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Modified Endowment Contract
A Modified Endowment Contract (MEC) is an insurance policy with a cash value component. A modified insurance contract typically begins as a cash value insurance policy and becomes a modified endowment contract due to excessive premiums paid into it. Cash value insurance policies have favorable tax advantages as long as the premiums don’t exceed the amount allowed to keep those advantages. Distributions from a MEC are taxable as ordinary income.
Distributions are treated on a Last In First Out (LIFO) basis. This means that distributions are made first from the taxable gains, and then from the non-taxable basis. If an owner takes policy distributions that exceed that exceed the policy basis, a 10% penalty may be assessed if the policy owner is under 59 ½.