A modified endowment contract (MEC) is a tax qualification of a life insurance policy whose cumulative premiums exceed federal tax law limits. The taxation structure and IRS policy classification changes after a life insurance policy has morphed into a modified endowment contract.
What is a MEC in insurance?
A modified endowment contract (MEC) is a cash value life insurance policy that gets stripped of many tax benefits. The seven-pay test determines if the policy qualifies as an MEC. MECs ended a popular way to shelter money from taxes by borrowing from insurance policies whose cash value grew too quickly.
Are modified endowment contracts good?
A few things to keep in mind: Money is tied up. Modified endowment contracts work best for investors who do not plan on making withdrawals before turning 59.5, else they get hit with the same tax and 10 percent penalty applied to early withdrawals from an individual retirement account or 401(k).
What happens when a life insurance policy becomes a MEC?
When a permanent life insurance policy becomes an MEC, you can no longer make tax-free withdrawals from the cash value. Before age 59 ½ you’ll pay taxes and a 10% fee to access your money. After age 59 ½ you’ll still pay taxes, but with no additional penalty.
How can we avoid MEC?
To avoid being declared a modified endowment contract, a life insurance policy must meet the “7-pay” test. This test calculates the annual premium a life insurance policy would need to be paid up after seven level annual premiums. (When a life insurance policy is “paid up,” no further premiums are due.)
What makes a life insurance policy a modified endowment contract?
As a result, under IRC section 7702 Congress passed legislation that created limits on the amount of money that can be put into a life insurance policy in a set period of time. If you exceed those limits then the policy becomes a Modified Endowment Contract.
What does a modified endowment contract ( MEC ) mean?
A modified endowment contract (MEC) is a life insurance policy whose benefits go past the federal tax law limit. The IRS taxes withdrawals under a modified endowment contract are similar to non-qualified annuity withdrawals.
Is the modified endowment contract subject to Tamra?
Cash-value policies are now subject to the Technical and Miscellaneous Revenue Act of 1988 (TAMRA) seven-pay test. This test limits the tax benefits of withdrawals on these policies. A modified endowment contract (MEC) is a life insurance policy whose benefits go past the federal tax law limit.
Which is better endowment insurance or whole life insurance?
If you buy an endowment policy that matures in 20 years, the cash value will build faster than a traditional or whole life term policy. However, you’ll be paying a higher premium. The exact cost will depend on the time and money you’re wanting to put in.
