Hidden Truths: Understanding MEC Life Insurance

If you're looking into buying life insurance, cash value life insurance specifically, you've probably come across the term called a MEC or a Modified Endowment Contract. Whether you're looking to buy whole life insurance or index universal life insurance, this term called MEC gets thrown around all the time like you're supposed to understand what it means. Most of the time people don't even understand what it means and they don't understand the negative ramifications, they don't understand where the positive elements of a MEC might be and how you could actually utilize MEC to your advantage. In this video what I'm going to do is explain to you how MEC works, what MEC is and how you can actually avoid it to take advantage of growth in the short term or maybe if you're later in life showing you why a MEC isn't necessarily so bad. So if you haven't already make sure you're subscribing at the bell that way you're notified every time I launch a new video because I got videos like this coming out all the time. Let's go. Hey what's going on cash flow hackers it's Chris with Life 180 and we are going through Modified Endowment Contracts today and you know this is just kind of one of those areas where I think a lot of people, agents specifically, need to really understand what a Modified Endowment Contract is. They need to be able to explain it to their clients better and if you're somebody who's looking to buy a cash value life insurance policy it's important that you understand what the MEC rules are, what it even means, how the regulations were created and that will empower you to be a more educated consumer that way the odds you make sure that your policy is designed in alignment with your values and beliefs and what your goals and objectives are and if you don't understand what the MEC rules are and you don't understand how to look for what the MEC calculations are then you're probably, unless you have an educated agent, you're going to run into a situation where you probably don't have an optimally designed policy. So that said let's just talk about this for a second. So basically the MEC was created in 1988. Now the Tax Reform Act of 1988 created something called TAMRA and TAMRA basically was created because of the fact that people were putting so much money into cash value life insurance contracts that with the creation of 401ks in 1981 what happened people were not contributing as much and the government and the officials wanted more money to be going into qualified accounts. Remember like we look at qualified accounts now like 401ks, IRAs, stuff of that nature, 457s, TSPs, 403ds. We look at those as just kind of the normal way of investing but back then they were all new accounts and in 1988 the Tax Reform Act basically was created to or the TAMRA in the Tax Reform Act was created to make it so people would stop putting as much cash value into whole life insurance contracts and universal life contracts at the time. Now why would they do that? Well what happened was because of the fact that they were putting so much money they wanted to redirect that money and they wanted to take away the advantage of all the benefits that came along with a life insurance policy. Now it's not like they got rid of them but they basically restricted them and I want to show you how this works and basically explain how this works. Now when you when you get into a life insurance contract you basically you buy a death benefit okay so when you buy a death benefit for a life insurance contract what happens is let's say in this one you bought a $500,000 death benefit. Now when you're when you're buying a cash value life insurance policy let's call it whole life insurance the life insurance company is going to say you have a maximum amount of money that you're allowed to put into the contract up to what's called the seven pay test. So what the seven pay test is is regulators in the Tax Reform Act with TAMRA basically said you can the seven pay test is the premium that would make it so whole life insurance was fully paid up and you could not you could not put more cash value into the policy than would make the policy fully paid up over that seven year period and that is the max they would allow you to put in and keep tax benefits the tax-free nature right of everything. So what would happen is if we look at this is the max right here and you were funding it here then you're you're good if you were funding it here right and and you were putting money above the threshold above the MEC threshold what would happen is that's bad you lose the tax-free benefits and then it becomes taxed as ordinary income right but here's the deal a lot of people don't understand this that there's also a minimum that you can pay in a whole life insurance policy for instance right that minimum would just be 100 base of the insurance to make it so it pays all the way to 121 years old and so anything this is when we talk about a properly designed contract anything in this range between the max and the minimum is flexibility for you to be able to design the policy according to what your goals and objectives are so when we look at this it's really important to understand that so let me be really clear a MEC is when you exceed the seven pay test and it's important to understand that a MEC really is much more clean on a whole life insurance policy than it is with like say an index universal life policy because of the fact that index universal life policies can actually never be paid up index universal life policies have other premium tests to to come up with their MEC limits right because there's a thing called the guideline level premium test cash value accumulation test you have to look at these things differently but it's important to look on the illustrations to figure out how this all works now the MEC test will be on there but it's not as pertinent to IUL as it is to whole life because of the fact that it doesn't really fall in line with the nature of what the MEC rules are because you can never