When to Consider a MEC for Your Portfolio

A Modified Endowment Contract or MEC is an insurance contract that can be an attractive retirement planning tool for someone looking to pass assets free of income tax to their heirs.

Generally, money accumulating in a MEC is not taxed unless it is withdrawn or borrowed against during the lifetime of the insured.

Money in a MEC accumulates and builds similar to an annuity, but unlike an annuity, generally the beneficiaries receive the death benefit free of income tax.

When the owner of a MEC withdraws funds from the contract the funds are first taxed as income to the extent of any gains in the contract. Subject to certain limited exceptions, there is also an additional tax of 10% for those under age 59½.

Typically, if the MEC has a named beneficiary, the death benefit will avoid probate and transfer income tax-free to the beneficiary.

With MECs and other forms of life insurance, techniques can be used such as setting up an ILIT (Irrevocable Life Insurance Trust), allowing you to have the death benefit distributed to beneficiaries how you see fit. The distributions can include parceling out payments over time instead of a lump sum, which would be spelled out in the trust.

Many states protect the proceeds of a MEC from creditors, making these contracts a popular financial instrument for business owners and others who want to ensure that their families have unencumbered access to funds after their passing.

A MEC is not for everyone and you may want to consider spreading the premiums out over a period of years to avoid MEC status. If you are considering a MEC, we suggest that you consult with your financial adviser, tax adviser, or other financial professionals before making any decisions that could impact your tax situation.

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