Having income from disability insurance is a smart way to provide yourself with a financial safety net in case you are unable to work due to a serious illness or injury. One of the keys to setting up the right disability insurance plan is knowing how much you may need, and then matching it up with the appropriate benefit amount.
A primary factor that can make a big difference, though, in how much you actually have available for paying your bills is taxation of your disability benefits. It is important to have a good understanding of taxes and disability insurance. That’s because in some cases, disability insurance benefits are taxable, and in other cases they are not.
When are Disability Insurance Benefits Taxable?
Whether or not you owe tax on disability insurance benefits from an individual or group plan is determined in large part based on how the premiums are paid. As an example, if you pay the premiums using after-tax dollars, then the benefits that you receive will be tax free.
Conversely, if you pay your disability insurance with pre-tax dollars, then you will owe tax on the benefits that you receive. If you and your employer split the premium payment, then only a portion of your disability income benefits will be taxable.
If your employer pays for an individual disability insurance policy on you – which may be the case if you are an owner or executive of the company – the rules regarding benefit taxation can differ somewhat. <Link to Disability Insurance for Key Persons>
For instance, in this case, if your employer receives the benefit from the coverage, then the premium will not be deductible to the company, and in turn, the benefit that is received will not be considered taxable. Learn more about employer-sponsored disability insurance plans. <Link to Employer Sponsored Disability Insurance>.
Do You Owe Tax on Social Security Disability Income?
For most people, the income benefits received from Social Security will not be taxable. However, similar to with Social Security retirement income, you could owe tax on up to 85% of your benefits if your annual income earnings exceed a certain amount.
For instance, in 2018, if you make less than $25,000 per year and you file your income tax return as an individual, or if your household income is less than $32,000 per year and you file your taxes jointly, then there is no income tax due on Social Security disability income benefits that you receive.
If you earn between $25,000 and $34,000 as an individual tax filer, or between $32,000 and $44,000 and you file taxes jointly, then fifty percent of your disability income benefits will be subject to income tax.
And, if you are an individual tax filer who earns more than $34,000, or a joint tax filer who earns in excess of $44,000, then you will owe income tax on eighty-five percent of your disability benefits from Social Security.
Because the Social Security Administration does not automatically withhold tax from your disability income benefits, you should either set aside your estimated amount of taxes to be paid. Or, you can request that Social Security withhold tax for you.
In either case, prior to tax time each year, the Social Security Administration will send you IRS Form SSA-1099. This form lets you know the amount of money that you received in Social Security benefits, which in turn, can help you in determining the exact amount of taxes that you owe.