What Is a Modified Endowment Contract?

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What is a modified endowment contract? If you’re shopping for a cash value life insurance policy like participating whole life insurance, you may have heard of the term “modified endowment contract” or “MEC” and how it can strip your insurance policy of certain tax advantages. Pay too much into your policy too fast, and you could be stuck paying taxes on policy loans and growth, and even penalized for accessing your wealth before 59 ½. 

If that sounds more like a qualified retirement plan than life insurance, you’re right. The IRS treats modified endowment contracts more like retirement savings accounts. And MECs don’t receive the tax advantages associated with other types of cash value life insurance, like whole life or universal life insurance. 

So why would an individual opt for a MEC over tax-advantaged life insurance? And why would someone choose a MEC over traditional retirement savings?

In this article, we’ll break down the differences between participating whole life insurance, MECs, and qualified retirement plans.


The biggest difference between participating whole life insurance, modified endowment contracts, and qualified retirement plans is how they are taxed. Taxes are one of the biggest drains when it comes to growing and protecting your wealth. So, if your primary goal is to increase wealth to use during your own lifetime, a participating whole life insurance policy is generally preferred to a MEC. However, if your primary goal is to pass down tax-advantaged wealth to your heirs, a MEC may be preferred over a traditional IRA.

Whole Life InsuranceModified Endowment ContractTraditional IRA
PaymentsAfter-tax dollarsAfter-tax dollarsPre-tax dollars
Contribution LimitsNo limits, as long as 7-pay test is passedNo limitsLimited
Interest & DividendsTax-free growth Tax-deferred growth Tax-deferred growth
LoansTax-freeTaxed on any amount exceeding principalTax-free, but repaid with after-tax dollars (double taxation)
Withdrawals/DistributionsNo PenaltyPenalty before 59 1/2Penalty before 59 1/2
Retirement IncomeTax-freeTaxed on any amount exceeding principalTaxed
Death BenefitTax-freeTax-freeTaxed, unless certain conditions are met

Here’s a more detailed explanation of each key area:


Both whole life insurance and modified endowment contracts are paid for with after-tax dollars. The benefit to paying taxes now instead of in retirement, like with a traditional retirement plan, is that no one knows what tax rates will be in the future. So if you’re worried about future tax rates affecting your quality of living in retirement or affecting your loved ones, choosing a financial tool like participating whole life insurance or a MEC can provide peace of mind and allow for more accurate financial planning. 

Contribution Limits

The biggest hurdle to using a traditional IRA or even a Roth IRA for retirement savings is the annual contribution limit. This is especially true if you started saving later in life or if you’re trying to make up for a market downturn. Modified endowment contracts have no contribution limit and are usually paid for in one lump sum or a series of upfront payments. In other words, if you have a large amount of cash you’d like to save for retirement and have already maxed out your annual contribution limits, a MEC could be a solution. 

Alternatively, you could purchase a participating whole life insurance policy. Although you can’t make one lump sum payment, you can structure your premiums so that you “frontload” your policy in the first 7-10 years. This allows for maximum growth of cash value and potential dividends over time while retaining tax advantages. Adding a paid-up additions (PUA) rider to your policy will also increase the amount you can pay into it.

Interest & Dividends

Interest and dividends in a whole life policy grow tax-free and interest can be accessed tax-free in the form of policy loans. Modified endowment contracts and traditional IRAs tax your gains. 


You can take a loan from your whole life insurance policy, modified endowment contract, or qualified retirement plan at any time without credit approval. A Traditional IRA or 401(k) typically places a limit on how much you can borrow and how often you can access this feature. MECs and whole life policies allow you to borrow at any time and you can borrow up to the level of cash value you’ve accumulated. 

From a tax standpoint, a MEC will require you to pay taxes on any amount you borrow that exceeds what you’ve paid into the policy. Policy loans from a life insurance policy or traditional IRA are tax-free, however, with a traditional IRA you’ll have to repay your loan with after-tax dollars that will be taxed again when you take distributions in retirement (double taxation).  


When it comes to liquidity, a whole life insurance policy is the clear winner because it’s the only option that allows you to access your wealth without penalty before age 59 ½.

Retirement Income

A traditional IRA will tax your retirement income as you take distributions. With a modified endowment contract, you’ll be taxed on earnings that exceed the principal you’ve paid into the policy. Whole life insurance withdrawals also tax you on earnings that exceed premiums paid, unless you take retirement income in the form of tax-free policy loans. This option allows you to enjoy a tax-free retirement. When you pass away, outstanding loans and interest are deducted from your death benefit. This will reduce the amount available to your heirs, but if your primary financial goal is extra retirement income, a whole life insurance policy is the way to go.

Death Benefit

Both whole life insurance and modified endowment contracts provide tax-free wealth to your beneficiaries. Traditional IRAs, and even Roth IRAs, have strict rules pertaining to how remaining funds are taxed, how they can be accessed, and when they are accessed. 


The truth is, most of the time individuals are better off purchasing participating whole life policies than modified endowment contracts. Whole life policies offer more living benefits. But everyone’s financial goals are different, and for certain individuals, modified endowment contracts make the most sense. 

A modified endowment contract 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

If you think a modified endowment contract will help you achieve your financial goals, schedule your complimentary virtual consultation here with a Paradigm Life Wealth Strategist.


If you don’t want a modified endowment contract and are shopping for a participating whole life insurance structured for maximum growth, we’re here to help. The Wealth Strategist at Paradigm Life are expert insurance agents who not only understand these types of cash value policies inside and out, but who own policies themselves.

You can schedule your complimentary virtual consultation here.

We structure policies that meet the 7-Pay Test, ensuring rapid growth while retaining tax-advantages and liquidity. Plus, we’ll meet with you annually to make sure your policy is working for your unique financial goals and budget. (Want to meet more often? We’re happy to!) 

Learn more about how to protect your policy from becoming a modified endowment contract by clicking here.

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