Life & Health Insurance Exam (National Portion)Taxes, Retirement, and Other Insurance ConceptsEasy
An insured individual receives a disability income policy benefit. Which of the following statements is true regarding the taxation of these benefits?
- ABenefits are tax-free only if they are paid from a Workers' Compensation policy.
- BAll disability income benefits are subject to federal income tax, regardless of who paid the premiums.
- CBenefits are taxable if the employer paid a portion of the premiums.
- DBenefits are always tax-free if the premiums were paid by the individual.
Show answer & explanationAnswer & explanation
Correct answer: C. Benefits are taxable if the employer paid a portion of the premiums.
If an employer pays all or part of the disability income premiums, the corresponding portion of the benefits received by the insured is taxable income. If the individual pays 100% of the premiums with after-tax dollars, the benefits are tax-free.
Why the other options are wrong
- A. Workers' Compensation benefits are generally tax-free, but this is a specific type of benefit, not a general rule for all disability income policies.
- B. This is incorrect; benefits can be tax-free if the individual paid all premiums.
- D. Benefits are tax-free if the individual paid 100% of the premiums with after-tax dollars.
Taxation of Disability Income Benefits
The taxability of disability income benefits depends on who paid the premiums and whether those premiums were pre-tax or after-tax.
- Individual pays after-tax premiums: benefits are tax-free.
- Employer pays premiums (pre-tax): benefits are taxable.
- Employer & individual share premiums: benefits are partially taxable.
Memory trick: Who Paid, Who Pays Tax: Employer Pays, Taxman Gains.