This is Why You Pay Taxes on Employer-Sponsored Disability Insurance

Your most valuable asset is not your car, home, or 401(k) balance. Your most valuable asset is you! More specifically, your most valuable asset is your ability to earn an income.

Think about it. The ability to earn an income is what allows you to purchase the tangible assets you own. This makes long-term disability insurance arguably the most important insurance you will ever carry.

How Does Long-Term Disability Work?

Disability insurance is comprised of two components. The first includes the triggering mechanisms for coverage to go into effect. Most long-term disability insurance policies require an individual to be unable to perform their job (or similar job) for at least 90 continuous days due to a physical disability.

During the 90-day period, many employers will provide short-term disability. Once the 90-day waiting period has been met, disability payments will begin. The monthly benefit will be a percentage of your pre-disability income, usually about 80%. Benefits will be paid until age 65 and may increase each year if your policy has a cost-of-living increase rider.

Why Are My Premiums Taxed?

It may seem counterintuitive, but paying taxes on your premium today will increase the benefit you receive if you file a claim. The IRS always wants their cut. With employer-paid long-term disability insurance, the IRS provides a choice.

Because the disability insurance is a benefit and considered taxable, either the premiums or the benefit must be taxed. Since the premiums for long-term disability insurance are substantially less than the potential payout, the small amount of tax paid today is worth it. For example, for an individual making $75,000 with a 20% marginal tax bracket:

  • Annual premium of $480 = $96 annual tax
  • Annual benefit of $60,000 = $12,000 annual tax

Here it becomes obvious. For about $100, your annual disability income benefit is increased by approximately $12,000. Although the likelihood of ever needing to file a disability claim is remote, the 20% additional benefit would go a long way in helping you and your family.

If you would like to learn more about your income protection options, or to receive a quote, contact our office anytime.