What primarily distinguishes a Modified Endowment Contract from other policies?

A Modified Endowment Contract (MEC) is primarily distinguished by the concept of excess contributions. This occurs when the total amount paid into the policy during the first seven years exceeds the IRS-defined limits for life insurance premium contributions. In a MEC, the tax treatment of distributions and loans becomes less favorable than that of a traditional life insurance policy. For instance, withdrawals are subject to income tax, and if taken before the insured reaches age 59½, a 10% penalty may also apply.

Understanding the implications of MEC status is crucial for policyholders, particularly regarding how and when they can access the cash value of their policy. Because the contributions exceed the allowed limits, the MEC status dramatically alters the benefits usually available under standard life insurance policies, thereby making it important to monitor premium payments closely to avoid unintended tax consequences.