Modified endowment contract
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Definition
A life insurance contract failing the seven-pay test; lifetime distributions are taxed last-in firstout with a penalty before age fifty-nine and a half.
Modified endowment contract in plain English
Someone stuffs a life policy with premiums so fast it fails the seven-pay test, then takes a loan and expects tax-free treatment like ordinary life insurance. Modified endowment contract status changes the rules: lifetime distributions are taxed last-in, first-out, with a penalty before age fifty-nine and a half. Death benefits can still be income-tax free, but living withdrawals and loans lose the friendly FIFO ordering. Seven-pay failure plus LIFO tax and a pre-59½ penalty equals MEC classification.
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