What is a modified endowment contract (MEC)?

This answer is about Life insurance.

The 7-pay test in plain English

The IRS applies a 7-pay test to permanent policies: if total premiums paid in the first seven policy years exceed the amount that would fully pay up the policy with seven equal annual premiums, the policy is a MEC. Certain policy changes (like reducing the death benefit) can also trigger a new 7-pay period.

What changes if a policy is a MEC

• Loans and withdrawals: gain (cash value above basis) is treated as coming out first and is taxable as ordinary income (LIFO).
• 10% additional tax: distributions before age 59½ may face a 10% federal additional tax on the taxable portion.
• Death benefit: still generally income-tax-free to the beneficiary.
• Cash-value growth: still generally tax-deferred while it stays in the policy.

Why some MECs are created on purpose

MECs still receive tax-deferred cash-value growth and income-tax-free death benefits. Some buyers who don't need to withdraw cash value intentionally over-fund a permanent policy for estate or wealth-transfer purposes, accepting MEC status because the benefits they care about are preserved.

MEC classification is a specific IRS test — confirm current 7-pay premium limits with the insurer or a tax advisor before over-funding a policy.