In 2020, about 54% of Americans had a life insurance policy.
If you’re one of those Americans, you might be wondering if you have modified endowment contracts. If you do, is it taxable?
Thankfully, we’re here to help answer all of your questions, so make sure you keep reading to find out all you need to know.
What Is a Modified Endowment Contract
A modified endowment contract basically just means that you can be taxed on your policy for life insurance. However, you’re only taxed if your premiums are higher than the limit the tax law sets.
While you might buy a life insurance policy that isn’t a MEC, it can turn into one depending on the IRS policy and taxation structures that they’ve set around the contract.
That means that if you make a withdrawal from the policy, it would be taxed as your regular income rather than income that wasn’t taxable.
To learn more about this, check out Paradigm Life.
History of MEC
One of the best features of cash-value life insurance was the ability to grow your money without having to pay taxes. Life insurance carriers started offering this in the late 1970s by giving people universal life products or single-premium services.
If you were a policy owner, you could withdraw interest and the principal as a loan that wasn’t taxed. You could do this as long as the policy didn’t end before the owner of it passed away.
However, Congress didn’t like that people weren’t paying taxes, so they passed the Technical and Miscellaneous Revenue Act of 1988. This is where the MEC started.
Now, if any policy receives a premium and is over those limits, it becomes a MEC loan instead of a cash-value insurance policy.
If you withdraw something from the policy, you’ll have to withdraw the taxable gain before you can take out the untaxable part. This is because there is a Last In First Out rule.
If you have a policy loan, this will be classified as ordinary income, and you’ll have to pay taxes on it.
If you’re under 59.5 years of age, then you’ll also have to pay a 10% penalty tax if you take out any distributions of withdrawals or loans.
One of the main benefits of having a MEC is that it can protect you from creditors. You can then leverage that money into even bigger death benefits without having to owe any of it to creditors.
It’s also great because it can help give you liquidity.
Learn More About Modified Endowment Contracts
These are only a few things to know about the modified endowment contracts, but there are many more things to keep in mind.
We know that dealing with financials can be stressful, but we’re here to help you out.
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