Is Disability Short-term Insurance Income Taxable?
Sometimes income replacement benefits are taxable and sometimes they are not
. The big issue is how you paid your premiums. Knowing what makes your income checks taxable gives you more control. You can choose to maximize your benefits; however doing so can raise your taxes slightly during the period when you are paying premiums.Insurance benefits are usually not subject to income taxes. If you have an automobile accident and file a claim you are not likely to have to pay taxes on any of the income you receive in benefits. This is also true when you file a homeowners claim.
Why don't you pay taxes on most insurance proceeds? There is no profit involved. When you get money from an insurer to fix your automobile after an accident, you are just being brought back to the state you were in before the accident occurred.
Disability insurance isn't different because it involves income. It isn't treated differently because it involves physical disabilities. It is treated differently because sometimes individuals pay for their disability premiums with pre-tax dollars.
If you paid for your insurance policy with pre-tax dollars, then any benefits you receive will be taxable. This is because you got a tax break when you were paying the premiums.
On the other hand, if you paid with post-tax dollars you can expect that in most cases your benefits will be tax free.
(Medical insurance is an exception to this rule. You can expect to receive benefits on a tax free basis whether post-tax of pre-tax monies are used to pay for your premiums.)
Paying with pre-tax dollars means that the money used to pay for your insurance was not used to calculate what you owe in taxes. In another words, if your taxable gross pay was reduced by the amount of the premiums, you paid with pre-tax dollars
If your employer pays for your income replacement without a payroll deduction then your premiums are being paid with pre-tax dollars. Your employer is writing off the cost of your premiums. This means that any money you receive will be taxable.
If your premiums are being paid through an automatic deduction from your paycheck, your benefits may or may not be taxable. This is because money deducted from your paycheck can be done on either a pre-tax or post-tax basis. You will need to ask your personnel department if you do not know how your insurance is being paid for.
Income replacement insurance carriers will generally allow you to insure no more than seventy percent of your gross income. The insurers want to make sure that you have an incentive to go back to work. Some individuals will choose to stay out of work longer, if their disability checks are too close to potential paycheck. This raises the insurer's costs and also raises the premiums for their insurance policy.
Receiving seventy percent of your former paycheck is probably enough to allow you to keep your bills current. However if you have to pay taxes on the insurance proceeds, you are going to have to get by on less.
The trade-off regarding this issue is that you will effectively pay more in premiums if you want this income to be tax free. Although the disability insurance policy's premiums will be the same either way, you will pay more in taxes during the period of time that you pay premiums if you want your benefit to be received without taxes taken out when you do have a claim.
Disability insurance is important to have. If you can't maintain your lifestyle without job based income, you will benefit from getting income replacement quotes. This insurance may cost a lot less than you might think.
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