When it comes to insurance policies most insurance agents do not wish to discuss or place Life insurance that is a Modified Endowment Contract.
They have been wrongly taught in their training that it is not good because of the tax issues involved. However, many of these agents only do this as it is the easy thing to do, which is to just not apply for them.
A Modified Endowment Contract (MEC) is basically a life insurance policy that has exceeded the funding requirements as required by federal law. Permanent life insurance has a corridor of cash value versus death benefit that cannot be exceeded.
Exceeding this will force the contract into a MEC. Basically, it is no longer looked at as a life insurance policy but the IRS will then see it as a non-qualified annuity. So why anyone forces a life insurance policy to become a MEC?
Let’s look at 5 reasons why a Modified Endowment Contract is a good option.
Creates an Annuity
When you overfund a life insurance policy, you are basically creating an annuity using a large cash deposit with a very large death benefit relative to the same money being placed inside an annuity.
I like to say that a MEC is an annuity with a massively large death benefit. If your goal is to create a large death benefit for your beneficiaries, then a MEC is a good way to go.
College Planning Tool
Under the current rules for college planning using the FAFSA, there are certain assets that do not count against the family when it comes to paying for college. One of these assets is the cash value inside of a life insurance policy or annuity.
If you simply move large portions of your assets into a MEC, you have removed that money off of the Financial Aid formula.
In doing this, you have created a large death benefit and preserved your financial assets, allowing you to qualify for a larger financial aid need. Any surrender charge, if any, you may experience if you decide to cancel the policy after the college paying a year is minimal compared to the loss of this asset in directing it toward paying for college.
Creating a Hybrid Long-Term Care Policy
One of the problems with long-term care policies is if you do not use them (you died before going into long-term care) you lose the premiums.
If you create a Modified Endowment Contract with a long-term care rider, you have the best of both worlds. You create cash value, you have a death benefit and you have long-term care all built into one policy.
The easiest way to do this is a product called Money Guard Reserve by Lincoln Financial. It is a lump sum universal life policy that has the long-term care rider built into it. You can get information about this by going to Money Guard Single Premium
Estate Planning
Creating a MEC is an excellent Estate Planning tool if it is determined that the policy owner does not need the premium or the cash value. They simply wanted to create a large death benefit for their beneficiaries. Of course, this has to do with Estate Taxation since death benefits are paid income tax-free.
It creates over the long term a no cash value universal life policy. Some cash value in the early years but none over the later years. Just think of it as a permanent paid up life insurance policy.
You have effectively protected your estate depending on how much you place in the policy.
The Almost Modified Endowment Contract (MEC)
If you fund an insurance policy up to the MEC limits but not above it, you can still create a nice policy that you can use the cash value on as your own funding source and create the death benefit leverage that could also protect your family. It is about leverage.
Using this strategy over the long term could possibly be even better than investing in real estate, or borrowing from banks or lending institutions at high-interest rates. It is the bank on yourself strategy. We have included it here as the almost MEC.
So, the next time you hear that Modified Endowment Contracts are bad, I suggest that you refer back to this article and then discuss it with a well-seasoned and well-trained insurance professional.
