A modified endowment contract (MEFC) is basically a money value annuity contract in the United States in which the total premiums paid over time have exceeds the predetermined amount allowed for the full tax deferment of a pure cash value annuity. The government allows an individual to invest in such a contract as long as the investment is used to pay the entire death benefit during the remaining period of the contract after death. There are usually other restrictions, such as the restriction that the premiums or endowments used in the investment must not be applied to taxable income. In addition, individuals who take advantage of the option to defer the distributions until distribution only receive a smaller benefit than their more accruing peers who also took advantage of the option.
The concept behind a modified endowment contract and other similar plans is to allow individuals the option to receive a larger benefit when they die and taking the benefits all at once when they die. However, there are both tax consequences involved as well as social consequences when individuals choose to defer their benefits. Deferring tax consequences means that the individuals’ endowments will be subject to taxation on their investment upon distribution and, in many cases, will receive a smaller benefit than those individuals could have received if they had delayed distribution. See the pros and cons here!
Individuals may also incur tax consequences when they take advantage of the option at https://paradigmlife.net/blog/understanding-modified-endowment-contract-mec/ to delay distribution. For example, delaying distribution through a modified endowment contract could increase the amount of tax-free gains accruing to the account. On the other hand, if the plan permits the early distribution of payments to beneficiaries, then these payments could accelerate the tax-free basis of the account.
Those utilizing a modified endowment contract realize that it is possible to pay taxes while retaining some or all of the death benefits. However, in doing so, the individual risks losing some or all of the death benefit. While this risk exists, it is not likely to be a significant concern for most life insurance policy holders. Moreover, life insurance contracts often contain provisions for tax relief, including an accelerated application process for death tax advantages, which can reduce the tax liability considerably. Understanding the federal tax laws, and properly utilizing the options that are available to you, can help you achieve the maximum benefits from your life insurance policy while minimizing your taxable income. Read more about insurance at https://www.huffingtonpost.com/entry/huffpost-open-enrollment-guide_us_5a00c80ae4b0368a4e8662e4.
Because a modified endowment contract allows for both the early distribution of payments and the deferment of taxes, it is often referred to as a tax-deferred investment option. The contract could provide policy owners with a large lump sum, which they can use to purchase insurance. Alternatively, policy owners can also use the deferred tax-free death benefit to buy additional life insurance coverage for themselves. By paying taxes on the death benefit and then using that money to purchase additional coverage, policy owners can greatly reduce their taxable income and provide their heirs with a substantial amount of capital gains tax-free.
There are many reasons why people choose to utilize modified endowment contract premiums or annuities. Some individuals and families receive these benefits at an early age, as part of their final expenses in life. Others may want to ensure that their loved ones have a death benefit in place in case of their untimely passing. Still others may need to use the deferred annuity benefits for medical or investment purposes, further reducing their taxable income.
How Does A Policy Become A MEC 