Close this search box.

Table of Contents

Modified Endowment Contract


A Modified Endowment Contract (MEC) is a type of life insurance contract that is subject to less favorable tax rules for withdrawals than contracts that are not classified as MECs. This classification generally occurs when the cumulative premiums paid into a life insurance contract exceed certain amounts specified under federal tax laws. Once a contract is classified as a MEC, it cannot be reversed, and the policyholder may face tax consequences on withdrawals, loans, and death benefits.


The phonetic transcription of “Modified Endowment Contract” is: /mɑdɪfaɪd ɛndoumənt kəntrækt/

Key Takeaways

<ol> <li>A Modified Endowment Contract (MEC) is a type of life insurance contract that has been funded with premiums exceeding the allowable limit according to federal tax laws. This surplus of premiums is taxable.</li> <li>With a MEC, though the death benefit remains tax-free, any withdrawals, loans, or dividends from the policy are now taxable on a ‘gain-first’ basis rather than a ‘return of principal first’ basis, and subject to a 10% tax penalty if the policyholder is under 59 1/2 years of age.</li> <li>Though a MEC has guidelines and tax implications given its over-funded nature, it could still be an attractive option for individuals who have maxed out other tax-favored investment plans and are looking for an additional way to accumulate tax-deferred savings.</li></ol>


The Modified Endowment Contract (MEC) is an important term in the business/finance world as it refers to a tax qualification of a life insurance policy whose premiums exceed federal tax law limits. It’s essential because once a life insurance policy is categorized as a MEC, it loses the tax benefits normally associated with life insurance policies. Instead, MECs are taxed like annuities, where withdrawals or loans are taxable on an income-first basis rather than a basis-first strategy and may also be subject to a penalty tax if taken before age 59.5. This term is vital for individuals or entities considering life insurance policies since it can significantly impact the policy’s long-term benefits and tax implications.


The purpose of a Modified Endowment Contract (MEC) in financial planning is to provide policyholders with a unique blend of insurance and investment features. It operates similarly to a cash value life insurance policy, where premium payments exceed the limit set by the IRS, thereby reclassifying the policy as a MEC. While life insurance benefits are usually tax-exempt, under a MEC, a significant portion of the policy’s earnings becomes taxable. Therefore, MECs can, to an extent, serve as a tax-deferred investment vehicle.MECs are often used by individuals seeking an added layer of financial security, particularly in retirement planning. The contract can provide a stream of income generated by the policy’s investment component. Furthermore, any surplus earnings from the policy may be utilized to cover certain expenses or care costs, providing financial flexibility for the policyholder. This kind of contract, however, may have limited appeal to younger investors who could face substantial tax charges and penalties for early withdrawal.


A Modified Endowment Contract (MEC) is a type of cash value life insurance contract in the United States of America where the tax benefits have been lost because it was funded with more money than allowed by federal tax law. Here are three real-world examples:1. Whole Life Insurance Policy: Let’s say a buyer purchases a whole life insurance policy and pays in a significant amount of money initially, likely exceeding the amount that federal tax law allows for maintaining the policy’s tax benefits. This policy has now turned into a Modified Endowment Contract, and any withdrawn gains are subject to taxes.2. Variable Universal Life Policy: An individual buys a variable universal life policy and over some years pays in more than the seven-pay limit. The IRS rules this policy as an MEC due to overfunding. Even though the person meant to garner investment growth on a tax-free basis, any withdrawal is now taxable on a gain-first basis.3. Life Insurance Retirement Plan (LIRP): Let’s assume that a person is setting up a LIRP by overfunding a cash value life insurance policy for the purpose of having tax-free retirement income. If the seven-pay test limit is exceeded, the policy becomes a Modified Endowment Contract. Now any withdrawal or loan against the policy’s cash value will be taxed.

Frequently Asked Questions(FAQ)

What is a Modified Endowment Contract (MEC)?

A Modified Endowment Contract (MEC) is a tax qualification of a life insurance policy whose premiums exceed the amount allowable to still maintain the tax benefits of a regular life insurance policy.

How is a Modified Endowment Contract created?

A life insurance contract can become a MEC if the total premiums paid during a 7-year testing period exceed the amount of premiums allowable by the IRS to maintain its life insurance status.

What are the tax implications of a Modified Endowment Contract?

Unlike traditional life insurance, when a policy becomes a MEC, distributions from the policy (including loans, cash surrenders, and dividends) are subject to income tax. Potential penalties may also apply if distributions are made before the age of 59.5.

How does a Modified Endowment Contract differ from a traditional life insurance contract?

The main difference is the way they are taxed. Distributions from a traditional life insurance contract are generally not subject to income tax, whereas distributions from a MEC are.

Can a Modified Endowment Contract revert back to being a traditional life insurance contract?

Once a contract is classified as a MEC, it generally cannot be reversed back to a standard life insurance contract, regardless of future premium payments.

In what scenarios may someone benefit from having a Modified Endowment Contract?

A MEC may be beneficial if someone is looking for an additional tax-deferred investment option and has maxed out other options, such as IRAs and 401(k)s. It might also be beneficial for individuals in estate planning scenarios if the policy owner is more focused on the death benefit over the life of the contract.

Can a MEC be transferred or rolled over into another life insurance policy?

It’s important to note that transferring or rolling over money from a MEC to another life insurance policy does not change the MEC status – the money would still be subject to the tax rules of a MEC.

How is the death benefit of a Modified Endowment Contract treated?

Similar to a traditional life insurance contract, the death benefit of a MEC is typically free from income tax.

Related Finance Terms

  • Life Insurance : The financial tool that forms the basis for Modified Endowment Contracts.
  • Seven Pay Test : The test used by the Internal Revenue Service to determine if an insurance contract qualifies as a Modified Endowment Contract.
  • Tax Deferral : A key aspect of Modified Endowment Contracts, which allows the policyholder to avoid taxes until the policy pays out.
  • Policy Loan : A loan taken from the cash value of a Modified Endowment Contract.
  • Death Benefit : The money that the beneficiaries of a Modified Endowment Contract will receive upon the death of the policyholder.

Sources for More Information

About Our Editorial Process

At Due, we are dedicated to providing simple money and retirement advice that can make a big impact in your life. Our team closely follows market shifts and deeply understands how to build REAL wealth. All of our articles undergo thorough editing and review by financial experts, ensuring you get reliable and credible money advice.

We partner with leading publications, such as Nasdaq, The Globe and Mail, Entrepreneur, and more, to provide insights on retirement, current markets, and more.

We also host a financial glossary of over 7000 money/investing terms to help you learn more about how to take control of your finances.

View our editorial process

About Our Journalists

Our journalists are not just trusted, certified financial advisers. They are experienced and leading influencers in the financial realm, trusted by millions to provide advice about money. We handpick the best of the best, so you get advice from real experts. Our goal is to educate and inform, NOT to be a ‘stock-picker’ or ‘market-caller.’ 

Why listen to what we have to say?

While Due does not know how to predict the market in the short-term, our team of experts DOES know how you can make smart financial decisions to plan for retirement in the long-term.

View our expert review board

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More