MODIFIED ENDOWMENT CONTRACTS (MECS)
A life insurance policy where the amount a policy owner pays during the first years exceeds the sum of net level premiums that would have been payable to provide paid-up future benefits in seven years (7- pay test). Also, keep in mind that once a policy becomes a modified endowment contract it can never go back, it will ALWAYS remain a MEC.
For a producer who sells life insurance and for the customer who purchases life insurance, the significance is the way a life policy, if it is deemed a MEC, will be taxed. In the past, life insurance has been granted very favorable tax treatment. However, for those policies that do not meet the specific test, it is the policy owner who pays.
If a policy is deemed a MEC and the policyowner receives any amount from it in the form of a loan or withdrawal, that amount will be taxed first as ordinary income and second as return of premium. There may also be a 10% penalty assuming the policyowner has not obtained age 59½.
TRANSFER FOR VALUE
If a policy is transferred for "valuable consideration" (sold to another party) and the insured deceases, the person who now owns the policy will be taxed on the excess of the proceeds less consideration paid. There are several important exceptions to the transfer for value rule. The transfer for value rule may not apply if--
- The basis of the policy in the hands of the transferee is determined in whole or in part by reference to the transferor's basis (the basis carryover exception);
- The transferee is the insured;
- The transferee is a partner of the insured;
- The transferee is a partnership in which the insured is a partner; or
- The transferee is a corporation in which the insured is a shareholder or officer.
The detrimental economics associated with replacing existing whole-life insurance policies with new ones and the changing health conditions of the insured often create the need to transfer existing policies rather than simply acquiring new ones with similar characteristics. The potential for less obvious transfers and more subtle elements of consideration triggering the transfer for value rule and the inconsistent nature of the exceptions to this problems, make this a dangerous area for the uninformed.
InsuranceCongress has placed limits on the amount of money that can be put into life insurance policies - what can you do to counteract this?
Managing WealthTo avoid MEC status, flexible-premium policies must cap the amount that can be paid into the policy over a period of seven years.
InsuranceIf you are banking on your life insurance payout being tax-free, you may be in for a surprise.
InsuranceTough times call for desperate measures, but is raiding your life insurance policy even worth considering?
Financial AdvisorWhen buying permanent life insurance, what amount of premium should you pay for the coverage?
Managing WealthHow to avoid some common mistakes that can cause tax and inheritance problems when you own life insurance.
Financial AdvisorFind out how Americans in their 20s can benefit from a well-thought-out life insurance policy, especially if they are able to build cash value for retirement.
Financial AdvisorLife insurance was initially designed to protect the income of families, particularly young families in the wealth accumulation phase, in the event of the head of household's death.
Personal FinanceTwo of the most common types of life insurance are term and whole life. Here's why the latter isn't a good idea for most military families.
Financial AdvisorIf you're looking for life-long security, choosing between these two is the key.