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What Is an MEC (Modified Endowment Contract) Life Insurance Policy?


The information provided in this article is not intended as specific tax advice. Please consult a tax advisor for more information.

In the  personal finance and estate planning universe, life insurance policies hold a special place. Often seen as a safety net for loved ones, they can also be leveraged as financial tools. One intriguing, yet often misunderstood, aspect is the Modified Endowment Contract (MEC). 

Introduced in the 1980s, MECs changed how life insurance policies are taxed, particularly when policyholders contribute substantial amounts in a short period of time. Following, we’ll explore what a Modified Endowment Contract is, its tax implications, and more. 

What Is a Modified Endowment Contract?

A Modified Endowment Contract is a life insurance policy that has received more money in premiums than the IRS (Internal Revenue Service) allows for favorable tax treatment. This means that an MEC does not get some of the tax benefits that regular life insurance policies do. 

For example, with a regular life insurance policy, you usually don't have to pay taxes right away  on money you withdraw. With an MEC, if you take money out before a certain age, you could be hit with taxes and penalties.

When premiums are paid into a life insurance policy more quickly than normal (usually less than seven years), the policy is still a life insurance policy. 

How Does a Life Insurance Policy Become an MEC?

Under the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), the federal government limits the amount of money that can be paid into a life insurance policy within the first seven years from the date of issue ( known as the 7 Pay Test). 

If the amount paid within the first seven years exceeds the limit, the policy will be classified as a MEC. Once a life insurance policy is classified as an MEC, it cannot be changed back to a non-MEC policy.

Are Single Premium Policies Considered MECs?

Yes. Under TAMRA, any net single premium life insurance policy, such as AAFMAA’s Wealth Builder Life Insurance policy, is considered an MEC.

Benefits of an MEC Life Insurance Policy

MEC life insurance policies stand out from other types of life insurance and provide several benefits, making them a valuable addition to your financial portfolio.

Tax-Deferred Growth

An MEC policy can provide tax advantages: cash value growth accumulates tax-free. Additionally, you have the flexibility to take out loans or withdraw funds without facing IRS penalties if you are older than 59-½ years, however, these are taxable events. This can be especially beneficial in times of financial hardship. 

Guaranteed Returns

Many MEC policies offer a guaranteed minimum rate of return on the cash value, providing a safe growth option to serve as the base of your comprehensive financial plan. You can customize your policy with a variety of features to suit your individual goals. Ultimately, an MEC policy is a wise investment for anyone looking to secure their financial future and provide for their loved ones.


MEC policies often allow you to borrow against their cash value, offering a source of liquidity when needed.  You will have quick access to your funds without going through lengthy approval processes or credit checks. This can be particularly beneficial if you are facing emergency situations or unexpected financial needs in a rising interest rate environment like we see today. You can tap into the policy's cash value at a relatively low interest rate without having to liquidate other assets and when you repay the loan, you’re really just repaying yourself.

Income-Tax-Free Death Benefit

Like other life insurance policies, an MEC provides a death benefit to beneficiaries, which is generally not subject to income tax. The tax-free death benefit of an MEC offers two main advantages: It provides financial certainty for beneficiaries, helping them cover immediate expenses such as funeral costs and debts, and it's more financially efficient than other investments. This ensures that your loved ones receive the full financial benefit of the policy.

How Are MEC Withdrawals Taxed?

MECs are subject to different tax rules compared to standard life insurance policies, and one of the key differences is the treatment of withdrawals. Withdrawals from an MEC are taxed on a "last-in, first-out" (LIFO) basis, meaning that any gains are withdrawn first and are subject to income tax. 

Withdrawal Penalties

In addition to regular income tax on the gains, withdrawals made before the age of 59½ are generally subject to a 10% penalty from the IRS. This is similar to the early withdrawal penalty for retirement accounts such as IRAs and 401(k)s.

Can I Have Multiple MEC Policies?

There is no legal limit to the number of MECs an individual can own. Each one is treated as its own separate contract for tax purposes. Because of this, having multiple MECs can be complex — making it essential to manage each policy carefully and seek professional tax advice on how to account for them.

Are There Tax Implications of Having Multiple MEC Policies?

If you decide to cash surrender one of several policies purchased during the same calendar year, you will have to pay taxes on the interest earned for all of the policies with that first policy. When you cash surrender subsequent policies, since you have already paid some or all of the taxes, you will pay less tax on the gain for those subsequent policies. 

Ultimately, the amount of total taxes — if the policies are surrendered — will be the same because the tax basis of the subsequent policies will be increased to reflect the taxes already paid. There will be no impact on policies that are annuitized if all policies are surrendered simultaneously or if the policy owners die.

Does an MEC Policy Like Wealth Builder Life Insurance Make Sense?

Yes. Although these policies are subject to taxes if they are redeemed, they still serve as a stable retirement planning tool. They are good alternatives to annuities, which become taxable upon the  owner’s death.

All AAFMAA life insurance benefits pass tax-free to beneficiaries. Wealth Builder Life Insurance can be appropriate for AAFMAA Members who do not qualify for other insurance products; for Members looking for a way to leave a tax-free inheritance to family members; or for Members who wish to annuitize their policies and receive a steady stream of income for the remainder of their life.

Learn More About MECs with AAFMAA

With an MEC policy in place, you and your loved ones can have peace of mind and feel secure about the  future. No medical exam or tests are required and coverage starts immediately. Learn how to get the most out of your MEC life insurance policy and explore the benefits of AAFMAA Membership. Or if you’re ready to secure your retirement now, you can apply online today or call 866-311-1812 to apply by phone with the assistance of an AAFMAA Membership coordinator.

This article was originally published March 19, 2015.