The Material Change Rule in Modified Endowment Contracts (MEC)

The Material Change Rule in Modified Endowment Contracts (MEC)

Policies entered into prior to June 21, 1988, and policies entered into on or after that date with low enough premiums to avoid being classified as MECs are generally treated the same as life insurance policies have been treated in the past. This means there will generally be no income tax applicable to withdrawals until the policyowner’s cost basis has been recovered (tax free). This is the cost-recovery rule or first-in-first-out (FIFO) treatment long associated…

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Benefit Reductions Within the First 7 Years of a Modified Endowment Contracts (MEC)

Benefit Reductions Within the First 7 Years of a Modified Endowment Contracts (MEC)

For Single Insured For contracts insuring a single insured, if death benefits are reduced within the seven-year testing period, there is a look-back requirement. The seven-pay test must be reapplied as if the contract originally had been issued for the reduced benefit amount. Example. Assume the guideline annual premium is $10,000 based on the original death benefit. The policyowner pays $9,000 each year for the first six years. In year seven, the policyowner withdraws $36,000,…

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The Definition of a Modified Endowment Contracts (MEC)

The Definition of a Modified Endowment Contracts (MEC)

A Modified Endowment Contract (MEC) is a life insurance contract that meets the requirements of Code section 7702, as well as a couple of other things. Understanding what an (MEC) is helps you make a more educated decision. These other items include: was entered into on or after June 20, 1988, and fails to meet the seven-pay test; or is received in exchange for a MEC. A policy that originally satisfies the seven-pay test in…

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Tax Treatment of Modified Endowment Contracts

Tax Treatment of Modified Endowment Contracts

To counteract what was perceived as abusive use of single-premium, limited-pay, and universal The tax treatment of certain amounts received from MECs prior to death—called distributions under the contract—is generally the same as the tax treatment afforded to annuity distributions. To the extent of gain in the policy, distributions are taxed on an income-first basis. In other words the first distributions out of the contract are not considered a tax free return of the policyowner’s…

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What is a Modified Endowment Contract (MEC)?

What is a Modified Endowment Contract (MEC)?

To counteract what was perceived as abusive use of single-premium, limited-pay, and universal life policies as short-term, tax-sheltered cash accumulation or savings vehicle, Congress passed legislation modifying Internal Revenue Code section 7702, which provides the tax law definition of a life insurance contract. Code section 7702A, which was drafted to correct the perceived abuses, defines a new class of insurance contracts called Modified Endowment Contracts (MEC). The basic difference between MECs and other life insurance…

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