A modified endowment contract (MEC) is a type of life insurance policy that has certain tax implications. MECs are typically used by individuals who are interested in building cash value in their policy, while still being able to access that cash value tax-free.
So, how does a modified endowment contract work exactly? Let`s take a closer look.
What is a modified endowment contract?
A modified endowment contract is a life insurance policy that fails to meet certain requirements set out by the Internal Revenue Service (IRS). Specifically, a policy becomes a MEC if it is over-funded, meaning that the premiums paid in the first seven years of the policy exceed the amount needed to pay the policy`s death benefit. When a policy becomes a MEC, it loses some of the tax advantages that are typically associated with life insurance policies.
How a MEC works
When you purchase a MEC, you pay premiums into the policy just like you would with any other life insurance policy. However, because a MEC is over-funded, some of the premiums you pay are used to fund the policy`s cash value. This can be beneficial if you`re looking to build up cash value in your policy, but it also comes with certain tax implications.
Because a MEC is over-funded, the IRS considers it to be a type of investment vehicle rather than a pure life insurance policy. As a result, if you withdraw cash from a MEC, you may be subject to taxes and penalties.
For example, if you take out a loan against the cash value of your MEC, you won`t pay taxes on the loan proceeds. However, if you surrender your policy or take out more money than you`ve paid in premiums, you`ll have to pay taxes on the gain.
In addition to tax implications, MECs also have other limitations that policyholders should be aware of. For example, there are limits on the amount of cash value you can accumulate in a MEC, and you may be required to pay surrender charges if you cancel your policy within the first few years.
Is a MEC right for you?
If you`re considering purchasing a life insurance policy, a MEC may be an option to consider if you`re interested in building cash value in your policy. However, MECs are typically not the best option for individuals who are primarily interested in life insurance coverage.
If you`re not sure whether a MEC is right for you, it`s important to speak with a financial advisor who can help you determine the best course of action based on your individual needs and financial goals.
In conclusion, a MEC is a type of life insurance policy that has certain tax implications due to its over-funded nature. While a MEC can be beneficial for individuals who are interested in building cash value in their policy, it`s important to be aware of the limitations and potential tax implications associated with this type of policy. Before making any decisions about purchasing a MEC, it`s always best to speak with a financial advisor who can help you determine the best course of action for your individual needs.