Tax TreatmentQuestion 235 of 716
Which statement about the federal tax treatment of a Modified Endowment Contract (MEC) is TRUE?
a.The death benefit of a MEC is taxed as ordinary income to the beneficiary, because MEC status revokes the §101(a) death-benefit exclusion
b.The death benefit of a MEC remains income-tax-free, but lifetime distributions are taxed LIFO with a 10% penalty before 59½
c.Lifetime distributions from a MEC are tax-free up to basis under FIFO, since MEC status changes only the death benefit
d.Both the death benefit and lifetime distributions from a MEC are taxed as ordinary income, with no penalty tax
Explanation
The MEC label under IRC §7702A changes the lifetime tax treatment only. Distributions during the insured's life are taxed LIFO (gain first as ordinary income), with a 10% additional tax under §72(v) if taken before age 59½. The death benefit paid because of the insured's death remains excluded from the beneficiary's gross income under §101(a).
Law Reference: IRC §101(a) and §7702AThis topic, taught in full in the California Life & Health Insurance Producer Exam guide. California Life & Health Insurance Producer Exam — Complete Study Guide (2026) — PDF + EPUB, $19.99 · 14-day refund →
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Reviewed by John Zihao Zhang — California-Licensed Life Insurance Agent (CA Dept. of Insurance License #4396095 — verify)