Modified Endownment Contract

A Modified Endowment Contract (MEC) is a special type of cash value life insurance policy that requires extra attention because of the tax laws associated with it. The federal tax law definition of “life insurance” limits your ability to pay certain high levels of premiums. May 14, 2012.

7-Pay Test

The rule is basically this- you can’t contribute more to a policy than you would on a 7 year pay whole life policy with the same death benefit (meaning a whole life policy you would completely pay for in 7 years.)  So if the policy costs $10,000 a year for 7 years, and you contribute $10K to it in year one and $15K in year two (and don’t correct it), your policy just became an MEC. 

The insurance company usually helps you to track this stuff, but they can screw up too.  After year 7, you can put more money into the policy without having to worry about it becoming an MEC, UNLESS you make a material change to the policy. 

Basically, the government doesn’t want you to have a policy with a death benefit of $10K that you are making $50K premium payments to every year.  It wants you to buy life insurance for life insurance purposes, not investment purposes.