Co-Founder, Coastal Financial Partners Group, California
MEC is a Modified Endowment Contract. It is a life insurance policy that meets the IRS definition of life insurance but fails a specific premium test (the seven pay test) meant to limit using life insurance as a tax sheltered investment vehicle and was established in a tax change in 1988 (TAMRA).
MEC policies still retain income tax-free death benefit characteristic. But, it changes the favorable tax treatment of cash value distributions normally associated with life insurance to tax treatment normally associated with annuities. Owners of a MEC would not likely plan to take cash from the policy.
Typically, MECs created on purpose are single premium policies and used in estate planning techniques. For example, instead of a large single premium annuity which would result in income tax payable on the death benefit proceeds, some high net worth individuals may elect to fund a single premium life insurance policy which provides an income tax-free death benefit.
Insurance Adviser - Broker, SC Insurance Services, Oahu, Hawaii
Jerry provides an excellent description of exactly what a "MEC" is just above here, so I won't re-hash that. Often when illustrating a policy the statement will appear with a warning that the policy will "MEC" at year so-and-so. That means that the policy will become a modified endowment contract at that point.
One of the benefits of Whole Life policies is that you can "over fund" them to a point without causing them to MEC. By doing that - paying more than the minimum premium - you can accelerate the cash value growth and even the benefit value of the policy if it's with a Mutual company that pays dividends and offers "paid up additions".
As Jerry mentioned some people choose to fund a policy with a single payment, which results in a MEC. However the MEC can be avoided and the policy be used for the tax benefits inherent with life insurance, and the resulting cash value used tax free, etc by funding the policy over 11 payments (11 years) rather than a single payment or fewer than 11. Those interested in the "Infinite Banking" strategies available with whole life policies will often take this option.
.JPG){kind=avatar}
MEC policies still retain income tax-free death benefit characteristic. But, it changes the favorable tax treatment of cash value distributions normally associated with life insurance to tax treatment normally associated with annuities. Owners of a MEC would not likely plan to take cash from the policy.
Typically, MECs created on purpose are single premium policies and used in estate planning techniques. For example, instead of a large single premium annuity which would result in income tax payable on the death benefit proceeds, some high net worth individuals may elect to fund a single premium life insurance policy which provides an income tax-free death benefit.
One of the benefits of Whole Life policies is that you can "over fund" them to a point without causing them to MEC. By doing that - paying more than the minimum premium - you can accelerate the cash value growth and even the benefit value of the policy if it's with a Mutual company that pays dividends and offers "paid up additions".
As Jerry mentioned some people choose to fund a policy with a single payment, which results in a MEC. However the MEC can be avoided and the policy be used for the tax benefits inherent with life insurance, and the resulting cash value used tax free, etc by funding the policy over 11 payments (11 years) rather than a single payment or fewer than 11. Those interested in the "Infinite Banking" strategies available with whole life policies will often take this option.