What is a MEC in life insurance?
Key takeaways. 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.
What triggers a modified endowment contract?
A modified endowment contract (MEC) is the term given to a life insurance policy whose funding has exceeded federal tax law limits. It must meet the statutory definition of a life insurance policy. The policy must fail to meet the Technical and Miscellaneous Revenue Act of 1988 (TAMRA) 7-pay test.
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).
How do you avoid a modified endowment contract?
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 happens if a life insurance policy failed the 7-pay test?
It is possible that a contract that requires seven level annual premiums will fail the 7-pay test because the statutory net level premium will be less than the actual premium paid. Once a policy has failed the 7-pay test, it becomes a MEC and remains a MEC for the life of the contract.
What is 7-pay MEC limit?
The 7-pay premium limit is a level annual amount of money that can be put into a cash value life insurance policy during each of the first seven policy years (or the first seven years after a material change in the policy, e.g. an increase in the face amount).
Which of the following would always be considered a modified endowment contract?
Which of the following would always be considered a Modified Endowment Contract? Single Premium Whole Life would always be a MEC as it would always fail the 7-Pay Test. Janelle is the beneficiary of a life insurance policy in which the insured has died.
Why is MEC bad?
In a nutshell, if your life insurance contract becomes a MEC, you’ll lose all the life insurance policy tax benefits that are otherwise available prior to payment the death benefit. That is a huge ugly deal for many people that invested in a permanent life insurance policy.
Can you take a loan from a Modified Endowment Contract?
When you have a Modified Endowment Contract and you withdraw funds or take out a policy loan, your subsequent taxes are due annually when you file your tax return. You’ll also have to pay an additional 10% penalty if you’re under age 59 1/2.
What is the 7 pay rule?
The 7 Pay Test essentially says that in order for a life insurance policy to remain life insurance, it cannot receive a premium larger than the premium necessary to make it paid-up after seven years.
What is the face amount of a 50000 graded death benefit?
What is the face amount of $50,000 graded death benefit life insurance policy when the policy is issued? Under $50,000 initially, but increases over time.
Is a MEC bad?
Pros and Cons of a Modified Endowment Contract After reading about all the advantages of a whole life insurance policy compared to a Modified Endowment Contract, it might seem like a MEC is a bad thing to have. The truth is MECs are neither good nor bad; their position depends on your financial goals.