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Whether you have disability insurance coverage through your employer or your own policy, you’ll want to know if the benefits are taxable.
That’s because the last thing you want to do is worry about taxes while you’re on a long-term disability claim.
In this post, we explore the different types of disability insurance plans and the applicable tax situation for each.
- Key takeaways:
- The tax treatment of your disability insurance benefits depends on the type of plan you have.
- Disability income is non-taxable for individual plans and taxable (with a few exceptions) for group plans.
- Always consult a tax professional with the expertise to provide qualified advice tailored to your tax situation.
What Is Disability Insurance?
Disability insurance pays you a monthly benefit while you can’t work because of an injury or illness. The payments usually start after a 90 to 120 day waiting period and continue until you reach age 65 or recover, whichever comes first.
Having disability insurance protects you from financial collapse in case of a long-term disability. When you need it the most, it provides a safety net so that you can continue to pay your bills and put food on the table.
The disability income you receive corresponds to your regular earned income. So the higher your income, the higher your disability insurance benefits.
But how does the Canada Revenue Agency treat your disability income? Do you have to pay tax on any of the benefits? After all, you could be looking at thousands or even tens of thousands of dollars difference in your take-home pay depending on the tax treatment of the benefits.
Do You Have To Pay Tax On Disability Benefits?
The answer to that depends on the type of disability insurance you have. In this section, we explore the tax rules of all the different types of disability insurance you can get.
Are long-term disability benefits from an individual policy taxable?
One of the best ways to protect your income is to buy an individual long-term disability insurance plan. That’s because it provides better benefits than a group plan. It’s also portable, so you’re covered even if you switch employers.
Because you pay for the insurance premiums with after-tax dollars, you receive the entire benefit tax-free.
Are long-term disability benefits taxable for the self-employed?
As a self-employed business owner, you don’t have the luxury of a group insurance plan. That makes it all the more important to get an individual disability policy from an insurance company.
For tax purposes, a self-employed disability insurance policy is treated the same as an individual plan. This means you don’t have to report the benefits on your tax return, as they are non-taxable.
Is the 'return of premium' benefits taxable?
One of the optional riders you can buy on an individual long-term disability insurance plan is a return of premium rider. With this coverage, you get some of the insurance premiums you paid if you don’t make a claim.
Since you paid for the premiums with net after-tax income, Canada Revenue Agency doesn’t treat the refund as a taxable benefit.
Although useful, the return of premium rider costs more money than the base coverage. You also don’t get the premiums back if you end up claiming benefits.
Are short-term disability benefits from a group insurance plan taxable?
Besides an individual disability insurance policy, many Canadians also have coverage via a benefits provider through their employer. Most employers offer both short-term and long-term disability insurance in their plans.
Because the employer pays for the insurance premiums, employees’ benefits in a claim are considered taxable income. Therefore, an employee will receive a T4 from their employer.
The benefit of employer-paid premiums is that the employer gets tax deductions for the costs.
Are long-term disability benefits from a group insurance policy taxable?
Long-term disability insurance begins once short-term benefits end. Like short-term disability, benefits from long-term disability insurance also count as taxable income if the employer pays the insurance premiums.
However, some plans are set up so that employees can pay the insurance premiums themselves—or at least pay a part of it. With these plans, you may deduct the premiums you pay from the disability income you receive. The rest of the benefit is taxable.
In practice, you will receive a T4 for the entire benefit. However, you can deduct your contributions when you complete line 10400 on your taxes.
In some cases, the employer contributions count as a taxable benefit, meaning you have to report it as a taxable benefit. In these situations, you will receive any disability income tax-free.
Are benefits from wage loss replacement plans (WLRP) taxable?
A wage loss replacement plan is an arrangement between an employer and two or more employees to provide disability protection using individual policies. A small business may set it up to offer better disability coverage to key employees.
Wage-loss replacement plans qualify as group sickness or accident insurance plans for tax purposes. This means that the premiums are tax-deductible for the small business, and benefits are taxable for the employee. However, premiums are not added to an employee’s income, so they are not a taxable benefit.
A WLRP must be set up properly by the employer to benefit from the tax-deductibility of the premiums. An eligible small business must be incorporated. Also, if a business wants to cover a shareholder, they must be an active employee.
Are government disability benefits taxable?
The three main types of disability insurance from the government are Employment Insurance, Canada Pension Plan, and Workers’ Compensation. Below are the tax rules for the benefits you receive from each.
Employment Insurance (EI)
You may be eligible for EI sickness benefits if you can’t work because of illness, injury, or quarantine. The maximum amount you get in 2021 is $595/week, which is taxable.
Canada Pension Plan (CPP)
CPP disability benefits are harder to qualify for because you have to show a serious and prolonged medical condition. The most you can get in 2021 is $1,413.66/month. Like EI sickness benefits, you also have to pay taxes on CPP.
Workers' Compensation
Workers’ Compensation only covers work-related injuries and illnesses. In BC, you can receive up to 90% of your take-home pay. Unlike the two other government programs, you do not have to pay taxes on Workers’ Compensation benefits. However, you will receive a T5007 tax slip which you have to report on your tax return.
How Do You Know If Your Disability Income Is Taxable?
The first step in determining whether your disability proceeds are taxable is to find out the type of disability policy you have. If it is an individual plan, you don’t have to pay any taxes.
However, if you have a group policy through your employer or association, it may be more difficult to establish its tax treatment. Who pays the insurance premiums and whether it is tax-deductible all play a role.
Here is a handy table showing the tax treatment of different types of disability insurance:
Type | Taxable? |
|---|---|
Individual disability policy | No |
Short-term disability insurance | Yes |
Long-term disability insurance (employee-paid) | No |
Long-term disability insurance (employer-paid) | Yes |
Long-term disability insurance (premiums split between employer and employee) | No, up to the amount paid by the employee. The remaining is taxable. |
Wage-loss replacement plan | Yes |
Employment Insurance | Yes |
Canada Pension Plan | Yes |
Workers’ Compensation | No |
Get Help With Your Disability Insurance Tax Questions
While it’s important, never base your decision to buy disability insurance solely on the tax consequences. Instead, consider how the long-term disability benefits can help prevent a financial disaster in a time of crisis.
And always consult a tax professional if you have questions or concerns about income tax. Qualified professional advice can help you when you’re collecting benefits on your disability insurance policy.
Call us today at 604-928-1628 or email us at info@briansoinsurance.com today for your free long-term disability quote.
Get Your Disability Insurance Quote Now
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I had a stroke at 65yr old and cannot work.My only income are Canada pension,quebec pension and old age security .I receive disability payments for 2 yrs from R.B.C.does the disability payments are taxable income?the R.B.C.is a private plan that I took yrs ago when I was self employed.
Hi Danny, if you bought the RBC plan and it is a personal policy, you should not have to pay taxes on the benefits.
Hi Brian:
Is a monthly Life Cert for a Work Disability Pension (from a Foreign Ins. Co.) tax empt.
A Personal Injury law suit was settled for 65%
Permanent injury, pain, suffering, loss of enjoyment of life, medical bills and loss of income . I was a Volunteer, never paid insurance premiums and don’t receive T4 equivalent ? Would appreciate your advice or recommend someone closer to home who could advise.