disability

Disability Insurance: Tax Poison Alternatives

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Sandy Botkin
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Here are some startling statistics regarding disability:

A typical female, age 35, 5’4″, 125 pounds, non-smoker, who works mostly an office job, with some outdoor physical responsibilities, and who leads a healthy lifestyle has the following risks:

  • 24% chance of becoming disabled for 3 months or longer during her working career;
  • with a 38% chance that the disability would last 5 years or longer,
  • and with the average disability for someone like her lasting 82 months.

If this same person used tobacco and weighed 160 pounds, the risk would increase to a 41% chance of becoming disabled for 3 months or longer.

A typical male, age 35, 5’10″, 170 pounds, non-smoker, who works an office job, with some outdoor physical responsibilities, and who leads a healthy lifestyle has the following risks:

  • 21% chance of becoming disabled for 3 months or longer during his working career;
  • with a 38% chance that the disability would last 5 years or longer,
  • and with the average disability for someone like him lasting 82 months.

If this same person used tobacco and weighed 210 pounds, the risk would increase to a 45% chance of becoming disabled for 3 months or longer.

Sandy’s tip: Based on these alarming statistics, I have always recommended that everyone gets a good disability policy. It isn’t cheap; however, it could be a life saver if you need it. Think of a long term disability as a form of “Living death” since you won’t be able to make money but you will still be incurring living expenses.

This is why many companies provide employees with disability insurance. However, it comes with a catch. Normally the insurance payments are tax free to the employee. However, if the payments were a tax free fringe benefit, the benefits when received are fully taxable.

However, employees have the option of including the payments in their taxable income. Under such circumstances, the benefits will be tax free forever. Thus, employees must either pay tax on the premiums or pay tax on the benefits.

Note for self employed people who pay for the disability premiums, there is a similar result. If they take a deduction for the premiums, the benefits are taxable. If they don’t take a deduction for the premiums, the benefits are tax free.

Tip: When you are young and in top shape health-wise, you might opt for tax free coverage. Conversely as you close in on retirement or hit age 45 or older, you might want to consider paying tax on the premiums or not taking a deduction if you are self employed.

Sandy’s hot tip: IRS has ruled (Rev. Ru. 2004-55) employees can elect to pay tax on the coverage even if they failed to do so previously. One possible tax planning tip is to elect to pay tax on the coverage in the year that you are injured or find out that you could be disabled. You might be able to avoid taxation on the benefits. Check with a good tax or financial professional about this.


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