MEC stands for Modified Endowment Contract. By law, the Internal Revenue Service limits the amount of cash value that can be accumulated in a life insurance policy. The amount of cash value must be relative to the amount of death benefit that the policy purchased. If the cash value and death benefit are out of sync, then the policy enters into a MEC status. This is commonly referred to as a “MEC’d” policy. The point where the cash value is projected to exceed the death benefit is called the “MEC Limit.”
What are the consequences of a MEC policy?
If you pay too much money into your life insurance policy, either up-front or over time, you lose certain tax benefits and may be subject to a penalty (depending on your age). Non-MEC status life insurance policies are awarded with tax-free policy loans. Once a policy is considered a MEC, policy loans may become taxable at ordinary-income tax rates. Additionally, the policy loan’s interest may be subject to a 10% penalty if the policy owner is younger than 59 ½.
What is the difference between a MEC and a Non-MEC policy?
The primary difference between a MEC and Non-MEC policy is the way the loans are calculated. Under a Non-MEC policy, loans are not taxed.
In a MEC policy, any interest in the policy will be included in the loan calculation. This interest portion of the loan would be taxable to the policy owner. If the policy owner is younger than 59 ½, there would be an additional 10% penalty on the interest portion of the loan. This would be paid by the policy owner at tax time.
What happens if my policy becomes a MEC?
A policy will become a MEC if you over-pay your premium. If this happens, the insurance company notifies the policy owner of two options:
- The insurance company can process the overpayment and notify the IRS
- Return the overpayment (eliminating the MEC possibility altogether)
Are MEC polices bad?
MEC policies are neither good nor bad, it depends on your goals; at the end of the day, each strategy is unique. Some clients may have funds that they want to pay into their policy and are willing to incur the tax implications of a MEC status. Other individuals will want to keep all of their life insurance policy’s tax benefits intact. Your agent will assist you in determining which strategy is best for you and your policy.
For further information about the MEC status of your life insurance policy – especially if you are considering an overpayment – contact your Life Insurance agent.
Michael Bonny
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