What happens if my policy is a MEC?
When your life insurance policy is classified as a MEC, you may be required to pay taxes if you withdraw funds from it, take a policy loan, or assign or pledge the policy.
This treatment also applies to such transactions in the two year period prior to a policy becoming a MEC. In addition, if a distribution is made before the policyowner reaches age 59.5, an Early Withdrawal Penalty may apply equal to 10% of the taxable portion of your distribution.
The tax and related penalty are only applicable to any gain attained within the policy. The amount of premium put into the policy (cost basis) is NOT subject to tax or penalty.
Upon the death of the insured, the policy's status as a MEC is no longer relevant, as the death benefit paid to the beneficiary will receive the same income tax treatment as the death benefit that is paid from a life insurance that is not a MEC.
In next blogpost, we will discuss how is MEC status determined.