Modified Endowment Contract (MEC)
A life insurance policy that has been funded with more premium than allowed by IRS rules (the 7-pay test), resulting in the loss of preferential tax treatment for policy loans and withdrawals.
Understanding Modified Endowment Contract (MEC)
If a policy is classified as a MEC, loans and withdrawals are taxed on a last-in, first-out (LIFO) basis - meaning gains are taxed before the return of basis. Additionally, pre-59.5 withdrawals from MECs are subject to a 10% early withdrawal penalty. Proper IUL design carefully stays below MEC limits to preserve the tax-free loan benefit.
Why This Matters for Retirement: Understanding Modified Endowment Contract (MEC) is essential for making informed decisions about tax-free retirement income strategies. Whether you are evaluating an IUL policy, planning Roth conversions, or comparing retirement vehicles, this concept directly affects your outcomes.