Modified Endowment Contract Series: The Pros and Cons of MECs

Modified Endowment Contracts: Chapter 3 of 5

As with every type of investment, you’ll find that there are pros and cons to each. An MEC is no different.

MEC Tax Considerations

No one wants to break any rules when it comes to the IRS, however those who choose to invest in a modified endowment contract are willingly and knowingly doing that. According to Phoenix Wealth Management:

“A modified endowment contract or MEC is a life insurance contract that, for federal income tax purposes, is funded in a way that violates the “7-pay” test under Section 7702A(b) of the Internal Revenue Code. In that case, lifetime distributions from the policy are taxed under less favorable annuity-like rules rather than the more favorable rules for distributions from non-MEC life insurance policies.”

Simply stated, some investors choose to break the rules in order to get the tax benefits in a life insurance policy to MEC conversion.

Advantages of MECs

• Opportunity to build more wealth using a tax-deferred investment
• Death benefit payments are not harmed by converting to an MEC
• Insurance investment products such as MECs have always been given preferential consideration by Congress
• MEC investors have the choice of when to pay the taxes made on the investment, and can wait as long as the age of 59 1/2 (retirement)

Disadvantages of MECs

• Extremely complicated tax laws to consider
• When distributions are taken out, that money may have additional taxes and penalties levied onto it as it will now be taxed on a “income-first” basis
• A standard 10% penalty tax will be levied on the withdrawn money if taken out before the age of 59 1/2 years

Because of the entangled nature inherent in MECs, only the most financially savvy individuals should pursue this investment opportunity. It is highly advisable that you contact your financial planner prior to attempting a Modified Endowment Contract strategy as the costs can be significant.

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