Life Insurance FundamentalsQuestion 271 of 315

A Modified Endowment Contract (MEC) is BEST described as:

a.A term policy that has been converted to permanent insurance
b.A universal life policy with cash value greater than the death benefit
c.A life insurance contract that fails the IRC §7702A '7-pay test' — premiums in the first 7 years exceed the cumulative premiums needed under a level-premium 7-pay paid-up benchmark
d.Any whole life policy with a 20-year premium-paying period

Explanation

Under IRC §7702A, a life insurance contract becomes a Modified Endowment Contract if cumulative premiums paid into the contract during the first 7 contract years exceed the sum of net level premiums that would have been required to fully pay up the policy in 7 years (the '7-pay test'). MEC status, once attached, is permanent. The economic effect: the death benefit remains income-tax-free, but all LIVING distributions (loans, withdrawals, assignments) are taxed gain-first under §72(e)(10) and subject to a 10% penalty if before 59½ under §72(v). Single-premium and 'short-pay' designs are most susceptible. Option A — premium-paying period alone doesn't trigger MEC. Option B describes a corridor issue, not MEC. Option D — conversion doesn't restart the 7-pay test, but it can trigger 'material change.'

Law Reference: IRC §7702A (MEC definition)

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Reviewed by John Zihao Zhang California-Licensed Life Insurance Agent (CA Dept. of Insurance License #4396095 verify)
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