Which is a better choice: pretax versus post tax long term disability insurance premium?


Let's get the definitions straight first.

  • By pre-tax, we mean that the premiums you pay have already been deducted from your salary before taxes are computed.
  • In contrast, post tax means that premiums are not deducted from your tax return.

Both have their advantages and disadvantages.

Pre-Tax Premiums

Your employer will usually deduct the premiums from your paycheck. The advantage of this is that you decrease the income that is taxable. The tax savings may be considerable, since you can move down to a lower tax bracket. The disadvantage with this set-up is that if you want to drop your coverage, you will have to wait until another open enrolment period is up. You may also drop your coverage if there is a change in status that will make this acceptable.

Now, when you need to make a claim, all proceeds from the insurance policy will be subject to taxes.

Post-Tax Premiums

If you opt to pay your premiums post-tax, then you don't get to enjoy the tax savings. However, paying post-tax gives you the flexibility of choosing when to drop your coverage. But if you do decide to drop coverage, you will have to wait until the succeeding open enrolment period to enroll again, or if you have another change in status.

The distinct advantage of post-tax payments is that all benefits arising from the policy is considered tax-free.

Other Tax Considerations

It also depends on who is paying for the policy. If your employer pays for the premiums, then the amount paid is taxable. If you are the one paying, then the amount can be deducted from your paycheck. If your employer pays a portion of the premiums and you pay for the remaining portion, then the portion paid by the employer will be taxable.

Which is better?

The question of which is better depends on several factors - such as your age and income.

Generally speaking, those who benefit from paying pre-tax are:

  • Individuals who have recently moved up to a higher tax bracket at the same year that premiums for the insurance are paid
  • Young individuals who earn low incomes

Those who benefit post-tax include:

  • Individuals that have other sources of income aside from his paycheck and the income from these other sources are in the amount that may be considered "substantial"
  • Older individuals (i.e. those closer to making a claim on their policies) that earn bigger incomes
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