New Jersey Life Producer Practice Exam

Money withdrawn from a modified endowment contract (MEC) may be subjected to what?

1. Favorable tax rules

2. Unfavorable tax rules

3. Regulatory audits

4. Settlement delays

The correct answer is: Unfavorable tax rules

Money withdrawn from a modified endowment contract (MEC) may be subjected to unfavorable tax rules because these contracts do not qualify for the same tax advantages as traditional life insurance policies. Specifically, when funds are taken out of a MEC, the withdrawals are taxed on a first-in, first-out basis, meaning that any earnings on the contract are taxed as ordinary income when withdrawn. Additionally, if the policyholder is under the age of 59½ at the time of withdrawal, they may also face a 10% penalty on the taxable portion of the withdrawal. This harsh tax treatment is a significant reason why MECs are often viewed less favorably compared to non-MEC life insurance policies, which allow for more advantageous tax treatment on withdrawals and loans.