Employment status has a dynamic relationship with health and disability. There has been a striking increase in the working age population receiving out-of-work disability benefits in many countries, including the UK. In response, recent UK welfare reforms have tightened eligibility criteria and introduced new conditions for benefit receipt linked to participation in return-to-work activities. Positive and negative impacts have been suggested but there is a lack of high quality evidence of the health impact when those receiving disability benefits move towards labour market participation. Using four waves of the UK's Understanding Society panel survey (2009–2013) three different types of employment and welfare transition were analysed in order to identify their impact on health. A difference-in-difference approach was used to compare change between treatment and control groups in mental and physical health using the SF-12. To strengthen causal inference, sensitivity checks for common trends used pre-baseline data and propensity score matching. Transitions from disability benefits to employment (n = 124) were associated on average with an improvement in the SF12 mental health score of 5.94 points (95% CI = 3.52 to 8.36), and an improvement in the physical health score of 2.83 points (95% CI = 0.85 to 4.81) compared with those remaining on disability benefits (n = 1545). Transitions to unemployed status (n = 153) were associated with a significant improvement in mental health (3.14, 95% CI = 1.17 to 5.11) but not physical health. No health differences were detected for those who moved on to the new out-of-work disability benefit. It remains rare for disability benefit recipients to return to the labour market, but our results indicate that for those that do, such transitions may improve health, particularly mental health. Understanding the mechanisms behind this relationship will be important for informing policies to ensure both work and welfare are ‘good for health’ for this group.