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- Disability insurance benefits are taxable when an employer pays the full premium for the employee’s coverage
- Individual disability benefits are generally tax-free when you pay the full premium with after-tax income
- When an employer and employee share premiums, the tax treatment may be split or otherwise determined by the plan’s structure
- Self-employed and incorporated business owners in Canada should consider policy ownership and premium payments when reviewing tax treatment
Disability insurance benefits in Canada may be taxable or tax-free depending primarily on who pays the premiums and how the policy is structured. Employer-paid benefits are taxable, while benefits from personally paid individual policies are generally received tax-free. The tax treatment can significantly affect how much income you actually receive during a disability, so understanding the tax rules can help you avoid surprises later.
Quick summary:
- You pay the full premium: Disability benefits are tax-free
- Your employer pays the full premium: Benefits are taxable as income when you receive them
- You and your employer share the premium: Benefits are partially taxable, based on the respective premium contributions
- Government-sponsored programs: Benefits may be taxable or tax-free depending on the specific program. For example, CPP disability benefits are taxable income
Is disability insurance taxable in Canada?
Whether disability insurance benefits are taxable in Canada depends primarily on who paid the premiums and how the premiums were paid, and how the policy or plan is structured.
Employer-sponsored disability benefits
In an employer-sponsored plan, the premium for disability insurance coverage can be paid either by the employer or shared by both the employer and the employee. In the former case, when the employer pays the complete premium, the disability benefits are generally taxable.
Because the employee did not pay the full cost of the coverage with after-tax income, the benefits may be included in taxable income when received.
When an employer and employee share the premiums, the benefits may be partly taxable or the taxable amount may be adjusted to reflect eligible employee contributions. The calculation can depend on the type of plan, the history of contributions, and whether the employee paid the premiums with after-tax income.
Individual disability insurance
The disability benefits received from individual plans are generally tax-free when you personally pay 100% of the premiums with after-tax income. The premiums are typically not deductible as a personal expense, but the resulting disability benefits are generally not included in taxable income.
Government-sponsored disability insurance
Government disability benefits follow different tax rules depending on the program. For example, Canada Pension Plan Disability (CPP-D) and EI sickness benefits are taxable income, so you may owe income tax on the payments you receive. Workers’ Compensation benefits for a work-related injury or disability are generally not taxable, although they must still be reported on your tax return.
Pre-tax vs. after-tax premiums
The way you pay your disability insurance premiums can affect whether your future benefits are taxable. Pre-tax premiums are paid before income tax is applied, while post-tax premiums are paid from income after tax. Disability benefits are mostly taxable when premiums were paid by an employer or otherwise paid with pre-tax income. When you pay the full premium yourself with after-tax income, the benefits are generally tax-free.
How does disability insurance taxation work for self-employed Canadians?
Self-employed individuals generally cannot access employer disability insurance plans. They have to rely on individual or government-sponsored plans. When self-employed Canadians pay the premiums for individual plans with after-tax dollars, the disability benefits they receive are tax-free. The premiums are generally treated as a personal expense and are not deductible.
Some self-employed Canadians operate through a corporation, which can introduce additional tax considerations. If a corporation pays the disability insurance premium, the tax treatment can depend on who owns the policy, who pays the premiums, and how the policy is structured.
Taxation of disability insurance for business owners and corporations
For incorporated business owners, disability insurance taxation depends largely on who owns the policy and who pays the premiums. The common structures are:
- Personally owned policy: The business owner pays the disability insurance premiums personally with after-tax income. The premiums are generally not deductible, but the disability benefits are generally tax-free
- Corporate-owned policy: If the corporation owns the policy and pays the premiums, the tax treatment can be different. The premium may be deductible as a business expense, but if the owner receives the benefits, those benefits will be taxable.
- Overhead expense disability insurance: Business owners should also distinguish personal disability insurance from overhead expense disability insurance. Overhead expense coverage is designed to help pay eligible business costs, such as rent, utilities, and employee salaries, if the owner becomes disabled. Premiums for this type of coverage may generally be deductible as a business expense
How are multiple disability insurance policies taxed?
If you have multiple disability insurance policies, the taxation can be different and will depend on who pays the premium for each policy type. For example, you may have an employer-sponsored disability plan and a personally owned individual policy. If your employer pays the premium for the workplace plan, benefits from that plan may be taxable.
If you pay the full premium for your individual policy with after-tax income, benefits from that policy are generally tax-free. However, having multiple policies does not necessarily mean you can collect the full benefit from every policy. Some group and employer-sponsored plans include offsets or maximums that can reduce benefits when you receive income from other sources. These may include:
- CPP disability benefits
- Workers’ compensation benefits
- Income from another disability policy
- Employment or self-employment income
- Partial or residual disability earnings
The terms of each policy determine whether these limits apply. Before buying additional coverage, check whether the new policy has an offset clause and whether your existing group plan limits the total amount of disability income you can receive.
What is disability tax credit (DTC)?
The Disability Tax Credit (DTC) is a non-refundable tax credit for people with a severe and prolonged impairment in physical or mental functions. It is designed to reduce the amount of income tax an eligible person may have to pay. To qualify for DTC, having disability insurance is not the sole requirement. The Canada Revenue Agency (CRA) administers the DTC, and applicants generally need a qualified medical practitioner to certify their impairment on Form T2201. Also, note that the disability tax credit is separate from disability insurance.
How to buy disability insurance in Canada?
If you want to know more about the available disability insurance options in Canada, get in touch with our expert licensed advisors. One of our advisors will help you compare short-term and long-term disability insurance quotes in Canada. We can help you assess coverage amounts, benefit periods, waiting periods, and policy features based on your income and occupation. Schedule a call now!
Frequently Asked Questions
Are short-term and long-term disability benefits taxable in Canada?
Both short-term and long-term disability benefits can be taxable in Canada. The tax treatment generally depends on who pays the premiums, not on whether it is a short-term or long-term disability policy. If you personally pay the full premium with after-tax income, the benefits will be tax-free, but if your employer pays 100% of the premium, the benefits will become taxable.
Are disability insurance benefits tax-free if I pay the premiums myself?
Yes, disability insurance benefits will generally be tax-free if you pay 100% of the premiums with after-tax dollars. However, the premiums will not be tax-deductible for the individual paying the premium.
Is CPP Disability taxable?
Yes, Canada Pension Plan Disability (CPP-D) is a taxable benefit. The tax will not be automatically deducted from the CPP-D benefits. You must thus report the benefits received through this when you file your annual tax return.
How long does it take to receive benefits after I become disabled?
The exact time when you start receiving the disability benefits depends on the waiting period of the policy. Short-term disability insurance has a shorter waiting period of 0 to 14 days, while long-term disability plans typically range from 90 to 180 days. Once the waiting period has ended, the insurer will also assess and approve your claim before payments start.
Can you deduct disability insurance premiums in Canada?
In Canada, you cannot deduct premiums paid for individual disability insurance. However, if an employer or corporation pays the premiums, it may deduct them as business expenses.
Are employer-paid disability benefits taxable?
Yes, employer-paid disability benefits are taxable when an employer pays 100% of the disability insurance premium. However, if the employee and employer share the premium, the tax treatment may be split. The exact treatment in this case depends on the plan’s structure.
Disability insurance benefits in Canada are generally taxable when an employer pays the premiums and tax-free when you personally pay the full premium with after-tax income. Tax treatment can also vary for government, self-employed individuals, and corporate disability coverage.
