Disability Income Insurance Taxation

If you have a disability policy, either through work or independently you need to know a thing or two about taxation.

Canada Revenue wants its taxes one way or another, coming or going, the choice is yours. Disability benefits can either be taxed on the premium or on the benefit. Since the premium is typically many times larger than the premium the best way is usually to pay the tax on the premium dollars rather than the benefit.

If you have a disability policy through work you want your employer to deduct the premium from your paycheque. If the employer pays even 1 cent of the disability premium, the benefit becomes taxable. The general rule of thumb for most employers is that benefit costs are split 50/50 with the employee. Usually the cost of health and dental benefits is far higher than the disability premiums so the 50/50 split ensures that the disability benefit is non-taxable at time of claim. However, for some single employees and especially employee’s who waive their health and dental benefit this may cause a tax problem.

Mr. Family Man
Life Insurance	$3.00
AD&D	$0.50
Long Term Disability	$23.50
Health Care	$62.75
Dental Care	$85.16
Total	$174.91

Assuming a normal 50/50 Split
Employee’s Cost	$87.45
Employer’s Cost	$87.46

Since Mr. Family Man’s 50% share, $87.45, is larger than his Disability Premium of $23.50 he is safe.

Now let’s look at someone who waived their health and dental benefits because they have coverage through a spouses plan.

Mr. Waiver Man
Life Insurance	$3.00
AD&D	$0.50
Long Term Disability	$23.50
Health Care	$0.00
Dental Care	$0.00
Total	$27.00

Assuming a normal 50/50 Split
Employee’s Cost	$13.50
Employer’s Cost	$13.50

Mr. Waiver Man’s share is now only $13.50, which isn’t enough to cover his entire LTD premium of $23.50, his disability benefit will be taxable.

So how do we fix it? We don’t want the employee paying for more than their 50%, and we don’t want the benefit to be taxable so what do we do? We give the employee a raise.

Payroll adds $10.00 to Mr. Waiver Man’s income, and deducts a full $23.50 from his pay cheque, Mr. Waiver Man see the same net paycheque at the end of the day. The employer portion now becomes $3.50 plus the $10 raise total $13.50, their portion is also the same. Mr. Waiver Man is paying the whole LTD premium of $23.50 which makes it non-taxable.

The only think CRA really cares about is that the employee is paying income tax on $23.50 of income. It’s a little extra work on the part of Payroll and Human Resources but it provides a huge increase in benefit to the employee.

Individual Disability Policies are usually best held personally and not inside a company for the same reason. You have to pay the premium is after tax dollars but a tax free benefit is usually a far better deal.