The mighty MECArticle added by T.J. Whalen on February 1, 2017
T.J. Whalen

T.J. Whalen

Cornelius, NC

Joined: January 31, 2017

The Mighty MEC: A Study and Summary of the Most Under-Appreciated (and Misunderstood) Financial Product in the Industry

Why is it that MEC's get such a bad rap?  In my many years of life insurance consulting, very seldom have I run across an advisor who actively promotes Modified Endowment Contracts for the features, benefits and advantages they can potentially offer their clients and prospects. 

Here I'd like to present a simple argument for the under-appreciated MEC.     

Here's the bottom line up front:  A Modified Endowment Contract offers the ability to combine the benefits of an annuity with the benefits of a life insurance policy in a way that can ultimately provide UNPARALLELED financial benefits to the right client. 

A MEC offers all of the benefits of a life insurance policy, PLUS a plethora of additional features that many advisors are massively under-utilizing! 

Let's take a closer look at the enigma that is the MEC.    What does 'Modified Endowment Contract' mean exactly? 

In a nutshell, the code interprets a MEC in this way:  If the cumulative premium payments in a life insurance contract exceed certain amounts specified under the Internal Revenue Code, the life insurance policy will become a MEC. 

Taxation of cash values under a MEC is similar to taxation under an annuity.  However, unbeknownst to many, the death benefit payable to the beneficiary in a MEC is generally NOT subject to income tax.     

So, can it not be inferred that a MEC is simply an annuity with a life insurance rider, that pays an INCOME TAX-FREE death benefit? 

The primary difference between a MEC and a 'true' life insurance policy revolves around one thing: the potential taxation of cash surrender values taken during the insured's lifetime. 

Since many seniors already own ( or are at least familiar with) annuities, would the inability to take tax-free withdrawals be a serious deterrent to seniors-especially if they knew they could pass on an income tax free death benefit to their loved ones, charities, etc. at their death? 

My assertion is that this would not be a deterrent.   

Let's take a look at all of the powerful things a MEC can do.    As mentioned earlier, a MEC works like an annuity with a life insurance 'alter ego'.  So let me break it down into it's 2 main components and discuss each separately- the 'annuity' side and the 'life insurance' side.  

On the annuity side:  If withdrawals are needed during the insured's lifetime, they are taxed just as an annuity would be (last in, first out).  This means that any interest withdrawn over the cost basis would be taxable, just as an annuity would be. 

Rates of return on many permanent life insurance products are competitive (and can actually be potentially BETTER) than rates of return annuities offer.

As an example, the caps in many top indexed life insurance products are in the teens (13, 14% and even higher in come cases).  Compare that to the caps on an indexed annuity. Even after accounting for cost of insurance, the growth potential in an IUL can beat that of an indexed annuity since the caps are so much higher.  

Lastly, some of the strongest MEC plans actually offer the ability to waive completely, or drastically reduce, the surrender charges to the insured.  This means that the insured could have access to 100% (or very close) of the single premium amount they dumped in-within the first year!  This can be a huge benefit in an emergency.     

On the life insurance side:  When the insured dies, the entire death benefit (which can be increased by gains in the cash value as well, AND is typically MUCH higher than an annuity's value at death) transfers to the named beneficiaries INCOME TAX FREE.  Upon the death of the MEC owner, the proceeds typically avoid probate, and the costs and hassles that go with probate. 

A MEC is an incontestable contract for the beneficiaries' sake, and can also add the advantage of privacy in high profile situations.  Also, most MEC plans have built-in terminal illness features, which allow the insured to access all, or part of, the death benefit to pay for medical expenses while they are battling their terminal illness. This accelerated living benefit is usually income tax free (since it is simply an acceleration of the income tax free death benefit).     

And that's not all! 

Many advisors are not aware of these 3 additional benefits that many MEC's offer:   

Many MEC contracts now offer Long Term Care benefits and other living benefits.  The newest innovation in the industry is the inclusion of long term care benefits (or other similar living benefits like chronic and critical illness) to life insurance contracts-including MEC's.  This provides an added element of protection that many other financial vehicles can't offer.   

A MEC can also provide protection from creditors (in most states, not all).  Wouldn't it be nice to be able to protect this valuable asset from creditors and/or potential lawsuits?  

Finally, with a MEC, the insured/owner of the plan can actually 'control' the dissemination and use of the proceeds that are paid to the beneficiaries.  This feature can be very useful if the insured/owner believes that their beneficiaries might misuse the proceeds after their death (the old story about Junior going out and buying a Ferrari with the death benefit proceeds instead of using the funds a little more wisely...) .  Rather than paying Junior $1 million in a lump sum, the proceeds can be spread out over a number of years-for example $50,000 a year for 20 years.    

In summary, the MEC has been given a bad rap in the industry over the last couple of decades, and I hope that my discussion here opens some eyes to the positive side of the under-appreciated and under-utilized Modified Endowment Contract.   

If utilized properly, the MEC can be an outstanding asset for many of your clients and prospects, and can help you, as an advisor, build your business as well!

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