Modified Endowment Contract (MEC) - Explained

welcome to the studio today I have my

dad dr. Tom McPhee with me and we're

going to talk about modified endowment

contracts what they are and some of the

consequences that you need to watch out

for if you are looking at a policy or

already have a policy so dad what

exactly is a modified endowment contract

well Jesse in the broadest sense of the

word a modified endowment contract to

swim a life insurance policy is over

funded and that means that you have put

more money into a policy in the first

seven years than what it would take to

pay the policy off or compare it ups

what is called and so if that happens

then the policy becomes a taxable event

very similar to a 401k or an IRA okay so

what are the guidelines for knowing when

that could happen and to keep it from

happening in a policy well first of all

in the initial design you want to make

sure that the policy is not scheduled to

have more premiums going into it and

that for seven year period but then at

the same time you want to be looking

later on and not be repaying a policy

loan or adding an extra premium payment

without checking with the insurance

company to see if that policy can hold

that money without becoming a modified

endowment contract okay so now on some

of the policies with our clients they

have made larger payments and the

insurance company then sends them a

letter and says if this lerner payment

goes through your policy will become a

modified endowment contract they let

them know and they usually send that

check back to them or just send them to

difference of what would be make it

become a modified endowment contract

that's right the insurance companies

really don't want the extra paperwork of

recording that and having to report it

to the IRS so most companies most good

companies are gonna contact the agent

contact the client to say hey did your

client really mean for this payment to

go through because they might have

intended it for a loan repayment or an

interest payment but it's actually

adding more premium than what this

policy can hold without being a Mack

so is there any strategy or a situation

where you would want a modified

endowment contract absolutely single

premium policies are max are are very

common for people that are doing estate

planning or they're just trying to up

the amount of money that they can pass

on tax-free to the next generation or a

charity or sometimes people are just

liquidating hard assets and they want

someplace to park the money and they're

not sure of what's going to happen in

the future as far as being able to make

future policy premiums and so a single

premium or maybe a couple of premiums

and then no more premiums and that

policy would make a Mac but it's still a

policy that is very beneficial

especially when someone's past the age

of 59 and a half because now they've

passed the penalty phase where you don't

have to pay the extra ten percent to the

IRS if you access the money so there's

some situations where a modified

endowment contract can be good most of

the time you want to keep a modified

endowment contract from happening if you

want to have access to the cash value

bill up into policy now with the

modified endowment contract can you talk

a little bit about the death benefit

does the death benefit ever become

taxable the death benefit by and large

in most life insurance policies remains

tax-free as far as federal income tax is

concerned but we've got to look at state

estate taxes we got to look at the

estate taxes at the federal level and if

the proceeds in a death benefit exceed

the estate value exempt from estate

taxes then there could be some tax on

that but by and large in all 50 states

and in federally their income tax free

okay and a modified endowment contract

with our policies and multiply endowment

contract or not that wouldn't affect the

estate total amount it doesn't okay no

so then the final question is is a

modified endowment contract if a policy

becomes a modified endowment contract or

if you buy a policy that's a modified

endowment contract is there any going

back to a standard life insurance policy

well again the if you design the policy

to be on

fighting down the contract in the first

place are you over fund it and you don't

get a refund for that extra amount that

made it a modified endowment Andre once

that's been reported to the IRS there's

no going back those regularly it's going

to remain a modified endowment contract

indefinitely and so what's really good

to know that even if it does become a

modified endowment contract or you

design a policy to be a Mac right from

the very GetGo you're never going to be

taxed on the premiums that you've paid

into the policy you're only going to be

texts on the growth and in a modified

endowment contract all it says is that

you have to take the growth out first

and that means you're going to pay taxes

on that growth immediately when you take

a loan if there's more cash value in the

policy than what you've paid for the

policy sure that makes it so you can

always get your cost basis back out

tax-free but you have to take the growth

up first so that corrects correct all

right and with a standard life insurance

policy the way it works is you get to

take your cost basis at first and then

any of the growth that's correct and and

of course if you switch to a loan when

you're pulling out the growth then

there's no tax there's an interest only

rate so there you have it some

information about modified endowment

contracts hopefully this was helpful if

you have any other questions about

modified endowment contracts and or have

a question about a policy you're getting

or already have make sure to reach out

to us if you have any questions email us

team at life - benefits comm or leave it

in the comments below thank you for

tuning in we'll see you in the next