Disability income insurance premiums

An investigation of the decision to pre-tax or post-tax the premiums

Abstract

Individuals who pre-tax their disability insurance premiums must pay tax on any disability benefits they receive. However, individuals who pay for the insurance with after tax dollars may exclude the benefits from their taxable income. In this paper, we investigate whether the expected tax savings are greater for individuals who pre-tax or post-tax disability income insurance premiums. Using disability statistics from the Commissioners Income Disability Table, expected values of tax savings are computed for various income levels and age groups. Generally, younger individuals with lower incomes achieve a reduction in expected taxes if they pre-tax the disability income insurance premiums. Older individuals with higher incomes often achieve a reduction in expected taxes when they pay for disability insurance premiums with post-tax dollars. Individuals who have just entered a higher tax bracket in the year of the insurance payments often achieve a tax savings by pre-taxing the premiums. Finally, individuals with substantial other income besides his or her salary, generally are better off to post-tax the premiums.