A modified endowment contract (MEC) is a type of life insurance policy that has exceeded the IRS's limits on the amount of premiums that can be paid in the first seven years. When this happens, the policy loses some of its tax advantages.

MECs are created when the total premiums paid for a life insurance policy exceed the amount that would be required to purchase a paid-up policy based on seven-level annual premiums. This is known as the seven-pay test.

If a policy fails the seven-pay test, it becomes a MEC. MECs are still life insurance policies, and they still provide death benefits to beneficiaries tax-free. However, withdrawals of cash value from a MEC are taxed differently than withdrawals from other types of life insurance policies.

With a MEC, withdrawals are taxed on a last-in, first-out (LIFO) basis. This means that the first money withdrawn is taxed as ordinary income, even if some of the money in the policy has been invested in tax-deferred investments.

In addition, withdrawals from a MEC are subject to a 10% penalty tax if the policy owner is under the age of 59½.

There are a few things that you can do to avoid MEC status. First, make sure that you do not pay more than the seven-pay test allows. Second, consider investing in a different type of life insurance policy, such as a universal life insurance policy or a whole life insurance policy. These types of policies do not have the same premium limits as MECs.

If you are unsure whether or not your life insurance policy is a MEC, you should contact your insurance company.

Sell Your Life Insurance policy