Updated: Sep 15, 2020
Is doctor disability insurance taxable? If so, what does that mean for me? Why pay with pre-tax dollars?
Is disability insurance taxable? It depends. Generally, if your employer (or yourself as owner of your medical practice) pays for your disability insurance coverage, your disability benefit would then be taxable to you if you were ever on claim. However, if you pay for your coverage personally, with after-tax income (or do not deduct your payments as a business expense), you would receive a tax-free benefit.
What does this mean for you? This is important to consider when discussing the amount of disability insurance you need. If you are earning $270,000 per year, you qualify to purchase approximately $12,000 per month of physician disability benefit for an individually owned policy, paid for with after-tax income. That’s $144,000 tax-free annually.
Compared to your $270,000 income this may seem too low. However when you deduct 35% to 40% in federal income taxes, state income taxes in some cases, and Social Security and Medicare taxes, your take-home pay is suddenly considerably lower than your gross pay. At a combined 40% effective tax rate, your $270,000 is now only $162,000 in annual take-home pay, much closer to the $144,000 in tax-free disability benefit you qualify for.
So why do people pay with pre-tax dollars?
If you prefer to pay less now, we want to make sure you understand the consequences that you will face in the future.
It is common in the disability insurance industry for doctors to prefer paying pretax to save money in the short term. However, by doing so, your benefit will go from 144k to 96k or lower (1/3 taken for taxes). Other doctors are unaware that this is a common aspect of Group or Association policies and will end up receiving a significantly lower benefit than they were planning for. We’ve dealt with both of these scenarios, and the good news is, just like an illness or an injury, the sooner you identify it the better you can treat it. “Sooner,” because the younger and healthier you are the more favorable rates you will qualify for. It’s always best to max your disability benefit at the youngest and healthiest point in your life.
Our goal as financial planners is to show you a transparent picture of your financial health. If you prefer to pay less now, we want to make sure you understand the consequences that you will face in the future. If you realize you are underinsured, the positive side is that we can help you find the supplemental disability insurance plan that will assure that you receive the benefit you need, while still getting the most out of your current, less expensive policy.
To learn more, contact us any time for a free consultation and quote.