Modified Endowment Contracts

Modified Endowment Contracts

Modified Endowment Contracts

Single premium life insurance policies have been around for a long time. However, people were using them as an investment vehicle that allowed them to pass on cash assets to their beneficiaries tax-free. In 1988, the government changed the taxation rules regarding how single premium insurance policies are funded to discourage people from trying to circumvent the taxation system with these insurance plans. Beginning on June 20, 1998 any insurance policy that is labeled as a Modified Endowment Contract (MEC) is subject to taxation and possibly penalties money is withdrawn from the policy loan, partial surrenders, pledges, or anything other than a death benefit given to a beneficiary.

People who have single premium life insurance policies that were enacted prior to June 21, 1998 are exempt from this law unless they make any material changes to their policy. Once they make a major change to their policy it can come under review by the government to determine if it qualifies to be listed as an MEC. Once the policy has been designated as an MEC it cannot be changed back. The evaluation uses what is called the 7 pay test. This is where they look at the amount of premiums paid to determine if the entire policy was paid off within seven years. If so, then the policy is listed as a MEC and subject to the new laws.

The test is applied in a few situations: when the policy is first purchased, when the death benefit is reduced within the first seven years of the contract period, and when the policy undergoes any major material changes. Most insurance companies are fully aware of these new laws and should be able to tell you the maximum amount you can pay on your life insurance plan to avoid this MEC label. However, should you inadvertently pay more than you allowed then you can ask your insurance company to refund you the excess amount.

Almost all single premium life insurance policies today are automatically listed as MECs. Other policies, such as universal life and variable life, which allow you to contribute as much to your policy as you want will have a cap on the amount of premium you can pay per month for at least the first seven years of your ownership. After the seven years expires, you are generally able to put as much on your policy as you want. This something you want to keep in mind when you are shopping for life insurance.

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