A modified endowment contract (commonly referred to as a MEC) is a tax qualification of a life insurance policy that has been funded with more money than allowed under federal tax laws.  A life insurance policy that becomes a MEC is no longer considered life insurance by the IRS, but instead, it is considered a modified endowment contract.  Being considered a MEC changes the order of taxation within the contract for money withdrawn and may penalize the life insurance owner for withdrawals before age 59.5.  Essentially a life insurance contract that becomes a MEC is treated as a nonqualified annuity by the IRS for taxation purposes prior to the insured persons passing.  A death claim can still be tax-free even if the policy payout out the death claim is a MEC.

If you are interested in obtaining quotes for a new life insurance policy or would like to purchase a new policy that is not a MEC, please enter your zip code above to get started.  In this article we cover:

  1. Tax Benefits of Life Insurance
  2. What Type of Life Insurance Can Become a MEC?
  3. TAMRA 7 Pay Test
  4. How a MEC is Taxed
  5. 7 Pay Calculation
  6. Why You Would Want a MEC?
  7. What Can you do if Your Policy is a MEC?

The Tax Benefits Of Life Insurance Contracts

Life insurance contracts are afforded special treatment under United States tax laws.  For instance, the death benefit is tax-free (even a MEC). Funded with after-tax dollars, the life insurance contract’s value will grow tax-deferred until the death of the insured, in which case the entire amount can be handed down free of any taxes to the next generation.  Any withdrawals taken from a life insurance contract are tax-free up to the total amount of the cost basis (the amount of money put into the policy) with the gain being considered the last part of the contract to be withdrawn for tax purposes (FIFO accounting).  These attractive tax benefits make whole life insurance a popular savings and estate planning vehicle for wealthy individuals.

What Type of Life Insurance Can Become a MEC?

Any permanent life insurance policy has the potential to become a modified endowment contract if it is “over-funded”.  This includes whole life, universal life, variable life, and variable universal life insurance.  A term life insurance policy can not become a MEC because there is not any cash surrender value and no incentive or the ability for an owner to pay in a high amount of premium dollars in order to take advantage of the tax breaks.  An important distinction to remember: A life insurance policy can not become a MEC from a high rate of return of the existing cash value.  It can only become a modified endowment contract from too many premium dollars being paid into the policy.

Tamra 7 Pay Test

As of June 21st of 1988, the federal government placed into effect the Technical and Miscellaneous Revenue Act (TAMRA), which placed limits on the amount of money that can be put into a life insurance contract during the first 7 years of the policy’s existence.  Because of the attractive tax features of a life insurance contract discussed above, prior to 1988 a small life insurance contract could be funded with a huge sum of money, grow tax-deferred, a large portion of the cash could be accessed tax-free for withdrawals, and the value passed on to the next generation free of taxes.  The small life insurance contracts had a small cost of insurance, and could still accumulate significant gain based on the dividend payments made into the policy by the insurance company (dividend payments grow larger as the cash value is higher).  Tamra sought to end this tax loophole by limiting the amount of money dumped into a life insurance contract.

Effect Of TAMRA (How A MEC Is Taxed)

TAMRA limits were meant to slow this practice by now considering these overly funded life insurance contracts as modified endowment contracts.  Any contract issued after June 21, 1988, which is funded in excess of the 7 pay test limits will now be considered a MEC. TAMRA has significantly reduced the number of contracts that exceed the 7 pay funding limits.

Gain First (LIFO) Taxation

A MEC will have any gain taxed first on withdrawals (LIFO accounting), which is the opposite of a life insurance contract.  A whole life insurance policy that becomes a MEC will almost certainly accumulate significant gain fairly quickly due to dividend payments. Even policy loans will be taxed, so it becomes much more difficult to access cash within a MEC policy unless the owner is willing to face the tax consequences.  The cost basis of a modified endowment contract is still not taxed but will be considered to be the last money to come out of a MEC contract for tax purposes.  The gain is taxed as income at the owner’s marginal rate of income tax level.

