Massachusetts Health & Accident Insurance Practice Exam

Which of the following statements is TRUE regarding the taxation of personal disability income insurance premiums?

1. The premiums are tax deductible for the insured

2. Benefits received are subject to tax

3. The premiums are not deductible, but benefits are tax-free

4. The premiums and benefits are tax-exempt

The correct answer is: The premiums are not deductible, but benefits are tax-free

The statement that the premiums are not deductible, but benefits are tax-free, is accurate regarding the taxation of personal disability income insurance premiums. When an individual pays for personal (as opposed to employer-provided) disability insurance, those premiums are made with after-tax dollars, meaning that they cannot deduct the cost of these premiums from their taxable income. As a result, when benefits are eventually received from the policy due to disability, those benefits are considered tax-free. This tax treatment encourages individuals to invest in personal disability coverage without the concern of a tax liability on the benefits they receive if they need to use their policy. In contrast, other statements may not hold true under the current tax law. For instance, premiums being tax-deductible would only apply in specific circumstances, typically involving self-employed individuals and certain business expenses, which does not pertain to personal policies. Similarly, benefits being taxable generally applies to policies where premiums are paid by an employer or deducted as a business expense, which is not the case for individual policies. Lastly, stating that both premiums and benefits are tax-exempt contradicts the basic tax treatment of personal disability insurance.