Have you ever heard of a modified endowment contract or a MEC?

Well, stick around to the end of the blog, because today we’re going to do a deep dive into the nitty-gritty of MEC contracts.

Basically, a modified endowment contract or a MEC is a life insurance policy that gets stripped of its tax advantages because it doesn’t pass the seven-pay test. The seven-pay test is a test used by the IRS to determine whether or not your policy will become a modified endowment. And the seven-pay test is really simple. It compares the amount of premium needed for you to pay up the policy in the first seven years. If the premium you actually put into the policy exceeds that, then your policy is determined to be a modified endowment contract. Once a MEC, always a MEC. If you put one penny more than is allowed by that seven-page test, your policy will always be a MEC and it will always be stripped of its tax advantages. So what are the tax implications of having a modified endowment contract or a MEC?


Basically, once the policy goes from being a life insurance contract and crosses that imaginary MEC line, it goes from being a life insurance contract to being treated as a non-qualified annuity. As with any non-qualified investment, a MEC, any distribution taken from a MEC will be considered ordinary interest or a return of the interest earned. That goes for any distribution, whether it’s a dividend distribution or a policy loan, which generally aren’t taxable. But if your policy is a MEC, the distribution can be taxable.

Additionally, just like a non-qualified annuity, any distributions or policy loans or surrenders prior to age 59 and a half are subject to that 10% penalty. Despite losing some of the tax advantages of life insurance when you have a MEC, there are some situations where it makes sense to go for the MEC. Particularly, if you don’t plan on accessing the cash value prior to age 59 and a half. Or a lot of times it makes sense if you have assets that you need to shelter from the expected family contribution, FAFSA calculation. 

So when wouldn’t you want your contract to be a modified endowment contract? You wouldn’t want your policy to be a modified endowment contract if your plan is to access the living benefits of the policy, whether it’s to make major capital purchases, educate your children, or supplement your retirement. If you have enough time to do the planning and you plan on accessing the living benefits of a life insurance policy, you would want to avoid a MEC at all costs.

It’s easy with the way we designed the life insurance contracts for cash accumulation to avoid that MEC. But sometimes people have a large lump sum of money that they want to put in immediately, and we have to split that up over several years so that the policy doesn’t become a MEC and we could take advantage of the tax advantages and the tax shelter offered by a life insurance policy.

But one of the things that I’ve found is the MEC issue is much to do about really, not a lot. The key is this number one, the MEC status could be avoided with proper planning and design, and that’s where we can help you. Secondly, keep this in mind. Whether your policy is a MEC or it’s not a MEC, you still enjoy the tax-free death benefits that are given to life insurance policies. And because of that, it still creates a nice little tax advantage.

If you’d like help designing a life insurance policy for cash accumulation or a modified endowment contract, be sure to visit our website at tier1capital.com to schedule your free strategy session today. And remember, it’s not how much money you make, it’s how much money you keep that really matters.