What defines a Modified Endowment Contract?

A Modified Endowment Contract (MEC) is defined by being overfunded according to the IRS tables related to life insurance. Specifically, the IRS has established guidelines which outline the maximum amount of money that can be paid into a life insurance policy without it being classified as a MEC. If the accumulated cash value exceeds these limits, the policy is categorized as a MEC.

This classification is significant because it alters the tax treatment of the policy's earnings. In general, life insurance policies grow their cash value tax-deferred, but a MEC loses some of the tax advantages. For instance, if funds are withdrawn from a MEC, any gain is taxed as ordinary income, and if a withdrawal is made before the policyholder reaches age 59½, an additional penalty tax may apply.

Understanding the criteria for a MEC is essential for insurance professionals and policyholders, as it helps in making informed decisions about policy funding and tax implications.