Disability insurance is a critical part of any financial plan because it protects your ability to earn an income, which is one of your most valuable assets. If you’re injured or sick and can’t work for several weeks or more, disability insurance will help you make up lost income. It’s such a critical part of your financial plan because it allows you to keep paying for the essentials while also saving for future goals, such as retirement.
A frequent question about disability insurance, are disability insurance premiums tax deductible? In most cases, disability insurance premiums are not tax deductible — but there’s more to this story. Here’s a little more about how it works.
DISABILITY INSURANCE THROUGH YOUR EMPLOYER
Many employers offer group disability insurance as part of your benefits package. In some cases, the premium for these plans can be paid with pre-tax dollars. This sounds like a good deal because you won’t owe taxes now on a work benefit. But if you ever need to collect your benefit, you will owe taxes on the money you receive. That means you won’t take home the entire face value of your benefit. Instead, a benefit that covers 60 percent of your income might leave you with only 40 to 50 percent of your income after taxes (or less, depending on your tax bracket).
There are also cases where you may be able to purchase additional disability coverage through your work with after-tax dollars. In that case, your benefit would be tax free.
PRIVATE DISABILITY INSURANCE COVERAGE
If you aren’t offered disability insurance through your work, or if you’re looking to supplement a work plan that only covers a portion of your salary, you can buy private coverage on your own. Like life insurance or car insurance, you can’t deduct the premiums you pay for private disability coverage. But, because you’re paying for private coverage with post-tax dollars, your benefit will be tax free if you ever need it.
TAXES AND DISABILITY INSURANCE
In many cases, you’ll have a mix of pre- and post-tax disability insurance coverage. Pre-tax disability insurance will likely come through your employer’s group plan (offered to everyone) while post-tax disability insurance is usually something you’ll buy on your own.
The tax treatment of your disability insurance premiums is an important planning consideration as it will impact whether you will owe taxes on your benefit, should you ever become disabled. A financial advisor can show you how disability insurance fits into your larger financial plan and help you anticipate the tax impact on various parts of your plan.