What are the different types of disability coverage, and how do they work?

Disability benefits can come from a government agency – the SSA – or they can be private. What is private disability insurance? It’s coverage provided by an insurance company such as Guardian. 

Social Security Disability Insurance (SSDI)

SSDI is a government-sponsored disability insurance program that is included in your Social Security coverage, so the premiums are paid for by a portion of your Social Security tax. The current tax rate is 6.2% for the employer and 6.2% for the employee, or 12.4% in total. If you are self-employed, you pay the entire 12.4% tax.

To qualify for coverage, you also need to earn a certain number of work credits based on your total yearly wages or self-employment income. Generally speaking, you need 40 credits to qualify, and you can only earn up to four credits each year, so it usually takes 10 years to become eligible for SSDI benefits (however, there are a few exceptions which allow younger workers to qualify).

There’s a six-month waiting period before you can start receiving benefits, which means that SSDI doesn’t provide protection for shorter-term disabilities that keep you out of work for a few weeks or months. That coverage is provided by short term disability insurance, which is also called STD (see below).

The Social Security Administration (SSA) has a strict definition of disability covering a limited set of severe medical conditions listed in the SSA’s Blue Book. The program only pays benefits for long-lasting or permanent medical issues that make you incapable of doing any work of any kind.

The process for claiming for SSDI benefits is notably stringent. The initial application requires extensive documentation and can take months to complete – and about two-thirds of these claims are rejected. While the initial decision can be appealed, the process can stretch out for years. If your claim is accepted, you’ll start receiving payments once the elimination period is over, and the average monthly income benefit is slightly over $1,000.2 Depending on your other sources of income, you may have to pay tax on Social Security disability benefits (see below).

Short term disability insurance (STD)

This is coverage for temporary disabilities not covered by SSDI or long term disability insurance (LTD – see below). Most short term disability policies are provided by private insurance companies, although some states provide their own plans. Coverage is typically obtained through the workplace as a group benefit available  to  employees. Premiums are usually paid by the employer, either partially or in whole (and employer-paid premiums are considered pre-tax income). Compared to SSDI or long term disability plans, the waiting period is much shorter – typically one to two weeks – and the income benefit usually equals 60%-70% of your normal earnings. However, those payments only last for a short period of time: the benefit period is typically 3-6 months or until you can get back to work. 

The process of applying for STD benefits is usually simpler (and much faster) than the SSDI claim process. The definition of disability will typically cover non-occupational injury or illness that keeps you out of work, but the insurance company will still need to see medical records or other evidence that you have a disabling condition. If you have coverage through work, your first step should be to contact your HR department to find out how to apply. 

Long term disability insurance (LTD)

Also called LTD, this type of policy is for the same kinds of long-lasting disabilities covered by SSDI, but it can be easier to qualify for, and the benefit amount  can be more generous. In a properly designed individual long term disability plan, the benefit amount should replace about 60%-70% of your after-tax income. However, those advantages come at a cost: You can expect to pay anywhere from 1% to 3% of your annual income for a comprehensive private long term disability plan.3

LTD plans vary greatly in cost because a lot of factors affect pricing, including your age, health status, income level, and occupation. The policies are also highly customizable: For example, you can choose a benefit period (i.e., the maximum length of time that you can receive income) as short as two years, or it could stretch all the way to retirement age, which obviously adds to the cost. You can also choose between two ways to define disability:

  • With an any-occupation definition of disability, you only qualify for benefits if you can’t do any occupation for which you are suited by education, training, and experience. However, unlike with SSDI, you may still qualify for partial benefits, depending on the terms of your plan. 
  • With an own-occupation definition of disability, you need only be disabled from doing your current occupation in order to qualify for benefits. So, for example, a dentist who can no longer use his or her hands to do dentistry could qualify, even if that dentist was otherwise healthy enough to do other work. 

Your company may offer group-rate LTD insurance as part of your employee benefits package, or you can purchase a more customizable individual long term disability insurance plan directly from an insurance company such as Guardian. If you get LTD coverage at work, your employer may subsidize a portion of the cost, but typically the policyholder (you) pays most or all of the cost of an LTD policy with after-tax dollars. That can actually be a good thing – and once you know how tax is paid on disability income benefits, you’ll understand why.  

When do I pay tax on disability benefits?

The rules for determining whether federal tax is owed on LTD or STD income depend on two things:

  • Who paid the premiums – you or your employer?
  • How were premiums paid – with pre-tax dollars or after-tax dollars?

Generally speaking, the tax rules work like this: if your employer paid the premiums, then the income you get on disability is taxable. Likewise, if you paid the premiums with pre-tax dollars, then your disability income is also taxable. However, if you paid the premiums with after-tax dollars, then your disability income payments are free from federal taxes.  In other words, the IRS either takes tax upfront (before premiums are paid), or they take tax on the back-end (from your weekly or monthly disability check). That means:

Short term disability income is usually taxed by the IRS

When your employer pays for the policy (as is typically the case with STD), the IRS considers those premium payments to be untaxed income – so they take taxes on the back-end when you make a claim and get benefits. However, if you paid for some or all of the premiums with your own after-tax dollars, then that portion of the income is not subject to federal tax.

Long term disability income can be taxed or not taxed by the IRS

Long term disability income plans can be paid for by the employer, the same as STD.  When the employer pays the premium, the payments while disabled will be taxable income.  However, if you paid for some or all of the premium with your own after-tax dollars, then that portion of the income is not subject to federal tax.

