Life Insurance
Modified Endowment Contract (MEC)
A modified endowment contract (MEC) is a life insurance policy that has been funded too rapidly—violating the IRS 7-pay test—causing it to lose the tax-preferred treatment that normally applies to policy loans and withdrawals, subjecting them instead to LIFO taxation and a 10% penalty.
Last reviewed: May 2026 · Editorial methodology
Definition
A modified endowment contract is created when a life insurance policy fails the IRS Section 7702A seven-pay test, which limits the total amount of premiums that can be paid into a policy during the first seven years to no more than the level amount required to fully pay up the policy in seven payments. If cumulative premiums in any of the first seven years exceed this threshold, the policy becomes a MEC for all future years—a permanent, irrevocable status change. The MEC status strips the policy of the tax advantages that make life insurance attractive as an accumulation vehicle: distributions (loans and withdrawals) are taxed on a last-in, first-out (LIFO) basis, meaning gains are withdrawn first and are fully taxable as ordinary income, plus a 10% early withdrawal penalty applies to amounts taken before age 59½. For a policy with $100,000 in gain and $80,000 in basis, a $20,000 loan from a MEC produces $20,000 of ordinary income plus a $2,000 penalty if the owner is under 59½. The death benefit of a MEC remains income-tax-free to beneficiaries under IRC Section 101(a), so MECs are not problematic for policyholders who never intend to access cash value. Single premium life insurance policies are always MECs.
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Cover Forge USA Editorial Team
Editorial Lead
This article was researched and written by the Cover Forge USA editorial team against federal sources (NAIC, CMS, FEMA, DOL, SSA, state DOIs) and standard policy forms. Bylines organize content by topic — they do not assert individual licensure. See our editorial-policy for details.
Reviewed 2026-06-14
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