4 ways to protect your financial freedom

An illness, a wreck, a misstep on a ladder -- here’s how to shield yourself from life-changing trouble.

By Liz Pulliam Weston

You've made the decision to abandon the corporate world and are about to pull the trigger on your plans for financial freedom -- or maybe you're still in the dreaming stage. Either way, you're putting your finances in order, drawing up spending plans and realigning investments for your post-9-to-5 life.

Sounds idyllic, but all your plans for financial freedom could be scuttled if you don't guard against catastrophe. Get in a serious car accident, contract a disabling illness or fall off a ladder while cleaning your gutters, and you could find yourself wiped out.

To protect yourself and your dreams for the future, here are four types of insurance you should at least consider. Two of these -- health and umbrella liability insurance -- are pretty much no-brainers for most people. The other two are more problematic, because they tend to be expensive. Here's what you need to know.

Health insurance: Consider catastrophic coverage

Even if you're young and healthy, health coverage is a must-have. One accident or illness could wipe out everything you have or land you in bankruptcy court.

You also should give some thought to your health insurance coverage if you're planning to retire early. Few companies offer retiree health benefits anymore, and Medicare doesn't start picking up your medical bills until you're 65.

Slightly more than half of the American workforce can get health insurance through employers, which usually subsidize some of the cost, according to the Employee Benefit Research Institute (EBRI). If you're trying to find coverage on your own, you typically can reduce the costs of coverage by opting for the highest deductible you can find.

Some policies, known as catastrophic coverage, make you pay for the first $1,000 to $5,000 in medical bills, but cover everything over that up to a limit of $500,000 to $1 million. Instead of costing $300 to $500 a month for two people in their 30s -- the typical cost for lower-deductible plans -- catastrophic policies can cost as little as $100 to $200 a month.

The costs increase the older you are, but catastrophic coverage, if you can find it in your area, will still be less expensive than the alternatives. A couple aged 55 could pay more than $1,200 a month for a traditional medical plan, while high-deductible plans will cost around $500.

As with most insurance, it pays to shop around. Contact several companies for quotes, or use an independent insurance agent who can help you comparison shop.

Umbrella liability insurance: Peace of mind

This type of insurance protects you if you are sued or cause damage to someone else. Your homeowners and auto policies have liability insurance built into them, but the coverage may not be sufficient.

The typical auto policy, for example, may have a maximum liability limit of $300,000 per accident, although your limit could be as low as $15,000 if you bought a bare-bones policy. If you cause an accident that results in $1 million of medical bills for someone else, you could be sued for the difference.

That's why insurance experts recommend you have liability insurance equal to at least twice your net worth -- if you're highly paid or seen as a possible lawsuit target (that means you if you're a doctor, a lawyer or any kind of public figures).

Most auto and homeowners policies have an upper limit of coverage of $500,000, so if you need more coverage you'll probably need to buy a personal liability or so-called "umbrella" policy. This policy extends over your existing coverage like an umbrella, kicking in after your auto or homeowner's coverage is exhausted.

Umbrella policies are one of the best-kept secrets in the insurance world. They're relatively inexpensive, so insurance agents don't make much of a commission selling them. But for $150 to $300 a year, depending on where you live, you can get $1 million of coverage -- and peace of mind.

Disability insurance: Replace your income

You may think your biggest asset is your house or your 401(k), but actually it's your ability to earn money. And chances are you don't have enough protection should you be hurt or become sick and be unable to work for more than a few weeks.

Your state's workers compensation fund, for example, usually provides benefits only if you get hurt on the job. Your employer probably provides some kind of short-term disability coverage, but the checks will end after three months to a year. If you can't work for longer than that, Social Security may provide some benefits -- but only if you're so disabled that you can't hold any job. So unless you don't mind switching from your current career to one flipping burgers or telemarketing, you probably want to have a long-term disability policy.

