Sometimes disability protection income checks are taxable and sometimes they are not. The big issue is how you paid your premiums. Knowing what makes your claim benefits 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 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 claim on your house insurance.
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 car 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 people pay for these policies with pre-tax dollars.
If you paid for your insurance 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.
(Health insurance pays benefits that are not subject to taxation. 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 disability insurance 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 income you receive will be taxable.
If your premiums are being paid through payroll deduction, your benefits may or may not be taxable. This is because payroll deduction can be done on either a pre-tax or post-tax basis. You will need to ask your human resources department if you do not know which way your premiums are being paid.
Income replacement insurance companies will generally allow you to insure no more than seventy percent of your gross income. The companies 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 contract.
Receiving seventy percent of your former paycheck is probably enough to allow you to pay your bills. However if you have to pay taxes on your disability 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 your disability insurance proceeds to be tax free. Although the amount of your 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 having to pay income taxes when you do have a claim.
Income replacement insurance is important to have. If you can’t maintain your standard of living without job based income, you will benefit from getting income replacement quotes. This coverage may surprise you with its price. It is probably less expensive you may think.
