What is a modified endowment contract in life insurance?

What is a modified endowment contract in life insurance?

Key takeaways. A modified endowment contract (MEC) is a cash value life insurance policy that gets stripped of many tax benefits. MECs ended a popular way to shelter money from taxes by borrowing from insurance policies whose cash value grew too quickly.

How can you avoid a 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 does MEC mean in insurance?

Minimum Essential Coverage (MEC) Any insurance plan that meets the Affordable Care Act requirement for having health coverage.

What happens when life insurance 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.

Is a modified endowment contract good?

If your main financial goal is to pass on the most tax-free wealth possible to your family, a Modified Endowment Contract can be a great estate planning tool. Compared to other savings vehicles like CDs or money market accounts, MECs typically earn a higher interest rate.

What happens when a life policy becomes a MEC?

Do beneficiaries pay taxes on life insurance policies?

Answer: Generally, life insurance proceeds you receive as a beneficiary due to the death of the insured person, aren’t includable in gross income and you don’t have to report them. However, any interest you receive is taxable and you should report it as interest received.

Can you reverse a MEC?

If you accidentally overfund your policy’s cash value, you may have the chance to refund the premium payments. After that, a policy’s MEC status cannot be reversed.

How is a MEC taxed at death?

Tax Implications of an MEC However, the cost basis within the MEC and withdrawals is not subject to taxation. The tax-free death benefit makes MECs useful for estate planning purposes, provided the estate can meet the qualifying criteria.

What is a matured endowment payment?

An endowment life insurance policy is a form of insurance that “matures” after a certain length of time, typically 10, 15 or 20 years past the policy’s purchase date, or when the insured reaches a specific age. If the insured dies before the policy matures, the policy’s beneficiaries are paid a stated death benefit.

How to calculate IRS guidelines for life insurance?

Conduct the seven-pay test on the policy using the premium shown for that amount of insurance.

  • Fail the seven-pay test at any point and the policy becomes a MEC,modified endowment contract.
  • Use the tax rules for annuities if the policy is a MEC.
  • Lose the “grandfathered” status if you make a material change in the policy.
  • What is MEC life insurance?

    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).

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