Modified Endowment Contract (MEC)
Terms related to the financial mechanics, value, and tax treatment of policies.
What Is Modified Endowment Contract (MEC)?
A modified endowment contract (MEC) is a life insurance policy that has been funded with premiums exceeding IRS limits under the "7-pay test" — meaning total premiums paid in the first seven years exceed what would be needed to pay the policy up in seven level annual payments. MECs retain the income-tax-free death benefit but lose the tax-advantaged treatment of policy loans and withdrawals: distributions (including loans) are taxed on a last-in, first-out (LIFO) basis, meaning gains come out first and are subject to ordinary income tax. Additionally, distributions before age 59½ incur a 10% federal penalty. MECs often result from large single-premium payments or overfunding policies with cash.
Nevada Context
Nevada policyholders who consider funding a life insurance policy with a large lump sum should confirm with a tax advisor whether the policy will cross the MEC threshold. Many carriers provide illustrations showing projected MEC status.
How It Affects You
Crossing the MEC threshold eliminates the tax-free loan benefit that makes cash value life insurance attractive for supplemental income. Careful premium planning — staying below the 7-pay limit — preserves the most favorable tax treatment.
Modified Endowment Contract (MEC) in Practice
A Nevada executive pays an illustrative $200,000 single premium into a whole life policy; the IRS 7-pay test is exceeded, converting the policy to a MEC — policy loans are now taxable gains, not tax-free advances.
Dollar amounts shown are illustrative. Actual amounts vary by carrier, applicant age, health status, and individual underwriting.
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