Tennessee Insurance Practice Exam

What characterizes a Modified Endowment Contract (MEC)?

1. It has a guaranteed cash value

2. It allows unlimited premium payments

3. It exceeds premium limits for life insurance classification

4. It is a type of whole life policy

The correct answer is: It exceeds premium limits for life insurance classification

A Modified Endowment Contract (MEC) is characterized by its premium payments exceeding certain limits set by the IRS for life insurance policies. Specifically, these limits are based on the 7-pay test, which dictates that if the total premiums paid exceed the amount that would have been paid on a seven-year paid-up policy, the contract will be deemed a MEC. One significant consequence of a MEC designation is that the tax treatment of withdrawals and loans from the policy changes. Withdrawals may be taxed as income to the extent of any gain in the policy, and loans may be subject to income tax if the policy lapses. This makes MECs unique in their tax implications compared to standard life insurance policies. While guaranteed cash value, unlimited premium payments, and being a type of whole life policy may describe other features of life insurance products, they do not specifically define the nature of a Modified Endowment Contract as effectively as the characterization related to premium limits does.