Disability insurance provide benefit payments to individuals who are out of work due to covered illnesses and injuries. These sources of income can be temporary or permanent depending on the type of insurance plan. Disability coverage can be obtained through the federal government or purchased directly from insurance companies. The Internal Revenue Service, however, will tax disability insurance payments depending on how premiums are paid and the earnings of the individuals.
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There are two types of disability insurance plans available for purchase in the United States that cover workers for different lengths of time. Short-term disability plans cover individuals who are out of work on a temporary basis such as several weeks up to one year. Long-term disability insurance plans provide coverage for time periods ranging from one year to lasting the rest of the insureds' lives. If individuals are not able to afford or qualify for these plans, they can apply for disability benefits through the Social Security Administration. This disability coverage is entitled to all American citizens if they meet the federal program's eligibility requirements. Individuals applying for Social Security Disability must have medical conditions that last longer than one year; this federal program does not cover short-term or partial disabilities.
Disability payments from individual plans are calculated differently from those distributed from the Social Security Administration. STD and LTD insurance benefits replace a majority of the insureds' incomes, generally 40 to 65 percent according to the Life and Health Insurance Foundation for Education. Social Security Disability payments, however, are based on the work histories of the insureds and how much they paid into Social Security. Each year, the SSA notifies eligible individuals via mail of how much disability benefits they are entitled to (see Resource 1).
Taxation of Payments
Benefit payments from the LTD and STD insurance plans and the Social Security Disability program are considered taxable compensation under certain circumstances. For instance, if the premiums of short-term and long-term disability plans are paid with pre-tax dollars, then the IRS will tax benefit payments. If money that has been taxed is used to pay premiums, then insureds will receive tax-free benefits. For those receiving Social Security Disability payments, their benefit payments will be taxed if their total household incomes exceed the program's limits. For individuals, their benefits are taxed if their combined earnings exceed $25,000 per year and for couples, the ceiling is $32,000.
All three types of disability options requires individuals to satisfy "elimination periods" before receiving benefit payments. Elimination periods, also called waiting periods, start from when the medical problems start to the agreed-upon time insurers are to pay out benefits. During these periods, insureds are responsible for the medical expenses associated with their disabilities. STD plans have elimination periods lasting several days to weeks, while those insured by LTD plan can wait months and up to a year to receive disability payments. The elimination period for Social Security Disability benefits is five months.