Is Disability Insurance Tax-Deductible?

Disability insurance is a critical part of any worker’s financial plan because it helps protect your income, which is one of your most valuable assets. If you’re injured or sick and can’t work for an extended period, disability insurance can help cover the income gap. That can allow you to keep paying for the essentials while also saving for future goals like retirement.

A common question is whether you can deduct disability insurance premiums on your taxes. In most cases, these premiums are not tax-deductible, but there’s more to this story..

The tax treatment depends on how the policy is paid for and structured. Because these rules are interconnected, it’s important to understand how different arrangements impact the tax outcomes for both premiums and benefits. Let’s dig into the details.

Can I deduct disability insurance premiums?

In many cases, you’ll have a mix of pretax and post-tax disability insurance coverage. Pretax coverage will likely come through an employer’s group plan, while post-tax disability insurance is usually something you buy on your own.

The tax treatment of your disability insurance premiums is an important planning consideration because it will affect whether you’ll owe taxes on your benefit received if you ever become disabled. Your Northwestern Mutual financial advisor can show you how disability insurance fits into a holistic financial plan. They can also help you anticipate the tax impact and develop a strategy.

Pretax premiums on employer plans make benefits taxable

Many employers offer group disability insurance as part of their employee benefits package. In some cases, the premium for these plans can be paid with pretax dollars. This sounds like a good deal because you won’t owe taxes now—but if you ever need to collect your benefit, you will be taxed on the money you receive.

That means you won’t take home the entire face value of your benefit. For example, a benefit that covers 60 percent of your income might leave you with only 40 to 50 percent after taxes (or less, depending on your tax bracket).

But some employers may allow you to purchase extra disability coverage using after-tax dollars. In that case, the portion of your benefit paid with after-tax dollars would be tax-free.

Premiums for private disability insurance are not tax-deductible

If you aren’t offered disability insurance through your employer, you can look into supplemental disability insurance. This is coverage you purchase on your own to cover a portion of your salary if needed. 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 receive it.

Can I deduct disability premiums if I’m self-employed, and are the benefits taxable?

Disability insurance premiums are typically tax-deductible if you’re a business owner and:

• Your company is paying disability insurance premiums on behalf of your employees—it’s considered a qualified business expense.
• You’re paying overhead insurance that would cover operating expenses if you became disabled and your injury or sickness prevents you from working for an extended period.

Any benefits paid out to an employee would be considered taxable income, but even if you’re self-employed, you generally cannot deduct disability insurance premiums if the policy is designed to replace your personal income. If you’re a business owner, it’s important to consult a tax advisor on when premium deduction is allowed.

Is Social Security disability income taxable?

When it comes to benefits from the federal government, Social Security Disability Insurance (SSDI) benefits are taxed the same way that regular Social Security benefits are taxed. You might owe taxes on a portion of these disability benefits if your annual combined income is above these IRS-specified income ranges:

• Single, head of household or qualifying surviving spouse: $25,000
• Married couples filing jointly: $32,000

If your combined income exceeds these amounts, then you may need to pay taxes on up to 85 percent of your benefit. You can pay the IRS directly or withhold taxes from your payment.

Are short- and long-term disability insurance taxed differently?

Whether we’re talking about short-term disability insurance or long-term disability, the same tax treatment applies. Long-term disability insurance covers you if a qualifying accident or injury keeps you out of work for many months or even years. But it typically doesn’t start paying right away. Often, you may wait six months or more before you get a check. That’s where short-term disability insurance comes in. It typically kicks in within a couple of weeks and pays a portion of your income until long-term coverage begins.

Disability insurance can help replace your paycheck

Life is busy enough without worrying about losing your income. Protect it—and your future financial security—with tailored solutions that can help replace your paycheck if you get sick or injured. Talk with your Northwestern Mutual financial advisor to see what makes sense for your situation.

Your advisor will get to know you and what matters to you. Then they will recommend solutions to help protect your money and help it grow.

Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company, Milwaukee, WI (NM) (life insurance, disability insurance, annuities, and life insurance with long-term care benefits). This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.