Unfortunately, you may find long-term disability policies are expensive and tough to get if your employer doesn't offer this coverage, said Raymond Parry, an account executive with James P. Bennett & Co. in Santa Monica, Calif. A 35-year-old white-collar worker looking for a $5,000 monthly benefit would pay $2,500 a year or more for an individual policy, assuming she was in perfect health, Parry said. Some people who try to get policies on their own, Parry said, find they don't meet the disability companies' strict underwriting criteria.

It's much easier to get a policy through your employer, if that's an option. About 25% of the nation's workers have long-term disability coverage through their jobs, U.S. Department of Labor statistics show. Either their company pays for the insurance, or the worker can buy it at reasonable group rates. The larger the company, the more likely it is to provide this coverage, said Joseph Luchok, spokesman for the Health Insurance Association of America in Washington, D.C.

If your employer doesn't offer the coverage or you're self-employed, your next best bet is to see if you can buy a policy through one of the professional or trade organizations to which you belong. If not, you can try to form your own group of at least 10 people to qualify for a discounted rate, Parry said. The insurance agent said he has formed such groups for small business owners who didn't have enough employees to qualify for group rates on their own.

If your only option is buying a policy on your own, make sure to get enough coverage. Most insurers won't provide benefits that replace more than 60% to 70% of your income, but opt for the highest percentage you can get. You can buy policies that cover you for the rest of your life, but they're often prohibitively expensive; look for one that pays benefits until age 65.

You'll need to go through an agent or broker, so pick one who writes a lot of this business and keeps up to date with the insurers' ever-changing policies.

Long-term care insurance: Safeguard your legacy

Long-term care insurance is a relatively new product, and financial planners are still arguing over who really needs it. Some say this coverage can both preserve your assets and ensure you receive high-quality care. Others say you're better off skipping these policies and using the money to build your retirement funds so that you can pay for care directly.

That debate won't be solved here. But here are some things to think about.

First, if you're under 50 or have more than $1 million in assets, you probably don't need to worry about buying this coverage. If you're over 50 and have $100,000 or more in assets you want to protect, however, you might want to at least consider long-term care insurance.

Here are the basics. Long-term care insurance covers the costs of serious illness that aren't picked up by regular health insurance or Medicare, the government health program for people over 65. If you can't properly feed, clothe or bathe yourself and need an aide to help you, long-term care insurance pays the bill.

Long-term care can be expensive: Figure at least $40,000 a year for nursing home care, probably more for care provided at home. Most people need long-term care for two years or less, although of course some people spend a decade or more needing help.

People who have $1 million or more of assets probably can pay for their own long-term care, although some people buy the policies anyway to ensure that their care costs don't eat up their children's potential inheritance. Preserving an inheritance is also the reason some people also buy policies for their parents.

At the other end of the economic spectrum are people who are simply too poor to pay for coverage, which typically costs $500 to $2,000 a year or more. If the premiums cost more than 7% of your income, says long-term care expert Bonnie Burns, you shouldn't even bother with this coverage. If you're truly indigent, you'll most likely end up qualifying for Medicaid, the government program that pays for nursing home care for the poor.

Experts disagree about when to buy the policies as well. You'll pay less for coverage if you buy it while you're young (well, 40 or so -- you usually can't get a policy at a younger age). But the savings may be moot since you're likely to pay for the policy for many more years before you actually need it.

Buy the policy too late -- after 65, say -- you'll pay a lot more. Monthly premiums for a 65-year-old are generally two to three times higher than the same policy for a 50-year-old. Although recommendations vary, the best time to buy long-term care insurance seems to be between age 50 and 60.

If you're interested in buying a policy, be prepared to do your research. Start by asking your state's Department of Insurance for their buyers' guide to long-term care insurance -- most states produce one, Burns said. The National Association of Insurance Commissioners also produces a "Shopper's Guide to Long-Term Care Insurance."

You might also be able to buy a policy through work. Although EBRI statistics show only 6% of American workers could buy long-term policies from their employers in 1999, that number is expected to grow "due to an aging population and baby boomers who will be increasingly likely to take care of aging parents," said EBRI analyst Ken McDonnell.

Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.