Understanding tax on group disability benefits

Many employers offer their full-time employees short-term and long-term disability insurance benefits. But how much of your income does disability cover? Are group disability benefits taxable?

If your employer offers disability coverage, it's important to know how these benefits work and how to take advantage of them.

Group disability insurance is a benefit offered by some employers that provides income to employees who can't work because of illness or injury. Group disability may provide short-term or long-term coverage and may be offered at little or no cost to employees, regardless of their health. Disability benefits are typically paid on a monthly basis.

You may qualify to receive disability insurance payments if:

• You are under the care of a doctor.
• Your illness or injury prevents you from working.

Group plans may also have a cap on the monthly benefit. Example: 60% up to $5000 a month. This is important to understand for high income earners.

Yes, group disability benefits are taxable. Because group long-term disability insurance is often paid for by the employer with pre-tax dollars, you'll be taxed on any benefits you receive.

Keep in mind that group disability plans do not generally cover bonuses, commissions or retirement plan contributions. This is because group disability benefits are tied to your W-2 income or base salary.

An individual disability insurance policy may sometimes be purchased as a supplement to a group plan or when group benefits are not offered.

Differences between group and individual disability benefits include:

Group disability insurance is available through an employer and are generally offered to all full-time employees, regardless of health. The coverage cost for group disability is the same for all qualifying employees and premiums are typically lower than individual disability plans. Group disability is tied to employment, which means the policy coverage is not portable if you leave your job.

An individual disability income insurance contract can help maintain your family’s quality of life by bridging the gap between what’s covered by your employee benefits and the remainder of your wages. Individual policies often offer better benefits because policies are underwritten individually.

Individual disability coverage is contractually guaranteed and portable, so you can keep the same coverage even if you change jobs. Some individual disability plans may offer an extended variety of compensation sources, such as merit-based bonuses.

Dive deeper into how individual disability insurance works

Employers may offer short-term disability, long-term disability or a combination of both coverages to employees:

This is temporary coverage for employees who can't work for a short period of time, typically up to 26 weeks. Benefits are usually paid weekly. Examples of qualifying conditions for short-term disability may include a prolonged sickness, the birth of a child or recovery after surgery.

This coverage kicks in after an elimination period of 90 days or after short-term disability ends. Benefits are usually paid on a monthly basis. Employees may receive benefits for term periods of typically two years, five years, 10 years, to age 65 or for life, depending on the policy.

Review more details on the difference between short-term and long-term disability coverage

The percentage of income that group disability covers may depend on the length of coverage. Group long-term disability typically covers about 50% to 60% of your income, before taxes. Short-term disability benefits may vary in percentage of income coverage, but tends to range from 60% to 100% of income.

However, some individuals may need more disability insurance coverage. In that case, some employers may offer what's called a buy-up plan, which allows employees to voluntarily obtain increased coverage, or "buy up" to a higher level of disability benefits.

For example, an employer may offer a group disability plan with coverage up to 50% of income but offer a group buy-up option that could increase coverage up to a higher percentage of income, such as 70%.

When deciding if a buy-up plan is necessary for you, consider the scenario of something happening to you that keeps you out of work, and your disability insurance coverage only offers you 40% or 50% of your salary. Is that enough for you to live on? If not, think about upgrading your coverage with a buy-up plan so you're prepared for all scenarios.

Group disability insurance plans can be valuable benefits for employees, but each individual's need for disability insurance varies. With all the different types of coverage out there—short-term disability, long-term disability, additional "buy-up" coverage or individual disability coverage—it's important to know what's the right fit for your scenario.

For help making sense of your disability insurance choices, connect with a local financial advisor who can help guide you based on your unique circumstances and needs.