesn’t matter, because your covered! You don’t just have liability insurance, you also have an umbrella insurance policy, that’s two lawyers of protection! But when you go to the insurance companies with the claims, you get denied on both policies.
Why? Because your general liability policy didn’t provide coverage for failed repairs. Since your general liability policy was useless and didn’t provide coverage your umbrella policy was also useless.
The good news is, you did have an LLC, so your personal assets were not at risk, but your business could still end up having to pay a large settlement.
If you’re considering an umbrella policy, keep in mind that it only gives you more coverage in areas where you already have existing insurance coverage. And remember, just because it’s “umbrella” insurance, doesn’t mean jack squat. That umbrella is full of holes and someone’s lawyer will reach for your assets through as many as he or she can.
LLC’s & Corporations, AKA ol’ faithful.
An LLC (corporations too), on the other hand, protects you from liabilities that arise in the LLC and prevents a plaintiff from being able to go after you personally.
What is at risk in a lawsuit against the business entity (LLC or corporation) however, is the assets of that business itself. A creditor could collect against the assets of that business. So, for example, if you have an LLC with multiple rental properties with equity, then those properties and their equity would be at risk in a lawsuit.
Next, let’s go over the cost of both LLC’s & Umbrella policies.
The cost of an LLC
The cost of an LLC, depending on how you go about getting one, will cost you a few hundred dollars. You can also expect about $50-$200 in fees per year to keep your LLC active with the State (about $900 annually in California, each state is different, AZ is zero).
If you have a partnership LLC or a corporation then you also have the cost of a LLC partnership tax return or a corporation partnership tax return.
The cost of an Umbrella policy.
You usually end up paying for an umbrella policy monthly. Let’s say you are able to get $1M in umbrella protection at a cost of $100 a month. That would cost you about $1200 a year.
Umbrella policies have benefits which include attorneys whom your insurance company will appoint and pay to defend you (and protect themselves from having to pay), but also contain certain exclusions to coverage that may leave you with no coverage for the liability you incur. (You might have some costly holes in your umbrella).
Now we can finally get to the part you’ve been waiting for!
Which is best for you, an LLC or an Umbrella policy?
What it comes down to is what kind of property you own. If you own a multi-unit property or commercial property you should consider having both an LLC and an umbrella policy because you have more liability exposure when you have more tenants.
On the other hand, if you have a single family rental in an otherwise good neighborhood where you feel less likely to be sued, then you should only consider an LLC or an umbrella policy on its own. (As in, only have one, not both).
You should always consider both an LLC and an umbrella policy and get all the information you need to make an informed decision so that you are protecting your assets in the most efficient and cost effective way possible.