Under a Modified Endowment Contract, what are the likely tax consequences?

Under a Modified Endowment Contract (MEC), the tax consequences primarily impact pre-death distributions. When a policy is classified as a MEC, any distributions made before the insured's death are subject to taxation. Specifically, the earnings on the cash value, which typically grow tax-deferred, will be taxed as income when withdrawn.

This treatment occurs because MECs do not qualify for the same tax benefits as traditional life insurance policies. Therefore, when policyholders take loans or withdrawals from a MEC, they may be taxed on the gains first, with the return of basis occurring afterward. This results in a taxable event for the policyholder, making the option regarding pre-death distributions the likely outcome.

The other options do not resonate in the context of MEC regulations. For instance, premium payments for a MEC are not tax-deductible; they are treated as personal investment. Similarly, although loans against the cash value may have interest implications, the interest on policy loans is not deductible for a MEC. Finally, the cash value in a MEC can indeed be surrendered early; however, such action would generally lead to taxable consequences depending on the amount of cash value accessed.