Are you an insurance policyholder? Do you know what your policy entails?
If you wish to protect your future and provide for your family when you’re gone, insurance is a great first step. However, studies show that 26.1 million Americans did not have insurance. This often stems from a lack of knowledge regarding insurance policies.
Have you recently come across the term ‘modified life insurance?’ Not sure how it differs from whole life insurance? Their differences may have a hefty impact on your future or your beneficiaries.
Depending on your long-term plan, this may or may benefit you or do the exact opposite. Here is a brief comparison of whole life insurance and MEC.
Here Are the Basics of Whole Life Insurance
Traditional whole life insurance is a type of insurance that provides lifelong coverage. Take note not to confuse this with other permanent life insurance. People often buy whole life insurance for retirement planning.
Whole life insurance includes cash value, which is an investment account. You can make tax-free withdrawals from this account. The manner of how you access your cash value can determine whether your whole life insurance will become a MEC.
The Premise for Modified Endowment Contract
In the late 1970s, insurance companies allowed policyholders to make huge cash value withdrawals. At the time, these were always tax-free.
MECs are part of the Technical and Miscellaneous Revenue Act (TAMRA) of 1988. Legislators drafted this to combat the abuse of large cash values.
The TAMRA includes the seven-pay test, which sets a limit on the premium installments. Even with the standard test, the limit is unique to each policyholder and insured. If your policy reaches this limit, your whole life insurance may become a MEC.
How Do Whole Life Insurance and Modified Endowment Contract Differ?
The obvious difference between whole life insurance and modified endowment contract is taxation. People tend to avoid MECs because of the tax disadvantage of cash value withdrawals.
The common denominator of the two is the death benefit. This is the payout given to the beneficiary once the policyholder has passed away. In neither is it subject to income tax.
When to OptFor a Modified Endowment Contract
Most people would keep their whole life insurance from turning into a modified endowment contract. This is because the withdrawals from MECs are taxable. Despite this, some investors still opt for a MEC over or along with whole life insurance.
A MEC is desirable to some investors because the death benefit is nontaxable. This makes it beneficial to you if you don’t plan on making withdrawals in your lifetime. This way, you can leave a tax-free inheritance to your heirs.
Do you plan on using this to your advantage? Understanding the MEC policy is a good step towards securing a tax-free inheritance for your beneficiaries.
What Else Should You Know as an Insurance Policy Owner?
Whole life insurance and modified endowment contracts have certain differences. However, given these differences, each can be beneficial to you, depending on how you use the policy.
Your whole life insurance policy can turn into a MEC without you realizing it. It pays to be diligent about monitoring your policy. To learn more about insurance and securing a future for your family, check out our other blog posts.