Penalty On Withdrawals Before Age 59 1/2

Any withdrawal taken before age 59 1/2 is subject to a 10% tax penalty on the amount of any gain in most circumstances.  This is in line with nonqualified annuity taxation, and retirement account taxation.  The cost basis is not subject to a penalty just as it is not subject to taxation.  There may be some circumstances in which a withdrawal before age 59.5 is not penalized, such as the withdrawal being under a 72T provision, which allows substantially equal payments to be withdrawn from an annuity, retirement account, or modified endowment contract each year without penalty.  These must continue to be withdrawn until the greater of 5 years or age 59.5.  The consequences of breaking a 72T are significant, and at Life Ant, we advise clients to always consult with a tax professional prior to beginning 72T withdrawals.

 Death Benefit Is Still Tax-FreeModified Endowment Contract

Even if paid by a modified endowment contract, a death benefit can still be passed on to beneficiaries tax-free, assuming that the normal requirements for a tax-free death benefit under life insurance rules are met. This means that the policy owner and the insured person can not have been the same person for at least 3 years prior to the claim being paid.

Because the death benefit is still tax-free, a MEC is still useful for estate planning purposes.  If a policy owner has no intention of withdrawing the cash value during the insured person’s lifetime, there are no consequences of the life insurance contract qualification as a modified endowment contract.

An owner can still put a significant amount of money into a life insurance contract, have it grow tax-deferred until the death of the insured, and pass on a significant amount of money to the next generation free of taxes.  The maximum amount of money that can be accepted into either a life insurance contract or a modified endowment contract is still limited by guideline premium limits, another limit placed by the federal government to avoid excessive use of this tax benefit.

7 Pay Calculation

The total amount of money that can be put into a life insurance contract during the first seven years is determined according to law by the age of the insured, the cost of insurance, the health risk rating, and assumptions about mortality rates and current interest rates.  While called the 7 pay test, it is not consequential how many payments are actually made, it refers to the cumulative premium payments that may be made in the first 7 years of a life insurance contract.  Each of the first seven years additional premium is allowed.  If there is excess premium allowed from one year it carries over to the next.  The 7 pay calculation will be given to you by your insurance company, or agent, and a warning will be given if this amount is exceeded.  Generally speaking, life insurance companies will allow you to withdraw the excess premium if this amount is exceeded, as long as it is done before the next policy anniversary.  Otherwise, a policy will be considered a MEC.

Used In Three Circumstances

The 7 pay test is used to test life insurance contracts in three distinct situations.

  1. During the first seven years of a life insurance policies’ life to test total premium payments.
  2. To re-test policies if the death benefit is reduced, which will reduce the aggregate 7 pay maximum.
  3. To re-test any policy which undergoes a material change (generally a change to death benefits or costs of insurance).

Never Lose MEC Status

After a life insurance policy is considered a modified endowment contract, it can not be reclassified as a standard life insurance contract again.  This is true even if changes are made to the policy which would otherwise not caused the policy to become a modified endowment contract.  Because of this permanent classification, clients must always be aware of the tax consequences if they are in danger of over-funding a policy under TAMRA.

Why Would you Want a Modified Endowment Contract?

In general, you would not wish to turn your regular life insurance contract into a MEC unless you are prepared for the tax consequences.  Typically, it is more efficient to purchase a whole life insurance policy and an annuity separately.  There may be times when you do want to overfund a life insurance policy for investment purposes.  If for instance, someone owns a whole life policy that typically receives an excellent dividend payment, and market interest rates are low, the total rate of return may actually be higher by overfunding the life insurance policy than it is by purchasing an annuity.

What Can You Do if Your Policy Becomes a MEC?

Unfortunately, you can not do anything to change the tax status of your policy after it becomes a modified endowment contract.  You can choose to continue to own it, and as long as you are not planning on taking withdrawals, or you are prepared to deal with the tax consequences if you are, you do not need to worry.  If you do not want to own a modified endowment contract any longer, you can purchase a new policy.  You may be able to fund it with the existing cash value of the modified endowment contract by using a 1035 exchange.  The new contract does not need to be a MEC if you do not wish to continue with that classification of life insurance.


  1. Very helpful articulate article.
    How can I determine how much I can put into a MEC? You reference that there are still guideline premium limits once a policy becomes a MEC, but I cant seem to find any information about those guideline premiums.

