Annuities✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
If a life insurance policy becomes a Modified Endowment Contract (MEC), the death benefit paid to the beneficiary:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Even when a life insurance policy is classified as a Modified Endowment Contract, the death benefit remains income-tax-free under IRC Section 101(a). What changes is the treatment of distributions taken before death: withdrawals are taxed under LIFO rules, and a 10 percent penalty applies to distributions before age 59 1/2. The policyholder loses the favorable living-distribution treatment, but the beneficiary keeps the tax-free death benefit.
Why the other options are wrong
- B) The death benefit is not taxable for a MEC; the loss of favorable treatment applies to living distributions.
- C) Premiums are never taxable amounts; MEC consequences concern distributions, not premiums.
- D) Life insurance death benefits are income-tax-free, not capital gains, and MEC status does not change that.
Memory hook
MEC = a penalty for overfunding, but the death check stays tax-free. Only living withdrawals lose the perks.