Which statement describes a Modified Endowment Contract (MEC)?

Which statement describes a Modified Endowment Contract (MEC)?

• A. MEC is any policy with flexible premium payments that never qualifies as life insurance.
• B. MEC is a policy that always provides tax-free distributions.
• C. The 7-Pay Test ensures no overfunding of the contract.
• D. A life insurance contract not passing the 7-Pay Test, resulting in loss of tax advantages.

Answer: (D)

A Modified Endowment Contract is created when a life insurance policy is funded so that, within the first seven years, the premiums paid exceed the amount needed to keep the policy from becoming an endowment (it fails the 7-Pay Test). When this happens, the policy loses its favorable tax treatment for distributions: any withdrawals or loans are taxed as ordinary income to the extent of the cash value, rather than being tax-free up to the cost basis, and early withdrawals may incur additional penalties. The death benefit generally remains tax-free, but the tax advantages of accessing cash value are gone. So the statement that best describes a MEC is that a life insurance contract not passing the 7-Pay Test results in loss of tax advantages.

A Modified Endowment Contract is created when a life insurance policy is funded so that, within the first seven years, the premiums paid exceed the amount needed to keep the policy from becoming an endowment (it fails the 7-Pay Test). When this happens, the policy loses its favorable tax treatment for distributions: any withdrawals or loans are taxed as ordinary income to the extent of the cash value, rather than being tax-free up to the cost basis, and early withdrawals may incur additional penalties. The death benefit generally remains tax-free, but the tax advantages of accessing cash value are gone. So the statement that best describes a MEC is that a life insurance contract not passing the 7-Pay Test results in loss of tax advantages.