Modified Endowment Contract (MEC)
An important aspect of life insurance

The term MEC (Modified Endowment Contract)1 is something every person considering the purchase of whole life insurance should understand. Established by Congress in October 1988, Any whole life insurance policy, if overfunded with premium, could become become a MEC and consequently cause important changes to the taxation of the policy's cash value.

A premium limit over the first 7 years of a policy is set. If the premiums paid into the policy exceed that limit, the policy becomes a MEC, if the policy premiums stay below that limit, it does not become a MEC. This is commonly referred to within the insurance industry as the Seven Pay Test.

MEC's are still life insurance policies, which offer income tax-free death benefits and tax deferred cash value growth; however, there are significant tax implications when distributions of the cash values are made. One of the primary benefits of using life insurance cash values for supplementing retirement income is that money withdrawn will generally be subject to tax only if the total withdrawn exceeds the total amount paid in premiums. Thereafter, any loans distributed are tax-free while the policy remains in-force. A distribution from a MEC life insurance policy is similar to accessing funds from an annuity.1

Luckily, most insurance agents or financial advisors who sell whole life insurance can determine how to avoid a policy from becoming a MEC. Illustration software can specifically calculate how much a policyholder can put into their whole life contract to maximize cash value without causing a MEC. It is critical for the policy owner to maintain a relationship with an agent on this for the life of the policy to ensure a MEC is avoided.

If a person's policy does become a MEC, most insurance carriers will provide a 60 day window from the time the policy becomes a MEC to reverse any premiums paid into the policy to trigger the conversion. Again, it is always the responsibility of the policyholder to monitor and maintain a clear understanding of whether or not their policy is a MEC or not.

Talk to your insurance professional about this if you are considering the use of whole life insurance within your retirement portfolio.

Bill Olmsted is a life and disability insurance specialist with the Financial Balance Group in Rockville, MD. He assists clients nationwide with both whole life and disability insurance plans. He can be reached at or directly at 301-917-2318.

[1] A Modified Endowment Contract (MEC) is a type of life insurance contract that is subject to last-in-first-out (LIFO) ordinary income tax treatment, similar to distributions from an annuity. The distribution is also subject to a 10% tax penalty on the gain portion of the policy if the owner is under age 59 1/2. The death benefit is generally income tax free.

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