Do you want to take a life insurance policy, but you’re torn between whole life insurance and a Modified Endowment Contract (MEC)?
A MEC could be the best thing that’s ever happened to you or your worst nightmare. They’re one of the best tax-advantaged ways to pass money to your beneficiaries. They’re highly valued for the living policyholder benefits rather than the death benefits accrued by the heir.
This article will unravel the pros and cons of a MEC. Read on to understand what you lose and gain by having a MEC policy.
What Is a Modified Endowment Contract?
A Modified Endowment Contract is a label given to whole life insurance policies that have exceeded the “seven-pay test.” A policy fails the seven-pay test if the amount of premiums paid during seven years exceeds the required amount of premiums to be paid. This could include tax advantages such as tax-free withdrawals, policy loans, and retirement income.
Advantages of a Modified Endowment Contract
MECs are neither good nor bad. Whether or not to consider this type of policy solely depends on your financial goals.
Income Tax-Free Death Benefit
Unlike in most cases where income earned in the form of interest is subject to taxation, a beneficiary of a MEC policy enjoys tax-free transfer benefits when the policyholder dies. However, this excludes the amount of interest accumulated after the death of the policyholder.
The policy needs to be transferred immediately after the death occurs. If not, the interest accumulated after that period will be taxable.
Long Term Investment
MEC is a viable option for those who want to keep money locked away until later in life (59.5+ years) due to free-tax benefits. You can pass the policy as inheritance or charity without subjecting it to tax after your death.
Additionally, you have guaranteed returns that are less volatile than the stock market. Consult Paradigm Life for your financial solutions. They offer customized solutions that increase your wealth while minimizing risk and taxes.
Deferred Tax on Cash Value Growth
Unlike mutual funds taxed annually, earnings within your MEC account will remain untaxed as long as you don’t make a withdrawal. You basically choose when to pay taxes. In the long haul, this tax advantage will accumulate benefits because of the time value of money.
Disadvantages of a Modified Endowment Contract
To understand MEC and its cons, let’s contrast it with the benefits you derive from a whole life insurance policy. Here are some of the disadvantages.
Taxed Cash Value When Withdrawn
You will get a 10% penalty if you withdraw from a MEC policy account before retirement age. While in whole life insurance, you can make withdrawals or take a policy loan tax-free. A MEC is an excellent option if you don’t plan to use the cash until after 59 and a half.
A MEC policy still provides you with options to withdraw cash, although they are taxable, unlike in whole life insurance. It grants you the opportunity to either withdraw money from your policy or take out a life insurance loan subject to taxation.
Therefore, a MEC serves well for someone who wants to pass a significant amount of money to their heir.
Modified Endowment Contract Explained
If your Life insurance policy ends up becoming a MEC, you will lose many tax-free benefits. However, A modified Endowment Contract serves as the best security for your beneficiaries. Choose a policy that aligns with your future financial goals.
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