Modified Endowment Contracts

MR. WATSON: A whole life insurance policy has great benefits besides paying a death benefit to the beneficiary. The cash values earn interest and that interest is not taxable. But some folks abused this feature by putting huge sums of money into the contract to shelter their interest from taxes. So, congress changed the tax code and now subjects each whole life policy to a test. If it passes the test, all is good. If it fails the test the policy becomes a M.E.C., this is bad. Either way, the death benefit is still tax free to the beneficiary. (see chart)

MR. WATSON: The chart below is very important. Please understand it. Simply put:

1. There is a test every whole life policy MUST pass
2. The test is called a seven pay test
3. If it passes the test, then the policy behaves like a whole policy as to loans (tax free)
4. If it fails the test, the policy would become a M.E.C. and loans would be taxable (but the death benefit is still tax free)
5. It is ONLY the responsibility of the company to make sure the policy does NOT become a MEC. Not the agent or the policyholder.

MR. WATSON: You do not need to know the test. You need to know it is a seven year test and what happens if it fails the test!!!