    1. The guideline premium tells you how to avoid a MEC. If you already have a MEC contract, you can check with your insurance company about maximum funding if this is your question. The question might be what your goal ultimately is. There may be a more financially efficient solution than cramming maximum amounts into a policy, or there may not be (such as a fixed annuity). I recommend speaking to a financial professional about your specific situation and goals.

  2. Where can I get the equation for calculating the MEC limit on a whole life policy? I keep reading about this 7 pay limit and want to calculate the actual figure off of my real policy. My insurance company converted my whole life policy to a MEC and I want to verify their math. Had they notified me I could have removed some funds, but now it’s too late. They won’t share the math with me other than stating it exceeded the limit.

    1. Andrew @ LifeAnt

      Hi Jeff,
      Unfortunately you won’t be able to see the equation for calculating the MEC. All of these insurance equations and rating systems use complex computer-based algorithms to determine everything, and they are typically unwilling or unable to show what all of these are. Insurance is heavily regulated by the states though, so they can’t do anything illegal or unfair without the knowledge of the state. Unfortunately in your case, your policy already exceeded it, so you might have to buy a new policy and just pay the minimum premiums to avoid this situation again.

  3. On a MEC, after the age of 591/2. are withdrawal taxable under the cost basis?

    1. Withdrawals of gain are taxable, but not subject to a penalty. A MEC is essentially an annuity contract, as a simple comparison.

  4. Sarah Niswonger

    My father has a policy that will become a modified endowment at age 88 with an annuity rider. What exactly does this mean? He will be 88 in 2021. Do we have options for this policy?

    1. Hi Sarah, I’m not sure if you have an annuity rider now, or if it starts at age 88? It sounds like the policy will become a MEC and you also have an annuity rider that you can use to start payments to your father. You could surrender the policy now, or hold it and collect money from the annuity, and then the beneficiary can collect the death benefit at death. If your father does not need the money now you probably should not consider surrendering it. If he needs money, you may be able to use loans or partial surrenders and keep the policy. This is complicated, I recommend sitting down with someone and discussing.

  5. My brother and I are owners of a MEC. I am under 591/2 and he is older. My question is if we surrender or sell the policy, how are the proceeds taxed and will there be a 10% penalty?

    1. Andrew @ LifeAnt

      Hi Sue,
      You’ll probably want to confirm that with your life insurance company. Since you are both owners but only one of you is older than 59 ½, then it would likely be up to the life insurance company how they want to proceed. I would assume that they will defer to you and allow you to withdraw the money without having to pay a 10% fee, but each state has slightly different laws and each company has slightly different policies, so it’s best to contact them to ask them.

  6. Hello, I have a post Mec policy. If my insurance company pays my beneficiary after my death, does the beneficiary need to pay taxes or not? do you have IRS information?

    1. Generally, there are no income taxes due on life insurance proceeds because life insurance was funded with after-tax dollars. However, there are exceptions to the rule and it can be quite complex. We suggest speaking with an accountant about your specific situation.

  7. I am interested in doing a 1035? exchange to move an annuity into a MEC. Is that a taxable event?

    I know annuity to annuity is not.

    Annuity to life insurance is.

    Annuity to MEC contract?

    1. You can not perform a 1035 exchange from an annuity to a life insurance policy, even if that new policy created a modified endowment contract.

  8. I am owner of my 82 year old dads UL. It’s 100K FV it’s been in force since 1982. There is very little CV in it. The Contract fund has a small amount in it. It’s on a quarterly billing but due to my budget and the premium I send my payment monthly. When i first took the policy over it was in danger of lapsing. I sent my premium payment this month and it was returned stating IRC 2207 as the basis. The policy has had about 38K paid in on it over its lifetime according to the info. He’s about to be 83 this year and I realize this policy is more a term policy than anything else at this stage. There is no return of contact fund so I try to keep the bare minimum to cover the cost of insurance admin fees etc..Can you tell me what may be going on?

    1. Hi Chuck. I am sympathetic to your situation but you seem to have the gist of it. The policy will continue to become more expensive. It may be difficult for you to keep up with. Depending upon your father’s health you may want to consider simply saving the money that you are paying into the policy in a savings account. You will need to make a decision with your financial advisor about the right course of action. A UL policy without cash value is essentially a renewable term policy with high fees. This is not an ideal situation for you to be in unless you can fund the policy appropriately.

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