truly pay up an index universal life policy because of the fact that it's on a universal life chassis utilizing annual renewable term and while sometimes on the illustrations you'll see a zero in the premium department that doesn't mean there's no cost for that premium it just means it's called a vanishing premium meaning you don't see it there it's happening on the back end of everything but one of the important things to understand when when you exceed that MEC limit for instance and you you breach I'll say breach the threshold for the MEC limit you lose the tax advantage nature of the cash value while you're alive and while that may be the case it's also important to understand that you never lose the tax advantage nature and the tax-free nature of the death benefit so that is where sometimes the living benefits well I'll say this sometimes it's advantageous to MEC the policy if you are later in life and if you say hey I'm doing this and this is typically for wealthier people who are saying I'm never going to touch this money I want to leverage you know say a percentage of my net worth because I want to pay I want to you know transition that to the next generation in the most tax advantaged way possible I can MEC this I can grow it I can get good living benefits while I'm alive because the living benefits because of the fact they're riders they retain their tax-free nature and then also the death benefit is going to be tax-free what will happen the downside is if that person wanted to tap into the cash value while they're alive then it's taxed as LIFO or last in first out meaning any gains that you have on the policy are going to be taxed as earned income before you get down to your your cost basis or the amount of money that you've actually paid in premium once you get down below there that won't be taxed the other element of the tax advantages that you lose when you MEC the policy is that you actually if you try to access the money before you're 59 and a half you actually are susceptible to the 10 access penalty the same way you would be in a qualified account like a 401k or an IRA the other element to this also that functions very similarly to a 401k and an IRA is the fact that this money is going to grow tax deferred right so it's going to grow that's one good part about it is it's going to grow tax deferred you're not going to have to pay taxes on your MEC policy every single year now as long as you fall underneath the MEC threshold and you follow the seven pay test and it's one of the things that I say all the time is I show this all the time and I think it's really important to see is that if we look at if we look at this as they say all right there's a maximum that we're allowed to pay and there's a minimum we can pay and the seven pay test is the MEC so what we try to do is we try to fund it right up to this limit like if like hypothetically speaking if they said that the max premium is that if the MEC premium would wind up being $10,000 per year equals a MEC what we want to do is fund it at $9,999 that's what we want to do and so what we do with this that 900 that $9,999 we create our own MEC we call it a maximum max efficient contract because life insurance is a contract it's contract law right when you when you when you sign on the dotted line especially with a whole life policy the the life insurance is company is contractually obligated to meet their responsibilities and and and their obligations to meeting you and uh meeting the obligations to you and making your policy whole and that is with the death benefit and the cash value growth through the through the payment and participation of a dividend that's how it works right so i think this is really important to understand that when we when we look at this um there are different ways to structure the policy there's a like literally an infinite amount of options that you have there at the end of the day when i look at it when we keep the policy as a non-MEC we basically have one of the most powerful and flexible assets in the world it's it's going to give you bond like returns muni bond like tax treatment and and money market like liquidity to me that's super powerful now if you are later in life like i said and you want to utilize some of your money for legacy and living benefits and you don't plan on tapping into the money at all you know it's there if you absolutely need it but remember that it's going to function more like a qualified account if you will however what's going to happen uh with that is that you you are going to have the living benefits and the death benefit uh to your availability and to your benefit right so there is a leverageable component to that and i can think of a lot of areas where that would work really well most people however are going to look to avoid MEC and when you are looking to avoid MEC just understand the reason that this all happened the reason think about it this way the reason that the regulators created MEC in the first place is because people were jamming so much money into these policies because of the benefits of them so now they all they did was put a governor they put a cap on how much you were allowed to put into the policies and retain the tax benefits so for me anything the government wants to restrict my ability to do i'm going to do it right at the max capacity right because there's a reason they're restricting it and and you know the wealthiest people in the world the most successful people in the world do this banks corporations they're the largest holders of whole life insurance in the world and this is why so hopefully you found value in this if you have any questions leave a comment in the comment section below happy to engage with every single one i think this is one of the elements of these policies that people just need to understand especially if you're a life insurance agent looking to help people if you haven't already subscribe hit the bell that way you're notified every time i launch a new video until next time have a blessed inspirational day we'll see you soon