Q. What is a MEC in insurance and why it is not good for the buyer?
A. MEC stands for Modified Endowment Contract.
MEC is important because cash-value life insurance is known for is tax-free benefits during accumulation and tax-free ways to access the cash value during distribution phases. But Congress has placed limits on the amount of money one can put into the cash-value life insurance policies so that rich people can't simply put as much money as possible into such great products and enjoy all the great tax benefits.
More specifically, all cash value policies are subject to the 7-pay rule, which limits the tax benefits of cash value withdrawals. Policies that fail this test are classified as MEC.
Corridor Rule
The corridor rule states that in order for any life insurance policy to avoid being classified as a MEC, there must be a "corridor" of difference in dollar value between the death benefit and the cash value of the policy. All single-premium policies are now classified as MECs. Flexible-premium policies must pass the seven-pay test in order to avoid MEC status. This test caps the amount of premium that can be paid into a flexible-premium policy over a period of seven years.
Important Factors
Each policy that is now issued will have its own MEC premium limit that is based on several factors, including the age of the policy owner and the face amount of the policy. Any premium paid into the policy in excess of this limit will result in reclassification of the policy as a MEC. However, the unused cap space within this limit is cumulative. For example, if the MEC limit for a policy is $5,784 the first year and $4,000 of premium is paid into the policy, then the excess $1,784 of unpaid premium is carried over to the premium limit for the second year.
This limitation expires after seven years, as long as no material changes, such as an increase in death benefit. Any material change such as this will effectively restart the seven-year test. A decrease in the death benefit will not restart the test, but it may result in the policy being immediately classified as a MEC in some cases. Once a policy has been classified as a MEC, it cannot regain its former tax advantages under any circumstances. The MEC classification is irrevocable.
A. MEC stands for Modified Endowment Contract.
MEC is important because cash-value life insurance is known for is tax-free benefits during accumulation and tax-free ways to access the cash value during distribution phases. But Congress has placed limits on the amount of money one can put into the cash-value life insurance policies so that rich people can't simply put as much money as possible into such great products and enjoy all the great tax benefits.
More specifically, all cash value policies are subject to the 7-pay rule, which limits the tax benefits of cash value withdrawals. Policies that fail this test are classified as MEC.
Corridor Rule
The corridor rule states that in order for any life insurance policy to avoid being classified as a MEC, there must be a "corridor" of difference in dollar value between the death benefit and the cash value of the policy. All single-premium policies are now classified as MECs. Flexible-premium policies must pass the seven-pay test in order to avoid MEC status. This test caps the amount of premium that can be paid into a flexible-premium policy over a period of seven years.
Important Factors
Each policy that is now issued will have its own MEC premium limit that is based on several factors, including the age of the policy owner and the face amount of the policy. Any premium paid into the policy in excess of this limit will result in reclassification of the policy as a MEC. However, the unused cap space within this limit is cumulative. For example, if the MEC limit for a policy is $5,784 the first year and $4,000 of premium is paid into the policy, then the excess $1,784 of unpaid premium is carried over to the premium limit for the second year.
This limitation expires after seven years, as long as no material changes, such as an increase in death benefit. Any material change such as this will effectively restart the seven-year test. A decrease in the death benefit will not restart the test, but it may result in the policy being immediately classified as a MEC in some cases. Once a policy has been classified as a MEC, it cannot regain its former tax advantages under any circumstances. The MEC classification is irrevocable.
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