Modified Endowment Contract. (All) If a policy fails to satisfy the “seven pay test” it no longer meets the definition of life insurance and the inside build-up of the policy becomes taxable as income to the policyholder. Basically, if there is too much put in the IRS views the contract as other than life insurance. The test is that if the accumulated amount paid into the contract in the first seven years exceeds the amount that would have been paid under a paid-up seven pay life policy, it is a MEC.
Modified Endowment contracts. Modified Endowment Contracts (MEC) are the result of paying too much funding premium into a equity indexed universal life, variable universal life , or other adjustable life policy in too short a period of time (usually in the first 7 years). The insurance company can accurately determine whether payments into a life insurance policy run the risk of becoming a "MEC." When a policy becomes a MEC, the tax status of death benefit is unaffected and any policy build up continues to grow tax deferred. However, any withdrawal of cash values prior to the insured's age 59 ½ will be subject to a 10% penalty. Additionally, withdrawals from the policy are taxed on the LIFO tax basis meaning the cash value "last in is the first out" therefore generating an instant taxable event. To Top
Modified Endowment Contract. Life insurance policies deemed "investment-oriented" under TAMRA '88. Distributions (loans or surrenders) taken from these policies while the insured is living are taxed as gain-out-first rather than tax basis-out-first. Also, distributions taken before age 59½ are subject to an additional 10% surcharge tax on any gains. Death benefits are treated the same as non-MEC contracts.