A modified endowment contract, typically called a MEC, is simply a fancy way of referring to a life insurance policy that doesn’t meet certain IRS guidelines for typical life insurance policies. This is because these policies don’t pass the government’s 7-pay test. This means that these policies can be totally paid off in less than seven years. As a note, this test only applies to policies that have been purchased after the 21st of June, 1988.
Because of the rules about paying off life insurance too fast, the IRS may tax withdrawals or policy loans as income, so policy owners may lose some of the tax advantages of typical life insurance if they decide to purchase a MEC. The rules for this kind of policy were put in place to stop people from using the cash value of their life insurance policies as savings or investment accounts and not as coverage for their beneficiaries. However, some people still consider using a MEC as part of their retirement planning strategy.
Advantages of Using a MEC for Retirement Planning
It’s true that the IRS has withdrawn some of the tax advantages of life insurance for policies that get funded to fast. However, beneficiaries still usually get to enjoy the proceeds of the death benefit without reporting income. Policy owners also still get to enjoy tax-deferred growth in their cash accounts. A MEC still has some of the main tax advantages of life insurance.
Why consider funding a life insurance policy quickly? The main reason is that a policy that is totally funded can start growing the cash account more rapidly. Some policies are even created to use this growth to increase the death benefit. Also, it’s possible to find insurers that offer products that also have riders that may allow the policy owner to use part of the benefit for long term care or other healthcare needs.
When to Consider Buying a MEC for Retirement?
People who plan to take frequent loans or withdrawals from the cash value of their life insurance policy might not decide that a MEC is the best solution for their needs. However, the main purpose of life insurance should be to leave a death benefit to beneficiaries, so this might not be that big of an issue.
People might consider using a MEC as part of their retirement strategy if they don’t intend to make frequent withdrawals or take out loans. Even people who may need to make withdrawals might find that the unfavorable tax treatment doesn’t outweigh the benefit of rapid tax-deferred growth. People who are trying to figure out which kind of life insurance will serve their needs during retirement might be wise to sit down and weigh their own particular situation with an experienced financial planner or insurance agent.