AD Banker Comprehensive Practice Exam

When an employee pays part of the premiums for group disability insurance, what tax consequence does this have?

1. The benefits are received tax free to the extent that the employee paid the premiums

2. All disability income benefits are fully taxable

3. All disability income benefits are received totally tax free

4. All employee-paid premiums are tax deductible

The correct answer is: The benefits are received tax free to the extent that the employee paid the premiums

When an employee contributes to the premiums for group disability insurance, that contribution has important tax implications for the benefits received. In the scenario where the employee pays a portion of the premiums, the benefits received from the disability insurance are generally tax free to the extent that the employee has paid the premiums. This means that if the employee personally pays for part of the premiums, any benefits that are subsequently paid out due to a disability are not subject to income tax, creating a tax advantage for the employee. This system is designed to recognize the employee's contribution in the financing of the insurance, thereby allowing them to enjoy the tax-free nature of the benefits received in return. It’s important to note that if the employer pays all the premiums, any benefits paid out would typically be taxable to the employee. Regarding other options, while some forms of disability income might be taxable depending on who paid the premiums and how they were paid, the specific situation where the employee pays part of the premiums results in tax-free benefits up to the amount contributed. The deductibility of employee-paid premiums and taxation of other benefits are not relevant in this context, reinforcing that the correct understanding of this tax consequence aligns with the choice indicating tax-free benefits corresponding to the employee's premium payments.