The taxability of disability income benefits is a pretty simple concept to master if you pay particular attention to "who pays the premiums".
When disability benefits are received for an employer-provided disability policy, these benefits are generally included as taxable income to the recipient. If the disability benefits are received from a policy where the individual made the premium payments, then the benefits are excluded from taxable income. Some hybrid disability policies exist; whereas, part is provided by the employer and the other part by the individual- in this case benefits will be includible in income to the extent of the employer pro rata share of premiums.
|Structure of Disability Contract||Tax Consequence of Premium||Tax Consequence of Benefits Paid|
Employer pays premiums
|Tax Deductible by Employer||Taxable to Individual|
Individual pays premiums
|Non-Deductible by Individual||Tax Exempt to Individual|
Jim has a salary of $70,000 with Widget Corporation (S Corporation) which puts him in the 25% tax bracket. His employer gives Jim a bonus in the form of the cost of disability insurance (premium $4,000) which is added to Jim's W-2. If Jim becomes totally disabled, he is entitled to 60% of his salary in disability benefits. What is Jim's after-tax monthly disability benefit if he is in the 15% tax bracket during his disability?
Jim's employer pays Jim a bonus of $4,000 which is applied directly to disability premiums on an individual disability policy for Jim. Jim's W-2 income will reflect $74,000. Therefore, Jim will pay tax on the premium payments and is considered the premium payer and therefore will not be taxed on the monthly disability benefits. He would receive $3,500 per month tax-free ($70,000 x 60% divided by 12 months).
Introduction to Long Term Care
InsuranceLearn to translate this complicated policy so you can rest assured you're covered.
Managing WealthThose with high incomes really can’t afford to be without disability insurance. Here's why.
Financial AdvisorDisability is a very critical type of insurance that most individuals should consider carrying. When it comes to your personal finances, long-term disability can have a devastating effect if ...
Financial AdvisorWhat every small business owner or professional needs to know about individual and business overhead disability income insurance plans.
InsuranceSocial Security benefits can be hard to collect. Find out why you need disability insurance to protect your income, and learn how to choose the right policy for you.
InsuranceWhat you need to know about group and individual disability income coverage.
RetirementWhen it comes to qualifying for Social Security Disability Insurance, you either do or you don’t. Here's how to find out if you do and how to apply.
TaxesDue to the Achieving a Better Life Experience (ABLE) Act, many people with disabilities will have an easier time financing their lives, starting in 2016.
Financial AdvisorHere's how financial advisors can help clients with disabilities arrive at the best solution over the long term when it comes to planning for retirement.
Financial AdvisorGoing on disability can be a stressful time financially. Here are 3 steps to take on disability to help protect against significant financial blowback.