The 10% penalty on distributions from a Modified Endowment Contract before age 59½ does NOT apply to:
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Answer & full 3-part explanation (select an option above, or peek)
Why B is correct
Under IRC Section 72(v), the portion of any distribution from a modified endowment contract that is includible in gross income is subject to a 10% additional tax, but Section 72(v)(2) excepts three categories of distributions: those made on or after the date the taxpayer attains age 59½, those attributable to the taxpayer's becoming disabled, and those that are part of a series of substantially equal periodic payments made for life or life expectancy - in other words, amounts annuitized over the annuitant's life or life expectancy, which is what option B describes. Notably, there is no exception for distributions made on account of death, unlike non-MEC annuity contracts under Section 72(q)(2)(B). A distribution taken merely to pay debts or ordinary medical expenses is not excepted, because the penalty is intended to discourage access to MEC funds before retirement age except through legitimate annuitization.
Why the other options are wrong
- A) Paying personal debts is not one of the statutory exceptions; a taxable MEC distribution used for that purpose still carries the 10% additional tax.
- C) There is no general medical-expense exception to the MEC penalty; ordinary medical bills do not qualify, and only the specific statutory exceptions apply.
- D) The penalty is not universal: distributions on or after age 59½ and amounts annuitized over life or life expectancy avoid it, so exceptions clearly exist.
Memory hook
Annuitize for life and dodge the 10% penalty — the IRS respects true lifetime payouts.