One of the most common questions I receive is “What the difference between an umbrella policy and an LLC?”
LLCs and Umbrella insurance policies are two asset protection tools for real estate investors, but they serve two totally different functions.
What’s an LLC?
An LLC is a limited liability company. An LLC is a business entity which is legally separate from its members. An LLC can be used to hold assets – like real estate – instead personally owning them to provide the members with asset protection. Property is transferred into an LLC by deed which is recorded with the county.
How Does an LLC Protect Me?
An LLC protects you because it is a separate “entity” from yourself under the eyes of the law. The actions of your investing business in your LLC are separate from your personal actions.
Here’s an example:
Let’s say a someone slips and falls in front of your rental property because you didn’t put down salt to melt the ice. The person gets seriously injured and has damages valued at $750,000. You have 1 rental property valued at $150,000 and your personal home valued at $250,000. The rental property has a $200,000 homeowners policy and your home has a $300,000 policy.
If your property is owned by personally in your name, your insurances only cover you up to $500,000. Leaving a $250,000 hole. As a result, you would have you pay $250,000 out of pocket from your personal bank accounts, could have your wages garnished, have a lien placed on your assets, or file bankruptcy to deal with that judgment
If your property is owned by an LLC, then the only asset is $150,000 which is protected by $200,000 policy. You might have some cash sitting in the company bank accounts but that’s it. Your personal home, bank accounts, retirement accounts, are all protected because they are completely separate from your business.
It’s important to remember that you must use an LLC properly to maintain its asset protection benefits.
I teach real estate investors how to properly use an LLC in my course Landlord Law School.
What’s an Umbrella Policy?
An Umbrella Policy is an insurance policy that covers your personal assets if your other insurance products don’t provide enough coverage.
How Does an Umbrella Policy Protect Me?
In the event of a lawsuit, your umbrella policy may kick in if the damages are greater than the policy amounts of your other insurances – like car insurance or homeowners insurance.
Here’s an example:
Let’s say you cause a car accident which causes damage to another person in the amount of $500,000. If you have a $50,000 insurance policy on your car, that won’t be enough to cover this judgment. Next, what typically happens is your homeowners insurance would kick in. Let’s say you have a $300,000 homeowners policy on your home because you house is worth about $250,000. You’re still in the hole $150,000. If you didn’t have any additional insurance, you would have you pay that amount out of pocket, could have your wages garnished, have a lien placed on your assets, or file bankruptcy to deal with that judgment.
However, if you have an umbrella policy for $1,000,000 that would kick in the difference of $150,000 and you would be covered.
So Which Should I Use?
A comprehensive asset protection plan will use a mix of entities, like a LLC, and insurance products like umbrella policies. Using just one or the other leaves gaps in protection. If an attorney sues your LLC and “pierces the corporate veil” they can reach your personal assets to satisfy the judgment. On the other hand, if you don’t have an umbrella policy and your personal assets don’t cover the judgment, you might have to sell your investment properties in an LLC to satisfy the judgment.
I teach real estate investors about how to properly use insurance and business entities in my course, Landlord Law School.