Tax Free Disability Insurance

Is Disability Income Insurance Tax-Free?

(Sometimes yes. Sometimes no. Here's a closer look.)

is disability insurance tax free?

So maybe you're just researching disability insurance and trying to find out if it's tax-free. Or maybe you're already set with a disability policy and just forgot to ask if it's tax-free when you signed the papers. 

Either way, it's time to get some answers. Now, the short answer is: Depending on which plan you get, it can be. But to really understand the topic, you'll want to talk to an independent insurance agent.

An independent insurance agent can help break down the different types of disability insurance out there and go through all the ins and outs of taxes as they relate to each. And they'd be more than happy to do it. But first, why not dive in to a little more info on the topic?

Individual disability insurance

What Is Disability Insurance?

Someone once said if you’re not sure where to start, start at the beginning. And it’s a good thing to know what disability insurance is before getting into the nitty-gritty of tax regulations. 

Simply put, disability insurance replaces your lost income due to a disability, illness or injury, normally covering between 40% and 70% of your salary. There are several different types of disability insurance that may apply to you, like:

  • Individual long-term disability insurance: This coverage handles long-term injuries, disabilities, and illnesses. These disabilities or illnesses keep you from working and are not to be confused with work-related injuries or illnesses. Coverage lasts years, and sometimes decades, depending on your benefits.
  • Individual short-term disability insurance: Just like long-term disability insurance, short-term also covers injuries, disabilities, and illnesses that keep you from working. Instead of lasting years, this coverage only lasts for days or months, hence the title short-term.
  • Group long-term disability insurance: Group long-term is offered through your employer. You can choose to participate in group coverage or opt out. This policy is offered to all eligible employees at your work and is the kind of disability coverage that lasts for years. Health risk factors are not accounted for since it is rated on a group basis, which is a huge plus.
  • Group short-term disability insurance: This group disability coverage is just like group long-term insurance in the sense that it is offered through your employer and covers disabilities, illnesses, and injuries. Again, it is offered to all eligible employees and you may choose to opt out if you so desire. Health risk factors are still not accounted for on this disability policy type and your employer normally pays for this coverage. 

Government-backed disability programs: 

  • Social Security Disability Insurance: This is offered by the federal government and is a federally funded disability benefits program. Sounds like a big deal doesn't it?
  • State disability programs: State disability programs are in just a few states across the country and offer temporary disability insurance.
Are Long-Term Care Policy Premiums Tax-Deductible

Is Disability Insurance Tax-Deductible?

Unfortunately, that's a big fat no. Disability insurance is not tax-deductible. The IRS doesn't see disability insurance as a medical expense, and therefore doesn't allow it to be deducted on your federal tax returns. 

Even though disability insurance is helping with what some would qualify as a medical expense, the IRS does not see it that way, since it does not pay for your actual medical expenses associated with disability or illness. Instead, disability insurance is providing you with replacement of your income, which is not a medical expense.

What if you're self-employed, is disability insurance tax-deductible?

Again, no. But hey, it never hurts to ask twice. But in this case, the answer is still no. Disability insurance is not tax-deductible even if you are self-employed. 

Are Disability Insurance Benefits Taxable?

There may be light at the end of the tunnel, so hold on. Understanding disability insurance benefits and their taxability is fairly easy. Most individual plans, and even some group short-term and long-term plans, are paid with after-tax dollars. 

What does this mean for you? Well, since they are paid with after-tax dollars, then the benefits are not taxable. Just to repeat, your benefits are not taxed. Woo-hoo!

The only exception is if your employer pays for your group short-term or long-term disability premiums — how nice would that be? And if your employer doesn't include the premiums that they paid on your disability policy in your gross wages each year, then the benefits are taxable to you.

What's So Great about Independent Insurance Agents?

Hours of research on disability insurance and taxes? No thanks. That’s why independent insurance agents were invented. An independent agent works for you, and not the insurance carriers. And that means they're there to deliver the best answers, options, and prices for your needs.

But they're not just there in the beginning. If you ever have questions or changes to your policy, they're just right down the road. So go on, give your local independent insurance agent a call, they're all geared up to help and they know a thing or two about what you need.

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