There are some disability payments called disability annuities. People working for the railroad or the federal government receive this type of disability payment. However, a disability policy you personally purchase and most disability policies purchased through the workplace are not disability annuities. The name for the payments from the government and railroad is "disability annuity," but it's not like an annuity you purchase from an insurance representative.
A disability annuity is a type of disability payment that federal employees and railroad workers receive. Unlike the tax-free payments from privately held disability policies or policies purchased through work with after-tax dollars, the disability annuity payments are subject to taxation. Even though you pay into the plan, it's not a traditional annuity but similar to a combination of retirement benefit payments and disability premium payments. Rather than base your payment on the amount of money in a specific contract, as would occur if it were the same as a regular annuity, your payment amount comes from a formula based on wages and years of employment.
Personal Disability Payments and Work Payments
When you receive payments from disability policies paid with after-tax dollars, you pay no taxes on the money. However, if your employer paid the premiums or you paid premiums through a cafeteria plan with pretax dollars, you'll pay taxes on the entire payment.
Social Security Disability Payments
There's only partial taxation of Social Security disability payments. You add your taxable income, non-taxed income such as interest from tax-free bonds, and half your Social Security disability together. As of 2010, if you're single and the amount is over $25,000 or you're married with an amount over $32,000, you pay tax on half your Social Security. If half of your Social Security benefits plus all your other income is over $34,000 for singles and $44,000 for married filing jointly, 85 percent of your Social Security disability is taxed.
Taxation of the Disability Annuity
There are two tiers to this type of disability payment, tier I and II. Those qualifying for both "Period of Disability" and "Total & Permanent Disability" pay taxes on tier I similar to Social Security disability, based on total income. You pay taxes on tier II as though it’s a pension. If you don't qualify for "Period of Disability,” the government taxes the entire amount as a pension.