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A
A MEC is a standard whole life policy with a higher cash value
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B
A MEC is a life insurance policy that has failed the 7-pay test — it has been funded too rapidly in the first 7 years, causing it to lose favourable life insurance tax treatment; MECs are treated like annuities for tax purposes — withdrawals are taxable as ordinary income, and a 10% penalty applies to distributions before age 59½
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C
A MEC is a term policy converted to permanent
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D
A MEC provides double the death benefit with no additional premium
Why this is the answer
MODIFIED ENDOWMENT CONTRACT (MEC) status is triggered when a life insurance policy is funded so rapidly that it fails the TAMRA '7-pay test.' THE 7-PAY TEST: A policy becomes a MEC if the cumulative premiums paid in the first 7 years exceed what would have been required for a fully paid-up policy in 7 payments; this rule was enacted by the Technical and Miscellaneous Revenue Act (TAMRA) of 1988 to prevent wealthy individuals from using life insurance as a tax-sheltered investment vehicle disguised as insurance. TAX CONSEQUENCES OF MEC STATUS: LIFO (Last In, First Out) taxation — withdrawals and loans come from gain first, principal last (opposite of non-MEC policies); gains are taxable as ordinary income; 10% premature distribution penalty on taxable amounts withdrawn before age 59½ (same as retirement accounts); the death benefit remains income-tax-free; the policy doesn't lose insurance characteristics, just the favourable tax treatment for early withdrawals. NON-MEC POLICY ADVANTAGES (that MECs lose): FIFO (First In, First Out) — basis comes out first, tax-free; policy loans not taxable as long as policy remains in force; partial surrenders of basis are not taxable. HOW TO AVOID: Spread premiums over more than 7 years; make smaller annual premium payments; once MEC status is triggered, it is permanent and irrevocable.
Source: Life Insurance License Exam, Modified Endowment Contract (MEC)