In this blog we are going to cover the Modified Endowment Contract (MEC) and its impact on the paid-up additions rider.
Up to the late 1980s, policy owners could place an unlimited amount of discretionary capital into a life insurance policy. All this changed in 1988 with a new law known as the Tax and Miscellaneous Revenue Act of 1988 or TAMRA. This law established a qualification test for life insurance contracts based on the amount of premium paid each year to the policy. If the premium is too large under the guideline, the policy fails the test and no longer enjoys life insurance status. It is then reclassified as a Modified Endowment Contract or MEC and it loses several tax favorable features enjoyed by life insurance contracts.
Although it is possible for the paid-up additions dividend option to affect the Modified Endowment Contract rules, it is not possible for a dividend payment applied to the purchase of paid-up additions to violate the MEC rules.
In fact, the limitations placed on paid-up additions through the MEC rules apply to the elective rider that the policy owner pays to add paid-up additions to the whole life policy. The MEC test restricts the annual premium that a policy owner can pay to a policy given the policy’s death benefit. The precise limitation depends on the age, gender, health classification, and certain other elements of the life insurance policy and this limit can change over time. To make you feel more relaxed, we should tell you that all insurance companies have the ability to report the maximum premium that you can pay into a policy year. Life insurance companies want to provide additional benefits to its policyholders and that is the reason they allow a policy owner to purchase elective paid-up additions riders, but as explained in Blog 63, life insurance companies impose restrictions on the amount a policy owner can purchase.
Notice that the limitations discussed above and in Blog 63 only apply to the paid-up additions rider. Even if a policy owner reaches the insurance company limit on allowable paid-up additions through the elective rider, the policy owner is still free to use the dividend option to purchase paid-up additions.
To summarize our last five blogs (Blog 62 through Blog 66), paid-up additions create more efficient cash value development in a whole life policy. Therefore, for any level of premium paid to a whole life insurance policy, we would like to ideally increase the percentage of that premium going to the purchase of the paid-up additions rider. Nevertheless, we need to balance this requirement with the reality of constraints imposed by life insurance companies and by MEC rules.
Those that understand all these nuances very clearly and know the relationships between competing rules and objectives are ready to excel in the art and science of designing high cash value dividend-paying whole life policies.
Remember, we are always available to advise you on the best way to utilize your IBC policy.
If you would like to learn how you can grow a substantial amount of cash that you have access to at any time without penalties, is unrelated to the stock market, and will generate income that is not included in your tax return, visit our website at http://InfiniteBankingSimplified.com/ or feel free to email us your questions at ContactUs@InfiniteBankingSimplified.com or call us toll-free at 1-844-443-8422.
Isis B. Palicio, LUTCF, MBA
Pedro A. Palicio, MBA, Ph.D.
Infinite Banking Concepts® Authorized Practitioners
We are experts in designing high cash value dividend-paying whole life policies.