A Modified Endowment Contract, or MEC, is a life insurance policy that has been funded with premiums that exceed certain limits defined by the IRS, primarily through the 7-pay test under Section 7702A. Once a policy is classified as a MEC, its death benefit generally remains income-tax free under Section 101, but its cash value distributions lose many of the tax advantages associated with traditional life insurance. Specifically, loans, withdrawals, and collateral assignments are taxed on a last-in, first-out (LIFO) basis, causing gains to be taxable when accessed, and potentially subject to a 10 percent penalty if the policyowner is under age 5912. MEC status is usually permanent for that contract, even if premiums stop or future changes are made. MEC rules were enacted to prevent life insurance from being used primarily as a single-premium tax shelter rather than as protection with ancillary savings features.

In field practice, advisors and advanced markets teams refer to modified endowment contracts when designing highly funded policies or reviewing older single-premium contracts. A producer might intentionally design a MEC for a wealthy client who values tax-free death benefits and does not plan to access cash values, accepting MEC treatment as a trade-off for maximum funding. More commonly, advisors seek to avoid accidental MEC status by keeping premiums within 7-pay and guideline limits. Illustrations often show whether a design is a MEC and provide warnings when a change, such as a face amount reduction, would trigger MEC status. During reviews, agents verify MEC status before recommending loans or withdrawals, and they coordinate with tax advisors when clients consider surrendering or exchanging MECs. Clear explanation of modified endowment contract implications is essential for suitability, disclosure, and long-term planning.