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The Benefits of Intentionally Creating a Modified Endowment Contract

Many people think creating a “modified endowment contract” (MEC) is bad. However, this negative perception oversimplifies reality. In certain situations, intentionally creating a MEC can actually be a strategic financial planning move.

What is a Modified Endowment Contract?

What is a Modified Endowment Contract? A MEC is a tax classification for cash value life insurance policies that have been overfunded or funded too quickly based on IRS formulas. Once a policy becomes a MEC, different tax rules apply:

  • Withdrawals are taxed as income first, then as tax-free recovery of basis
  • Loans are also considered income if the policy lapses or is surrendered
  • No more tax-free withdrawals under FIFO (first-in, first-out) rules

This loss of tax advantages is why most planners recommend funding policies properly to avoid MEC status. However, there can be reasons to embrace the MEC tax treatment.

Why You Might Intentionally Create a Modified Endowment Contract

Intentionally Creating a MEC For high-income earners already facing the highest tax rates, the tax-free treatment of life insurance cash value may not be as beneficial. They may be better off pre-paying the tax hit now, so future cash value growth comes out tax-free in retirement when they are in a lower tax bracket.

Rapidly transferring assets into a life insurance policy funded as a MEC can be a powerful tax planning strategy in this scenario. All future internal growth is tax-deferred and can be withdrawn free of income taxes in retirement.

Other Benefits of Creating a Modified Endowment Contract

Other Benefits of MECs In addition to the potential future tax advantages for high earners, intentionally creating a MEC carries some other benefits:

  • MECs have no funding limits, allowing faster buildup of cash value
  • Income taxes are paid only once upon withdrawal, not loan taxation each year
  • MECs are simplified in terms of tax tracking (no need for complicated FIFO calculation)

While not for everyone, embracing the MEC status can allow you to supercharge cash value accumulation and growth, especially for high-income clients. Strategic use of a MEC can complement other tax planning strategies.

MECs and Long Term Care

Another area where intentionally creating a MEC is beneficial is with hybrid life insurance policies that provide long-term care benefits. These “asset-based” policies allow you to access a portion (2-3 times typically) of the death benefit for long-term care expenses tax-free if needed. (1)

These policies should be funded right up to the legal limit to maximize the long-term care benefit pool available. This MEC status is actually advantageous because it allows for a larger benefit pool than could be funded through just tax-free transfers to the policy.

Without the MEC tax treatment, the long-term care benefit would be restricted based on IRS life insurance funding limits. But by embracing the MEC, you can supercharge the policy’s long-term care coverage through a larger initial maximum over-funded premium.


So for those looking to link long-term care coverage with life insurance, the MEC structure is strategic for achieving maximum leverage of your premium dollars. The temporary tax hit is worth it to ensure you have an ample risk pool for future long-term care costs.

As with any sophisticated planning technique, consult professional tax and legal advisors to review your personal situation. But don’t automatically dismiss the idea of structuring your cash value life insurance as a MEC. It may be the best way to maximize the policy’s benefits based on your specific goals.

(1) Learn more about Hybrid Life/LTC here.

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