You may owe tax on Social Security Disability income – depending on what other income you have

Is Social Security Disability taxable? The rules aren't so simple, because it depends on the amount of other benefits you receive from the Social Security Administration (if any) plus your additional income (including sources that are usually tax free, such as U.S. Savings Bond interest). In any case, these disability benefits need to be reported on your tax return along with other Social Security income; according to the SSA website, these are the rules for determining whether and how much you’ll owe the IRS in taxes:

You will pay tax on only 85 percent of your (SSDI and retirement) benefits, based on Internal Revenue Service (IRS) rules. If you:

  • file a federal tax return as an "individual" and your combined income* is
  • between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your benefits.
  • more than $34,000, up to 85 percent of your benefits may be taxable.
  • file a joint return, and you and your spouse have a combined income* that is
  • between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your benefits.
  • more than $44,000, up to 85 percent of your benefits may be taxable.
  • are married and file a separate tax return, you probably will pay taxes on your benefits.

 

*Your adjusted gross income 

+ Nontaxable interest 

+ ½ of your Social Security benefits 

= Your "combined income"

You may also owe state and local taxes

This information only applies to federal income tax; depending on where you live, your disability income benefit may also be subject to state and local taxes. To avoid unpleasant surprises, it’s a good idea to consult a local tax professional or local government tax agency.

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How can I get a disability policy that provides tax-free income?

Many STD and LTD plans are acquired through the workplace, and as noted, the income benefit is typically subject to federal (and state) taxes. Individual “after-tax” STD and LTD plans are available that can provide a tax-free benefit. However, employees will need to pay the premium, or have premium be a taxable event. If you can get group STD or LTD coverage through work, the advantages may outweigh the tax benefits of an individual plan. 

SSDI benefits are very limited – on average, just over $1,000 a month – and if you are fortunate enough to be able to supplement that amount with other sources of income, your SSDI benefit will likely be subject to tax. And if you don't earn enough to pay tax on SSDI benefits, you may not have enough income to live on.

That’s why you should consider getting a long term disability policy. If coverage is available at work, that can be an excellent choice: Because the company is buying for a large group of people, the premium is typically lower than for an individual policy. Your employer may also subsidize a portion of the premiums, further lowering your cost. On the other hand, because the company is effectively “buying in bulk,” you will probably have less opportunity to tailor the policy to your needs. If part of the premiums are paid with pre-tax dollars (which is common), then that portion of the benefit will be subject to tax. Finally, if you leave the company, in most cases, you’ll also lose your coverage.

Consider getting an individual LTD policy

You can get an individual policy as standalone coverage or to supplement your work plan. This lets you tailor the coverage to your specific needs, and since it is paid for with after-tax dollars, the replacement income it provides is also tax-free. 

Long term disability insurance is typically bought through a financial professional. Be prepared to share as much as you can about your financial situation, tax strategies, and goals with your financial professional so that he or she can create the  disability insurance plan that suits your needs. If you don’t have a financial professional, or if that person doesn’t have a lot of experience with disability insurance, a Guardian financial professional can give you a disability insurance quote. Why a financial professional and not a regular insurance agent? Because disability insurance is meant to replace a portion of your income – and can be  a key part of your overall financial plan. 

Frequently asked questions about disability benefits and tax issues

Is disability income taxable federally?

Whether you pay tax depends on what kind of policy it is, who paid for it, and whether it was paid for with pre-tax or after-tax dollars. The income should be reported on your tax return, employer-paid short and long term disability income is subject to federal tax. SSDI disability benefits may be considered taxable disability income – and subject to federal income tax – if you have enough additional income.

Do I have to file taxes on my disability income?

You typically have to report disability benefit income on your tax return, but if the premiums were paid for with after-tax dollars, then you should not owe federal tax on that money. If premiums were paid by your employer, then your benefit income will be taxable. SSDI income must be reported along with other Social Security benefits, and it may be taxable if you have enough additional income.

Can you file taxes for disability income?

Yes, you should file an income tax return for your disability benefits, and you can even have federal tax withheld. To withhold tax for SSDI, file IRS Form W-4V. If you are receiving disability benefits from an insurance company, you can have tax withheld by filing IRS Form W-4S.

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Disclaimer

References:

1 Social Security Administration Fact Sheet, December 2019.

2 https://www.policygenius.com/disability-insurance/long-term-disability-insurance-vs-social-security-disability-insurance/  last accessed September 2020

3 Council for Disability Awareness, https://disabilitycanhappen.org ,last accessed June 2021

Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.

For more information, please visit irs.gov.

Guardian’s Group Long Term Disability Insurance is underwritten and issued by The Guardian Life Insurance Company of America, New York, NY.  Products are not available in all states.  Policy limitations and exclusions apply.  Optional riders and/or features may incur additional costs. Plan documents are the final arbiter of coverage. This policy provides disability income insurance only.  It does NOT provide basic hospital, basic medical or major medical insurance as defined by the New York State Department of Financial Services. Policy Form # GP-1-LTD-15.

Individual disability income products underwritten and issued by Berkshire Life Insurance Company of America (BLICOA), Pittsfield, MA. BLICOA is a wholly owned stock subsidiary of The Guardian Life Insurance Company of America (Guardian), New York, NY. Product provisions and availability may vary by state.

GUARDIAN® is a registered service mark of The Guardian Life Insurance Company of America® © Copyright 2021 The Guardian Life Insurance Company of America, New York, N.Y.

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