Disability Income Insurance

There is a way to receive disability coverage proceeds on a tax-free basis. It is important to note that you cannot wait until you are receiving benefits. You must pay for your insurance policy with income that has already been taxed. If you pay for your income replacement policy with income you haven't paid taxes on, you will not escape taxation when you get benefits. Insurance benefits are not usually subject to taxation. If you have an auto 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 after a fire in your home. Why are insurance proceeds generally not taxable? There is no profit involved. If you had to file a claim to have your auto fixed, you are just being made whole. Income replacement insurance isn't treated differently because it involves income. It isn't treated differently because it involves physical disabilities. It is different because sometimes people pay for their disability premiums with pre-tax dollars. If you paid the premiums on your insurance policy 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. (Healthcare 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 income 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 subject to taxation. If your premiums are being paid through an automatic deduction from your paycheck, your benefits may or may not be subject to taxation. This is because money deducted from your paycheck can be done on either a pre-tax or post-tax basis. You will need to ask your personnel department if you do not know how your insurance is being paid for. Disability 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. Paying too much can cause a claimant to malinger. This raises the insurer's costs and also raises the cost of their contract. Receiving seventy percent of your former paycheck is probably enough to allow you to keep your bills current. However if you have to pay taxes on your benefits, you may have to make some serious adjustments. The trade-off regarding this issue is that you will effectively pay more in premiums if you want this income to be tax free. Although the amount of your premiums will be the same either way, you will pay more in taxes when you are paying premiums if you want your benefit to be received without having to pay income taxes when you do have a claim. You cannot consider yourself to be fully insured unless you have adequate income replacement. This is a most important but mostly overlooked form of insurance. Many individuals are without this important protection because they have never investigated it. Income replacement insurance can cost much less than you may think. Take the time to get information and quotations on the Internet or from your local broker.