Personal Finance: Cut Taxes On Disability Benefits ? Here's How ...

Disability insurance is a prime fringe benefit for employees. But many workers often end up paying taxes on benefit checks.

Some simple steps can help recipients cut taxes on benefits.

The need is potentially widespread. "According to our 2012 survey, 52% of U.S. workers have short-term disability insurance," said Mike Fish, vice president of voluntary benefits with The Hartford. And 44% have long-term disability insurance.

Such coverage can be valuable. If you are unable to work because of illness or injury, health insurance won't replace lost earnings. Disability insurance can fill the gap.

Workers are more likely to become disabled than to die prematurely. And such calamities are not limited to laborers .

Executives and professionals and business owners also suffer disabilities caused by stress.

California and four other states require participation in state disability insurance programs , which can supplement workplace plans.

Such insurance can help replace income in the event of injury. But insurance paid for by an employer comes with a potential tax trap. Say a hypothetical Bob Hall has a heart attack. His earnings stop. Hall collects disability benefits from his employer's policy. But he owes income tax on that money.

That's because Hall's company paid all the premiums for his disability insurance.

The same tax treatment will result if Hall pays the premiums with pretax dollars set aside in his employer's cafeteria benefit plan.

Tax-Free Tactics

But there are ways to get disability insurance benefits without owing income tax. One is to pay for the coverage yourself.

In our example, Hall might ask his employer to arrange for the company to treat disability insurance as taxable compensation.

If Hall's company is willing, his employer can calculate his share of the premium and include that amount in Hall's gross income. Hall will pay tax on that amount, so he's effectively acquiring the coverage with after-tax dollars.

Then benefits will be untaxed.

Employer-sponsored group disability insurance may be relatively inexpensive. Fish puts the average yearly cost around $400.

If Hall is in the 35% bracket and reports that $400 as income, he'd pay $140 a year in extra tax. But if Hall is disabled he could collect thousands of dollars a year in tax-free benefits.

Another way to get tax-free benefits is to buy individual disability insurance. You'd pay the premiums so any payout would be tax-free.

Even if you have coverage at work, you might buy an individual policy as a supplement. That's because group disability coverage often limits benefits. Employers don't want to reward employees for not working. And short-term coverage will stop paying if you're out of work for a long time.

Source: http://news.investors.com/investing-mutual-funds/101212-629159-cut-taxes-on-disability-benefits.htm?src=3MC629159

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