Are Disability Insurance Benefits Taxable?

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If you have a disability insurance policy, become disabled and can’t work, you’ll be grateful you have disability insurance to replace a portion of your paycheck.

An important thing to consider is “Are my disability benefits I receive taxable?”

Pre-Tax vs. Post-Tax

Every disability insurance policy has premiums that someone must pay. Those payments will be paid from either pre-tax dollars or post-tax dollars.

Pre-tax dollars refer to income before taxes, where no deductions of federal, state, and withholding taxes have occurred.

Post-tax dollars refer to income after federal, state, and withholding taxes have been deducted.

Taxation of benefits depends on who pays the long-term disability premiums (the employer, employee, or shared) and whether premiums are paid with pre-tax or post-tax dollars.

Group Disability Insurance

If you have a group policy, in most cases, premiums are paid by the employer on a pre-tax basis and are not reported on the employee’s W-2 for that year. The employer receives a tax deduction for premiums paid as a business expense and the employee pays taxes on any benefits received.

Group benefits typically cover about 60% of gross income only, NOT bonuses, to a maximum level amount (for example $10,000/month). Benefits are taxable and you cannot take your policy with you if you leave your employer.

It’s also important to know that many group LTD policies have a Social Security Disability Insurance (SSDI) offset built into the policy so that benefits received from the insurance company are reduced dollar for dollar by the amount you receive from social security. This further reduces your benefit amount.

Individual Disability Insurance

If you have an individual policy, in most cases, you pay the premiums on a post-tax basis. Individual benefits typically cover about 60% of gross income PLUS bonuses. Benefits are tax-free and your policy stays with you as long as you continue to pay premiums, no matter where you work.

Individual disability policies are more customizable to the individual, as opposed to group policies. A top notch policy will not require a Social Security Disability offset.

The Bottom Line

Generally, if premiums are paid with pre-tax dollars, your long-term disability insurance benefits are taxable to you. If premiums are paid with post-tax dollars, your benefits are tax-free.

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