Should I Form a Limited Liability Corporation or is Umbrella Insurance Enough?

by Kevin on October 20, 2012

I’ve been writing on personal finance topics since early in 2008. I’m about to hit my 5 year anniversary mark. As of right now I have been operating as a sole proprietor contractor for all of my clients. We draft up a basic contract that I’ll get paid X amount per every article. I turn in a certain number of articles per month and send an invoice.

I’m in a pretty low risk industry. I don’t operate heavy machinery, and I’m not consulting on the designing of a bridge that could collapse. The risk of being sued over the written word is pretty small, especially if I am doing appropriate fact checking.

Nonetheless there is some risk involved. Someone might read an article on investing and interpret what I wrote as “sell everything and put all of your money in Apple’s stock!” Then they do that, and Apple’s shares drop 25%. I could, in theory, be sued for that advice. (Even though everywhere I write has a disclaimer about everything being an opinion and not fact. You can still be sued… the¬†plaintiff¬†just may not win. It is still a hassle!)

I’ve been dragging my feet on protecting myself better. Why? Because I’m a lazy human being just like you are. You don’t want to set up a budget, fine. I don’t want to set up better legal protections for myself. Let’s both just sit back and watch TV instead.

But it finally hit me hard… I need to do this. I have financial assets I need to protect. And I’ve found two options to look at.

Forming an LLC vs. Buying an Umbrella Insurance Policy

There are two ways I can protect myself: forming a limited liability corporation and purchasing an umbrella insurance policy. Which option is better for me?

What is Umbrella Insurance?

An umbrella insurance policy is a policy that goes over all of your other insurance policies that kicks in if your coverage under one of those policies is exhausted.

For example, let’s say you have a homeowners insurance policy with a $300,000 liability limit. Someone trips on your front step and busts all of their teeth on your front porch. They happen to be a model that relies on their beautiful smile to earn $1 million per year. They sue you and are awarded damages of $1.5 million.

In this case, your homeowners insurance would write a check for $300,000 and that would be the extent of their participation. That leaves you with $1.2 million to pay per the court order. If you had a $2 million umbrella insurance policy, it would kick in and pay the remaining $1.2 million for you.

And considering that most umbrella policies cost just a few hundred dollars per year it seems like a worthwhile investment.

What Benefit Does an LLC Provide?

On the other hand, forming a limited liability corporation can, in theory, limit your liability from anything done as the business. If you’ve ever done business with someone whose business name reads “Business Name, LLC” then they have formed the same type of corporation.

The idea behind an LLC is to protect the owner from liability caused by anyone participating in the business. Any liability damages awarded can only go after company assets, not your personal assets. For example, let’s say you run a delivery business and your employee causes a wreck that results in $1 million in liability damages awarded. If you were operating as a sole proprietor (which you never would for that type of business, that’s crazy), then that liability would fall directly on you even though it was your employee doing business that did the damage. If you had an LLC, they could only go after the assets of the company but not your house and non-business assets.

However, there is a bit of untested gray area in my state about having an LLC that is just you. If you are doing work as part of the business, and you’re the only member of the business, and you cause damages, then was it really the business that caused the damages or you? It has been somewhat untested in the courts for my state, so the potential benefit remains to be seen.

In my state is also costs $300 per year to have an LLC. Other states might charge $300 to form it and then a lower fee to renew each year. Not mine. It is $300 every single year, and you have to add a page or two to your taxes.

How Should I Protect Myself from Liability?

In reality I shouldn’t do just an LLC or just an umbrella policy. I should do both. Even if it cost me $1,000 per year to protect myself from liability, that would be well worth it.

But, to start out? I’m definitely going to get an umbrella policy because it doesn’t just cover business liability. It will cover me on my entire life from driving my car to having someone trip on my front step to someone misinterpreting my words as professional financial advice.

If you haven’t purchased an umbrella policy for yourself, I highly recommend you get started immediately. I know I am.

{ 1 comment }

CAV Insurance October 26, 2012 at 1:25 pm

What I like about an umbrella policy is that is protects your future assets. If you work out of your home and (like you mentioned) someone trips on your step and sustains injuries. If you end up owing them compensation that is beyond what your current homeowners policy covers, your future earnings could be in jeopardy. Making a small investment in an umbrella policy can save you money and protect your current and future assets.

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