Paying the premium pretax generally makes the benefit taxable.
A premium paid through a Section 125 cafeteria plan is pretax, and benefits from it are generally taxable to the employee. Confirm treatment with your tax advisor.
The tax trade-off of paying disability premiums pretax
A Section 125 cafeteria plan lets employees pay certain premiums with pretax dollars. Employees save income and payroll tax on the premium. The trade-off arrives later: when premiums for disability coverage are paid pretax, the benefits received are generally taxable to the employee.
The reasoning is straightforward. Tax law looks at who paid the premium and whether the payment was taxed. Premiums that were never taxed produce benefits that are taxed. Premiums paid with after-tax dollars produce benefits that are generally not taxed. An employee who is out on disability and receiving a taxed benefit may be surprised at how little arrives.
Many employers offer the choice. The employee elects pretax or after-tax at enrollment, with the election locked for the plan year in most cases. An employee who rarely expects to claim may prefer the immediate tax saving. One who is concerned about a long absence may prefer after-tax premiums so that a benefit is not reduced by tax.
We explain the options in enrollment materials and set up the cafeteria plan document correctly. Treatment of a specific employee should be confirmed with a tax adviser.
What to decide and where it connects
Read the Section 125 Guide
How cafeteria plans work.
See the After-Tax Option
After-tax premiums are treated differently.
Read the Parent Guide
Coverage, cost and compliance for short-term disability.
Questions about this topic
Are pretax disability premiums a good idea?
They lower taxable pay now, but benefits are generally taxable later. Employees weigh the two.
Can employees choose pretax or after-tax?
Often yes, depending on how the cafeteria plan document is written.
Who should confirm the treatment?
A tax advisor, since the answer depends on how the plan is set up.
Ready? Send us your renewal, or talk it through with someone first. General information, not legal or tax advice.
Where these details come from.
IRS Publication 15-A: Taxation of sick pay and disability benefits.
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