Your auto insurance does more than safeguard you while you drive. It can also protect some (or all) of your savings, including your retirement.
But only if you have enough coverage. If not, you could lose a big chunk of your retirement in the event of a serious at-fault accident. Up to 25% of your paycheck could also be garnished, maybe for years, should a court judgment exceed your maximum liability.
The Employee Retirement Income Security Act prohibits creditors from accessing some “qualified” plans, such as pensions and employer-sponsored IRAs. However, not all retirement plans have that protection.
Whether your individually established and funded retirement plans are protected depends on where you live. In the following eight states, laws protect a traditional IRA but not a Roth IRA: Alabama, California, Georgia, Hawaii, Idaho, Indiana, West Virginia, and Wyoming.
The other 42 states and the District of Columbia generally protect both types of IRAs – but even so, exceptions may apply. For example, in Ohio there’s no protection for either SEP or SIMPLE IRAs.
In states like Georgia, California, Maine, and Missouri, part of an IRA can be withdrawn to cover a legal judgment against the owner. While it’s stipulated that enough be left to support the owner’s household, “enough” is determined on a case-by-case basis. According to Nolo.com, this could become an issue if your IRA balance is high, have another income source, or are fairly young (and thus have more time to contribute to retirement).
Planning the right insurance level
Some drivers carry only the state-required minimum, which can be as little as $50,000 total for injuries and property damage. Talk to your agent about the pros and cons of going with the bare minimum coverage. After all, if you get sued you’ll be required to pay for anything that remains after your insurance is tapped out.
How much could that be? According to the Insurance Information Institute, the median personal injury award for vehicular liability in 2016 was $42,089. But there must have some spectacularly high judgments or settlements that year, since the average award was $722,614.
For this reason, you should protect your assets by getting automobile liability coverage that’s at least as high or higher than your net worth. However, insurance companies do limit the amount of coverage you can buy; typically that’s $500,000.
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‘Rainy day’ coverage?
As your net worth rises, an “umbrella” policy could be the way to go. This coverage adds more liability coverage, to be accessed if regular coverage were exhausted.
It isn’t prohibitively expensive. According to the Insurance Information Institute, a $1 million umbrella policy will cost between $150 and $300 a year. Learn more by reading, “What Is Umbrella Insurance – and Do You Need It?”
Here’s one scenario: Suppose you caused a serious accident resulting in a lawsuit and a legal judgment of $1.2 million. However, your regular auto insurance policy covers only up to $300,000.
What’s next? Possible payment sources would include sale of assets, garnishing of wages, most or all of your ready cash, and, in an unprotected state, possibly withdrawals from your self-funded IRA.
In other words: You stand to lose everything you worked so hard to get. Compared to this kind of risk, that annual $150 to $300 for an umbrella policy sounds like chump change.
What’s the likelihood of being in an accident with a judgment that high? No one can say. To avoid losing everything you’ve worked for, however, it’s smart to carry enough insurance to cover at least your net worth.
In fact, some experts suggest insuring from two to five times your net worth. Doing this would help protect you in the event of a judgment like the one noted above. It would also shield future earnings, i.e., you wouldn’t have up to 25% of your wages garnished for years to make up the difference. Think of the opportunity cost of those dollars, especially since you might have to rebuild your finances from scratch.
If you live in a state where IRAs are not protected, talk with your insurance agent about getting sufficient vehicle coverage. Your financial future could be at stake.
Award-winning journalist and veteran personal finance writer Donna Freedman is the author of “Your Playbook for Tough Times: Living Large on Small Change, for the Short Term or the Long Haul” and “Your Playbook for Tough Times, Vol. 2: Needs AND Wants Edition.”