Ordinary Life Insurance
Individual life insurance issued in amounts of $1,000 or more with annual or larger premium modes, underwritten individually, as distinguished from group or industrial insurance.
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Practice This Concept
A policyowner takes a partial withdrawal from the cash value of a permanent life policy. The total premiums paid exceed the amount withdrawn. For income tax purposes, the withdrawal is:
A nontaxable return of premium (basis) to the extent it does not exceed the policyowner's cost basis — Under IRC Section 72, money withdrawn from a policy's cash value is first treated as a return of the policyowner's cost basis, the premiums paid, and is therefore nontaxable up to that basis. Only withdrawals in excess of the cost basis represent taxable gain and are included in income. The 10% penalty generally applies only to distributions from modified endowment contracts (MECs) taken before age 59 1/2; an ordinary life insurance policy is not subject to that penalty.
National insurance concept
A life insurance policy is classified as a Modified Endowment Contract (MEC) when:
Total premiums paid exceed the limit that would be required to endow the policy within seven years — A Modified Endowment Contract results when a life insurance policy fails the seven-pay test under IRC §7702A: the premiums paid exceed the sum that would be required to endow the contract within seven years from issue. Single-premium policies or heavy early premium payments commonly trigger MEC status. Once a policy is classified as a MEC, the favorable distribution tax treatment of ordinary life insurance is lost for living withdrawals and loans, although the death benefit remains income-tax-free. Avoiding MEC status is a central concern in the design of cash-value policies with large early premiums.
National insurance concept
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