Modified Endowment Policy vs. Permanent Life Insurance

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A modified endowment policy is a life insurance product that can be useful for estate planning or retirement income with less volatility than market-based assets. It’s considered a form of limited pay permanent life insurance because it’s often purchased in one lump sum or over the course of a few annual payments, instead of level annual payments for life.

If you’re thinking about buying permanent life insurance but you don’t want to make annual payments every year in perpetuity, a modified endowment policy may be the right option for you. But before you buy, you should know that certain limited pay life insurance policies offer more benefits and advantages than others, especially when it comes to taxes. 

Read more: Understanding the Modified Endowment Contract (MEC)


When you buy a permanent life insurance policy, it typically features a built-in savings account called Cash Value. Your cash value reflects how much your insurance company would pay out if you were to terminate the policy, minus any fees or penalties. You can withdraw your cash value tax-free, up to the amount you’ve paid into your policy in premiums. You can also borrow against your cash value tax-free in the form of a life insurance policy loan. What’s more, permanent life insurance policies grow cash value in addition to what you pay in premiums. Some policies base growth of indexes or mutual funds, while others—namely participating whole life insurance—pay a guaranteed rate of return not tied to markets, plus non-guaranteed dividends.

Through the 1970s, many people purchased this type of whole life insurance specifically with the goal of maximizing tax-advantaged returns and growing cash value. Of course, the quickest way to do that is to pay a large sum upfront, either buying the policy in one single payment or a few payments spread out over the early years of ownership. But in 1988, life insurance laws changed, limiting tax advantages to policies. 

Today, if you want to purchase a policy in one lump sum or with few payments to optimize growth, the IRS taxes cash value when you use it, whether you withdraw it or take a policy loan. Essentially, a modified endowment policy works more like a qualified retirement plan, such as a 401(k), than a cash value life insurance policy. The difference is modified endowment policies aren’t exposed to market volatility the way stocks, bonds and mutual funds are. 

Here’s an overview of the difference in tax treatment between a whole life policy and a modified endowment policy:

Taxes & Whole Life Insurance 

  • Tax-free growth of interest and dividends
  • Growth of cash value can be used tax-free
  • Tax-free policy loans
  • Tax-free retirement income
  • Income tax-free death benefit
  • Estate tax-free death benefit

Taxes & Modified Endowment Policies

  • Tax-deferred growth of interest and dividends
  • Growth of cash value is taxed when used
  • Policy loans are taxed
  • Retirement income is taxed
  • Income tax-free death benefit
  • Estate tax-free death benefit


When would it make sense to choose a modified endowment policy with limited tax advantages over a whole life policy? It depends on what you’re using your policy for. Generally, if your primary goal is to pass down tax-advantaged wealth to your heirs and lower estate taxes, a modified endowment policy fits the bill. It’s a one-time purchase you can essentially set and forget. Modified endowment policies may also be a viable option for retirees looking to protect some of their retirement income from market fluctuations.

A modified endowment policy could be right for you if:

  • You don’t plan on accessing you cash value until after age 59 1/2
  • You want guaranteed returns with less volatility than the stock market
  • You’ve already maxed out other qualified retirement plan contributions
  • You want to increase the tax-free death benefit your heirs receive
  • You want to make one lump-sum purchase instead of paying life insurance premiums annually for life
  • You’re approaching retirement or already retired

On the other hand, a whole life insurance policy is preferred if you’re looking to capitalize on the benefits of your policy during your own lifetime. It’s more hands-on in terms of managing your policy and making regular payments over a number of years, but the ability to take tax-free policy loans increases your liquidity and cash flow, whether it be for real estate, retirement, a child’s education, investment opportunities, business capital, or an emergency fund.

A whole life insurance policy could be right for you if:

  • You want liquidity and the ability to access your cash value at any time
  • You want guaranteed returns you can access tax-free
  • You want tax-free retirement income
  • You want to increase the tax-free death benefit your heirs receive
  • You’re committed to long-term financial goals 
  • You’re young and have time to maximize cash value


What if you don’t want to pay insurance premiums every year until you die, but you want the tax-advantages and liquidity offered with whole life insurance? There is a third option: The Wealth Maximization Account from Paradigm Life.

Wealth Maximization Accounts are participating whole life insurance policies that are structured to be paid-up in as few as 7 years. They still retain the tax advantages of regular whole life policies, but generate growth quickly similar to a modified endowment policy. What’s more, a Wealth Maximization Account may also include supplemental insurance called Paid-Up Additions that allow you to overfund your account in its early years within the parameters outlined by the IRS for life insurance tax treatment. This supercharges your cash value and delivers exponential growth over the lifetime of the policy. 

If you’re deciding between a modified endowment policy or a permanent life insurance policy, schedule a free virtual consultation with a Paradigm Life Wealth Strategist and get expert guidance on which is best for your financial goals. We work with clients in all 50 states and Canada, and source a variety of insurance products from the nation’s top-rated mutual insurance companies to find you the perfect policy. 

Tap to schedule your complimentary virtual consultation here.

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