Your Cafeteria Plan and Disability Benefits
A Section 125 Cafeteria Plan is a great way for employers to offer benefits that it could not otherwise afford to provide. The benefits offered under such a plan are deducted pre-tax so the cost of the premiums are significantly less than what these employees could be coughing up had they availed of insurance coverage using after-tax income.
One of the benefits that can be offered through a cafeteria plan is disability benefits. Disability insurance essentially provides for an employee’s daily living expenses if he or she falls ill or gets injured, rendering him or her unfit to work.
While this is certainly a useful benefit, paying for a disability policy through a cafeteria plan can reduce the benefits the worker receives. This is because the employee pays the premiums with pre-tax dollars; that is, the dollars used to pay for that disability insurance policy were never taxed. If these benefits are therefore paid, the IRS would require its share of the revenue on the back end, making the disability benefit taxable. This can take an unfortunate chunk out of the benefit payments meant to support you while you recover.
On the other hand, if you were to acquire a disability insurance policy on your own, or if you purchased one through your employer but paid the premium with after-tax dollars, any benefits paid to you are completely tax-free.
How exactly does taxation in this case go?If you as the employee receives the benefit amount directly from the insurer, the amount given to you could already be net of withholding and FICA taxes, plus Medicare. The gross amount of the benefits payment will be entered into you Form W-2 under the taxable income column. Or, it could also be that you’ll have to separately file the disability insurance benefits under another Form W-2. If it’s an option to have taxes taken out of the payments as they occur, you should probably do it ? you don’t want to have to pay the full amount of the taxes next April 15. If the benefits are all paid out because the employee is unaware that they are taxable, he will be in for a big headache when the W-2 or 1099 forms are given out on January the next year.
But for sure, the taxes won’t eat up the whole amount of the disability benefits, so when you think about it, it’s still much better to get taxable disability insurance than to leave yourself without options should you get sick or injured. You will still have some money coming in.
If the pre-tax premium through a cafeteria plan is the only way you can afford a disability policy, you should have one. But should finances permit, it’s most advisable to avail of a disability policy outside of a Section 125 Cafeteria plan.
Best of all, just hope you never need it. But in any case tax advantages aren’t the only consideration, when an employer or employee considers what items they include in their Section 125 Plan they should take council from a professional.
Give us a visit at http://taxfreepremiums.com to know more about the benefits included and the resulting tax savings a Section 125 Plan offers. You can also learn more about our automatic document solution that can give timely and cost-effective updates to your Section 125 POP plan document.
