Life Insurance✓ Verified · outline & fact-checked · Sep 2026Difficulty 3/5
A policy is funded with premiums that exceed what a seven-pay whole life contract would require, causing it to be classified as a modified endowment contract (MEC). Which tax consequence applies to a MEC?
Select an option to reveal the answer and the full 3-part explanation — free, no signup.
Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
A policy becomes a MEC under IRC §7702 when it is funded faster than seven equal annual premiums would be needed to pay up the policy. The consequences apply to distributions: withdrawals and loans are taxed on a LIFO basis, meaning taxable gain comes out first, and a 10% penalty tax applies to distributions before age 59½, with limited exceptions. The death benefit, however, remains income-tax free to the beneficiary. MEC status does not make premiums deductible or convert loans into tax-free events.
Why the other options are wrong
- B) Loans from a MEC are taxable distributions under LIFO, unlike ordinary policies where loans are generally tax-free.
- C) The death benefit of a MEC is still received income-tax free under IRC §101.
- D) Life insurance premiums are generally not tax-deductible, and MEC status does not change that.
Memory hook
MEC = overfunding too fast. Payback: LIFO taxes plus a 10% early-withdrawal bite.