We’ve written a lot about retirement income and Social Security benefits upon retirement. We’ve also discussed taxes levied on withdrawals from retirement plans, annuities, and pensions.
But what about taxes on disability retirement income? If you retire because you can’t work, is the disability retirement income you receive taxable?
The short answer is “yes.” The IRS is pretty adamant that anyone who retires due to a disability must report the payment, whether it’s received as a lump sum or over time. Whether you’ve reached the minimum retirement age or not, those payments need to be reported, and they will be taxed.
However, as is typical with issues concerning the IRS, the more in-depth answers aren’t quite so clear cut.
Clarity on Disability Income
Before determining how disability income is taxed, it’s a helpful idea to know what it is. In general, there are three types of disability income:
Social Security Disability Income
SSDI pays benefits to you and some family members, as long as you’ve worked long enough, recently enough, and paid Social Security taxes on your earnings. To qualify, you need to be younger than 65 years old, and have earned “work credits.” These are calculated based on earnings and the number of years you worked. Also, when you reach the age of 65, your SSDI benefits stop, and you automatically start receiving Social Security retirement benefits.
Supplemental Security Income
SSI is based on need versus work history. The program is supported by regular taxes, versus how long you’ve worked. If you’re single, you must have less than $2,000 worth of assets, and less than $3,000 if you’re married. Unlike what happens with SSDI at age 65, SSI is ongoing, as long as you meet the financial qualifications.
Private Plans
You might have a disability pension that pays out if you're unable to work due to illness or injury. However, such plans could impact SSI benefits, as Supplemental Security Income is based on income needs.
To Tax? Or Not to Tax?
The IRS is pretty clear that “if you retired on disability, you must include in income any disability pension you receive under a plan that is paid for by your employer.” So yes. What you receive from a disability plan goes on your Form 1040, either on line 1 (if you haven’t reached minimum retirement age) or lines 5a and 5b (if you have).
However, other payments you might receive due to your disability might not be taxable. These include the following:
- Benefit payments from a public welfare fund
- Workers' compensation for an on-the-job illness or injury, as long as it’s paid under a workers' compensation act or similar law.
- Compensatory (not punitive) damages for physical injury or illness
- Disability benefits under a “no-fault” car insurance policy if you should lose income or income-earning capacity due to injuries from an accident
- Compensation for either permanent loss or loss of use of a body part, or permanent disfigurement
- Payment for injuries received as a direct result of a terrorist attack against the United States or its allies
- Disability benefits received from the Department of Veteran Affairs
What about SSDI and SSI? SSDI can be subject to taxes, but a great deal depends on other income you might have, not to mention the state you live in. That’s right. While most states don’t tax Social Security disability benefits, Connecticut, Colorado, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, and West Virginia do, in some situations.
And monies received from the SSI program are not taxed.
Due to the complexity of disability retirement plans and their payments, it’s important not to assume when it comes to whether (or not) the proceeds are taxable. Instead, talk to your financial advisor or tax professional for insight.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
