Does disability insurance void Obamacare?

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Dear Insurance Adviser,
I receive a disability insurance benefit from a private individual disability policy, so the money is tax-free. I am applying for health insurance from “Covered CA,” the Obamacare exchange in California. It appears that if I do not report the disability benefit, I will qualify for premium assistance (a tax credit). If I report the benefit, then it seems that I will not qualify and will have to pay a higher health insurance premium. Which way should I go? Thank you so much.
— Hien

Dear Hien,
First of all, let me congratulate you on having the wisdom to buy individual long-term disability insurance on yourself! Statistically, fewer than 20 percent of people who do not have group disability insurance through an employer buy individual policies.

As you point out, individual disability benefits are not subject to state or federal income tax because you’ve paid the premium with after-tax dollars. On the other hand, most people who are covered under group disability insurance at work receive it as a tax-free benefit, so when they become disabled the insurance payments they receive are subject to income tax. That tax can be avoided if you pay tax upfront on your group disability insurance coverage, if your employer allows that. Then, if you’re ever disabled, you won’t have to worry about any tax on your disability claim checks.

Under the Affordable Care Act, aka Obamacare, you must buy your health insurance through a federal or state-run health insurance exchange to be eligible for a premium discount in the form of a tax credit. You’re eligible if your taxable income is up to 400 percent of the federal poverty level. For 2014, that translates to income of about $46,000 for a single person or around $94,000 for a family of four.

When you apply through an exchange, you’re supposed to estimate your taxable income and receive immediate credit against your premium if you qualify. Then, when you file your income taxes and your final taxable income is known, there will be an adjustment up or down to the credit you received. If you underestimate your income, you will have to pay back some of the credit you received.

The bottom line, Hien, is that your individual disability insurance benefits that you’re receiving tax-free would not be included on your IRS form 1040 under taxable income and therefore should not have to be reported as income. This should definitely make you eligible for health insurance discounts when buying on an Obamacare exchange.

Good luck!

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