Taxation✓ Verified · outline & fact-checked · Sep 2026Difficulty 3/5
A life insurance policy is classified as a Modified Endowment Contract (MEC) when:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Under IRC Section 7702, a life policy becomes a MEC if premiums paid exceed the 7-pay test limit (roughly the amount needed to endow the policy in 7 years). MEC status changes the tax treatment of withdrawals and loans: distributions are taxed on a LIFO basis — gains come out first — and amounts withdrawn before age 59½ may incur a 10% penalty. Death benefits remain income-tax-free.
Why the other options are wrong
- B) Term policies have no cash value and cannot become MECs; MEC analysis applies to cash-value policies.
- C) The face amount alone does not create MEC status; the funding level relative to the 7-pay test is what matters.
- D) Early surrender has its own surrender charges but does not itself make the policy a MEC.
Memory hook
MEC = you overfunded too fast. The IRS punishes it with LIFO taxation (gains out first) and a 10% early-withdrawal penalty.