Is Long Term Disability Taxable – Overview
The navigation of long term disability can be really confusing sometimes. Long term disability insurance generally offers you financial benefits if you are unable to work for some injury or chronic illness for a longer period. Long term benefits can be both tax free and taxable.
You can always seek guidance from a tax professional or an accountant to determine whether your policy has any tax benefits.
Multiple factors can affect the taxability of your long term disability insurance. The taxability of your plan depends on which type of policy you choose, whether it is a private policy or a group policy, and the percentage of your premium.
Is Long Term Disability Insurance Taxable?
This question has a complex answer. Although long term disability insurance can be taxable and non-taxable, it entirely depends on different factors.
- If you pay pre or post tax dollars or premiums
- The percentage of the premium that you need to pay within the policy
Private Long Term Disability Insurance Policy
People pay for private long term disability outside of their employment individually. You have to pay for the entire premium all by yourself. The taxability of your policy depends on whether you pay your premiums with post tax or pre-tax funds.
- When you make a payment that has not been taxed yet, it is called the Before tax or pre-tax dollars.
- When you make a payment that has withheld tax dollars, it is called after tax dollars or post tax dollars. There is no need to pay for this later.
If you pay your premiums with pre-tax cash, there is a high chance that you may be required pay taxes on your disability benefits. However, if you pay your premiums with post tax dollars, your disability benefits will not be taxable. Most private insurance policy premiums have the payment option with post tax dollars.
However, in the end, it is all about the claimant’s choice. People often choose a post tax option to avoid any additional payment later. With this option, the taxes will already have been paid.
Group Long Term Disability Policy
Group long term disability insurance is something that you receive through the employer. If your employer pays your entire premium, there is a high chance that your benefits will be taxable. That means you have to pay income taxes on your disability benefits when your employer is paying all the premiums of your long term disability policy.
Sometimes, the premium of your long term disability insurance can be split between your employer and yourself. In this situation, a portion of your disability benefits will be taxable. The portion your employer is paying is taxable, whereas your percentage depends on the payment option you chose, post tax dollars or pre tax dollars.
You should also figure out whether your employer is paying with pre- or post-tax dollars. It can change the taxability of your benefits.
Long Term Disability Lump Sum Settlement
You can choose a lump sum settlement instead of intermittent payment plans for your long term disability insurance benefits. With this, you will receive the entire Long term disability benefit at once.
In these situations, the taxability of your lump sum depends on whether you chose post tax or pre tax dollars as your payment option. If your benefits are taxable, you will see a significant reduction in your total benefits by taxes.
State and Local Taxes
All the rules often apply to federal taxes on long term disability benefits. There is a chance that local and state taxes will apply to some of the disability benefits. You must understand the taxes before using the benefits to pay any other expenses.
The rules can differ depending on the employee’s residence, the area of employment, and the place where your policy is issued. The tax issues can be extremely complicated if an employee does not live and work in the same state.
Never forget to seek tax advice from an expert before spending the benefits on something else.
What Taxes Will You Have to Pay?
Disability benefits can always replace your lost salary. The taxes you have to pay for receiving the benefits may be somewhat similar to the taxes you had to pay before as an employee. The disability benefits ate subject to the (FICA) Federal Insurance Contribution Act and Federal income tax.
FICA can collect a part of the earnings from both the employee and the employer. The amount is generally used to fund social security and Medicare. You may have to pay both the FICA contributions and the federal income tax on the benefits if your disability insurance is subject to taxes.
The taxability of your disability benefits depends on multiple factors. It depends on who is paying the premiums and which payment option you use, the post-tax or pre-tax dollars.