What does MEC mean in life insurance?

The Modified Endowment Contract is very similar to a regular whole life policy, except for the fact that the premiums paid into the contract are higher than on a similar life policy. The premiums paid in, cause the cash value of the policy to accumulate a lot faster than a whole life plan.When considering a modified endowment contract, compare the cost of insurance among several plans to make sure you get the best contract. Compare life insurance rates now by using our FREE tool above!

If the proceeds are paid out to the beneficiary, upon the insured’s death, they are completely tax-free. However, if the insured wants to take policy loans or distributions while they are still alive, the distributions are not always tax-free. If the contract was purchased before June 21, 1988, it is exempt from the new law. Any proceeds withdrawn by the insured are tax-free. The tax law change makes the modified endowment taxable like an annuity if purchased after June 20, 1988. The amount paid in is your cost, but amounts above that at taxable.

What is the Test for MEC?

The Federal tax law definition of life insurance places a limit on the amount of premium you are allowed to pay for a death benefit. The life insurance contract is a MEC if the premiums violate the “7-pay Test.” The tax law places a limit on the amount of cumulative premiums that can be paid into the policy in the first seven years.

The reason for this law is that many people were paying large premiums, building up large cash values in addition to the premiums and using their policies as loans and tax-free distributions.

If you make any material changes to your life insurance contract, if could change the status of the contract. It would start the 7-year count over again. A contract that was not an MEC could become one with changes to it down the road.

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Good Reasons to Own a MEC

1. In the current low-interest rate environment, a MEC might give you more benefits than a fixed annuity. Your spouse would have the benefit of a death benefit if you do not live to the maturity date, providing funds for retirement of supplemental income.
2. It is a method of forced savings.
3. CD alternative. CD rates are so low, that after you pay the taxes on your interest, you will be lucky to have anything left. The MEC is tax deferred until you take the money out.
4. It works well if you want to leave some money as a legacy, but you have funds available for use if you live longer than expected.

When MEC is Not a Good Idea

1. When Funding a College Education for Your children. (Since you will not likely be over 59 ½ years old at the time, and will be subject to a 10% early withdrawal penalty)
2. As a money market alternative. Money markets do not pay much in the way of returns, but they are completely different types of assets. They are used for money that you will be using in the near term. If you have a MEC, you will have to wait until you are 59 ½ to take distributions without the 10% early withdrawal penalty.

Modified Endowment Contracts have been a part of the insurance industry for a long time. People used to purchase these plans because, they allowed them to borrow amounts larger than what they had put into them, tax-free. People could take distributions tax-free.

If you have a contract that was issued before the new tax laws took effect, congratulations, you have a good thing.

If you are just now considering purchasing a contract, take into consideration, your age, when you might need the funds and whether you can find safe interest bearing investments that will pay decent returns. Also, decide if you need a death benefit as well. When searching for modified endowment contracts, be sure to compare the overall costs and accumulation amounts. Enter your zip code in our FREE tool below to compare life insurance rates now!

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