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This hidden threat can devour more than $100,000 of your wealth

  • One in 10 financially successful individuals doesn't have excess liability coverage.
  • Ten percent of wealthy families were forced to pay legal judgments of more than $100,000.
  • Home and auto policies offer liability coverage, but it's probably not enough.
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Here's something that can destroy your savings in a relatively short period of time: a lawsuit.

Investors will take great pains to protect themselves from market volatility or to save a few dollars in taxes, but shielding their wealth from legal judgments is often an afterthought.

"Clients don't think about it at all or they think about the risk being so small," said Michael McGrath, vice president with EP Wealth Advisors in Valencia, California.

"When your net worth goes up, that's when the conversation has to happen," he said. "Your auto policy might have $300,000 in liability coverage if you're in a horrible crash.

"If you get sued, that's a problem."

A survey from Chubb found that 10 percent of respondents were forced to cough up at least $100,000 in legal judgments. Only 1 in 10 of those polled had excess liability coverage.

The property-casualty insurer polled 200 individuals and families with at least $1 million in investable assets.

Here's how to protect your assets from being taken to the cleaners.

Excess liability

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Your home and auto policies already offer some form of liability coverage in the event you're sued for bodily injury or property damage.

Most homeowner's policies offer at least $100,000 in liability insurance, according to the Insurance Information Institute. Auto policies generally offer up to $250,000 for bodily injury per person, $500,000 per accident and $100,000 for property damage, according to NerdWallet.

To cover claims in excess of what home and auto policies provide, insurers sell excess liability coverage (also known as an umbrella policy) in increments of $1 million. You can purchase $1 million of coverage for $150 to $300 per year, according to the institute.

If you're sued and you don't have excess liability insurance, you'll be responsible for any dollar amounts over what your home and car policies will pay.

"Your basic car and homeowners' coverage is just a couple of hundred thousand and nobody will sue you for just that — they'll sue you for way more," said David Mendels, director of financial planning at Creative Financial Concepts in New York.

He knows this personally: Mendels once left his car to be serviced at an auto mechanic's shop. An employee at the shop hit a pedestrian with his car while backing it out of the garage.

The pedestrian sued Mendels for more than $3 million, but wound up getting only $20,000 from his insurer in a settlement.

Asset seizure and protection

American investors are paying as much as 3.5 percent per year in advisory and fund fees.
Yuri Arcurs/PeopleImages | Getty Images
American investors are paying as much as 3.5 percent per year in advisory and fund fees.

If you're short on liability insurance, your house is just one of the assets that's up for grabs in a lawsuit.

Depending on the state in which you reside, your individual retirement account may be fair game for plaintiffs, as well. The same follows for annuities and the cash value in your life insurance policy, said David E. Hultstrom, co-founder of Financial Architects in Woodstock, Georgia.

Your future earnings are also vulnerable.

Some of your assets may have in built-in protections. For instance, 401(k) plans are protected from creditors under the Employee Retirement Income Security Act.

Further, if spouses own a house or a brokerage account as "tenants by the entirety" as opposed to owning them jointly, they may have some creditor protection depending on the state in which they reside.

"Legally you each own 100 percent of the property under 'tenancy by the entirety,'" said Hultstrom. "In this case, a creditor can only take your house if you're both liable or if the spouse who isn't the debtor dies."

The right amount of coverage

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How financial advisors arrive at the appropriate amount of excess liability coverage will vary.

Not only should you cover your net worth and your future earnings, but you should also weigh other factors that can expose you to litigation.

That includes owning multiple residences, volunteering on a not-for-profit board or having teenage children.

"If you don't have enough coverage, the burden of defense is a big one, and it falls on you," Mendels said.

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