What is a modified endowment contract (MEC)?

A modified endowment contract (MEC) refers specifically to a life insurance policy that has exceeded the premium limits set by the Internal Revenue Service (IRS). These limits are designed to distinguish between life insurance policies that are primarily for protection and those that are seen as investment vehicles. When a policy is classified as a MEC, it becomes subject to different tax treatment than ordinary life insurance policies.

One of the key implications of MEC status is that the tax advantages typically associated with life insurance, such as the tax-free growth of cash value and tax-free withdrawals or loans, are altered. MECs are taxed on withdrawals or loans on a last-in, first-out (LIFO) basis, which means that any gain in the policy is taxed as ordinary income first, which can lead to unexpected tax liabilities for policyholders.

In contrast, the other options do not accurately define a modified endowment contract:

• A policy providing accidental death benefits focuses primarily on specific coverage, rather than the premium structure issues that define a MEC.

• Term life insurance policies, by their nature, typically do not accumulate cash value, which is a key aspect of policies that can become MECs.

• A policy meant solely for retirement savings implies a purpose limitation, while a MEC can