Once a policy is classified as a modified endowment contract (MEC), distributions taken during the insured's life, such as loans and withdrawals, are:
Explanation
In a MEC, living distributions (including policy loans) are taxed LIFO, so the taxable earnings come out first as ordinary income, and a ten percent penalty may apply if taken before age 59 1/2, similar to annuity taxation. They are not tax-free, not deductible, and not penalty-exempt. Importantly, MEC status affects only living distributions; the death benefit paid to a beneficiary generally remains income-tax-free. This is why overfunding a policy into MEC status must be done knowingly.
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