What are Modified Endowment Contracts (MECs) primarily related to?

Modified Endowment Contracts (MECs) are primarily related to high contributions made in the first seven years of the policy. Specifically, the IRS has established guidelines that limit the amount of money that can be contributed to a life insurance policy in the early years without it being classified as a MEC. When a policy is classified as a MEC, it means that it has failed the "7-pay test," which assesses whether the total premiums paid exceed the amount that would have been paid for a seven-year period based on a specified premium schedule.

Once a policy is deemed a MEC, it is subject to different tax treatment, notably regarding the taxation of distributions from the policy. Withdrawals and loans taken from a MEC can be taxable, and they may also incur a 10% penalty if the policyholder is under age 59½. Understanding the ramifications of a policy being classified as a MEC is critical for policyholders who are considering making significant contributions early in the life of the policy.