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Modified Endowment Contract Cash Value Policy & Fixed Indexed Annuity

The MEC Cash Value Policy should be funded over a 5 to 7 year period which will lower the death benefit and avoid the MEC status. The Cash Value is suitable for before 65. The FIA is suitable for those over 65.

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MEC rules have changed the way clients are able to fund a cash value life insurance policy. The following article discusses these new rules and examines how they have an effect on those who are trying to find a way to generate wealth in a tax free manner to be used in retirement.

Fixed Indexed Annuity: For those near retirement


Fixed or equity indexed annuities (FIA) are some of the first things that advisors will think of when they are considering a protective tool for building retirement income. The reason these come to mind is because a Fixed Indexed Annuity will provide an individual with principal protection. They will also provide upside potential as long as the stocks’ returns are good. Annually, an Fixed Indexed Annuity should return between 4.5 to 6.5 percent. These are excellent retirement tools that are commonly used by those who are very near to retirement.

Cash Value Life Insurance Policy: for those under the age of 65

When an individual is under the age of 65, the FIA may not be the best choice. Instead, advisors will suggest a cash value life insurance policy that can be used to protect and generate wealth. The cash value that is in the policy will, generally, grow at a higher rate and will be tax free. These funds can also be removed from the policy without taxes when the person reaches the age of retirement. Cash value life insurance policies are not recommended for those who are over 65 years of age because of the mortality costs that are associated with the policy.

Over funded MEC (Modified Endowment Contract) Life Insurance Policy

The policy will have to be over-funded if it is going to be used as a means of generating retirement income. The policy can be over-funded by using cash and the death benefit of the policy will have to be available at the lowest possible amount that is allowed by the MEC, Modified Endowment Contract, rules. Should the insurance policy become a MEC, funds that are borrowed from the policy that are in excess of the premiums that have been paid will be considered taxable income?

Single Premium Life Insurance Policy

Prior to the development of MEC rules, it was possible to purchase single premium life insurance policies. These policies would allow clients to put thousands of dollars into a single policy in one year if the death benefit was low. This actually makes a lot of sense because the client will generally be looking to buy the policy as a means of generating income and not so much for the death benefit. The faster a client is able to fund their policy, the more retirement growth they will achieve.

MEC (Modified Endowment Contract) Rules:

These old types of policies were very popular, which is why the MEC rules were passed by Congress. The rules established a timeline of 7 years in which premiums had to be paid in order to drive the death benefit that the individual has to purchase to avoid the life insurance policy from becoming a MEC.
For example, the old rules may have allowed a client of 55 years of age to pay a premium amount of $100,000 into a cash value policy in one year and have the death benefit be a low amount. Since the death benefit is as low as it is, the policy will have a tremendous amount of cash that could later be used for retirement income.
With today’s rules, if that same client attempted to fund the same amount over a year’s time, the death benefit that the client is required to purchase in order for the policy to be considered MEC would be over $1.5 million.

Funding Cash Value Policy over 5 to 7 years

This creates an enormous difference in the costs when a policy that has a $270,000 death benefit is compared to one that has a $1.5 million benefit. The rules create an unattractive situation for those who want to short-fund any cash value policy with the sole purpose of getting the most benefits in retirement. This is one of the main reasons planners will recommend that all premiums be paid over a 5 to 7 year time span. This will help with MEC compliance and will lower the amount of the required death benefit while increasing the cash value in the policy.
The big question that is often asked is whether it would be better for a client to make use of an FIA or if they should over-fund a single premium policy that is considered a MEC. The best way to answer this question is to use an example. A client is 55 years of age and is lucky to have good health. The client also has $100,000 available funds in a money market account that can be allocated to a safe account that will create tax free retirement money.
The options the client has is to use a FIA or an Equity Indexed Life Insurance policy, especially Revolutionary Life. We will make the assumption that the client will fund $100,000 in the first year in an FIA and the same amount into an EILI. The EILI will have a low death benefit and is a MEC.
Category: Insurance

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