Will Your Disability Benefits Be Taxed?

Not all disability benefits are the same.  If you purchase a disability plan and pay the premiums for the coverage, your benefits will not be taxed.  That’s because you’re using after-tax dollars to pay for the coverage.  But if your employer is paying the premiums for your disability policy, then any benefits you receive will be taxed.

Unfortunately, not many physicians consider this when planning for how much disability coverage they need.  Is it an important consideration?  Yes, and here’s why.  A physician with an annual income of $230,000 purchases a disability policy with a monthly benefit of $12,500.  The monthly benefit from the disability policy would pay $150,000 in annual benefits.  And assuming a 35% tax bracket, the physician’s $ after tax income would be $149,500.  Sounds like the physician selected an appropriate amount of coverage – right?

Well, that depends on who’s paying the premium.  If the policy is an employer group plan, for instance, and the employer is paying the premium her benefits will be taxed.  Assuming the same 35% tax bracket, the net disability benefit would be $97,500 – creating an income gap of $52,500 for the year.  If the physician in this example is on disability claim for 10 years, her income gap would have grown to over $500,000!  That creates a sizable hole to climb out of when she returns to work.