Is Income From Disability Insurance Taxable?
Disability insurance policies provide insureds with income while they are unable to work due to injuries or illnesses. There are two main types of disability policies: short-term and long-term. Depending on how the premiums are paid, benefits received can be taxed by the IRS.
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Types
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Short-term disability (STD) plans provide insurance coverage and benefits for a couple of weeks or as long as two years. Long-term disability (LTD) policies typically cover workers for a couple of months but could be purchased to provide benefits for the rest of the insured's life. Both policies can be bought individually or coverage can be obtained by workers through their employer-sponsored plans. Group disability policies such as employer-sponsored plans are "guaranteed issued" plans, which means everyone is eligible to receive coverage without taking medical exams.
Features
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STD and LTD policies have waiting periods that insureds must satisfy before receiving benefit payments. Waiting periods for STD policies typically last a couple of weeks while LTD plan waiting periods may last a couple of months. In some instances, the waiting periods can be waived if the disability is evident, such as a broken arm. Disability policies may allow insureds to stop paying premiums if they are disabled for longer than 90 days (waiver of premiums) and increase coverage amounts at a later time (additional purchase benefit).
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Facts About Disability
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Thirty percent of workers at age 20 are likely to suffer a disability before reaching retirement, according to the Social Security Administration. The Council for Disability Awareness (CDA) reports that the leading causes of short-term disability claims are back injuries, heart diseases, cancer and arthritis, while the leading cause of long-term disability is musculoskeletal/connective tissue disorders (22.8 percent of all LTD claims).
Taxation of Disability Benefits
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Benefit payments from both types of disability policies are subject to taxation depending on how the insurance premiums are paid. Generally, all group disability insurance policies, including those sponsored by employers, pay out taxable benefits because insurance payments are made with funds before they are taxed. To receive tax-free benefits, insureds have to pay for their insurance coverage with after-tax dollars.
Warning
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Disability policy benefits do not cover 100 percent of workers' salaries. In fact, they may cover only 40 to 65 percent, according to Life and Health Insurance Foundation for Education. Some insurers such as MetLife cover more of the insureds' earnings (60-70 percent). Insurance companies intentionally pay less to provide workers with the incentive to return to work.
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