What happens when a life policy exceeds certain IRS table values?

When a life policy exceeds certain IRS table values, it is classified as a Modified Endowment Contract (MEC). This classification occurs when the premiums paid into the policy exceed the limits established by IRS guidelines, which are intended to ensure that life insurance policies are used primarily for protection rather than as investment vehicles.

The designation of MEC has important tax implications. Specifically, if the policy is considered a MEC, any withdrawals or loans taken against the cash value are subject to taxation in a way that differs from traditional life insurance policies. Typically, the cash value of life insurance policies grows tax-deferred; however, with a MEC, distributions are taxed as ordinary income to the extent that there is a gain in the policy, and that gain is taxable even if the policyholder is under 59½ years of age, which might incur additional penalties.

Understanding this classification is crucial for anyone in the life insurance field, as it influences how policy benefits are accessed and whether they will incur taxes, thus impacting the advice that agents provide to their clients regarding their insurance options.