Insurance Pro Blog Podcast | Life Insurance and Annuity Insights

 

Most people think that creating a Modified Endowment Contract (MEC) is a bad thing. We discussed that at some length in last week's episode.

That's mainly because the tax advantages of using life insurance are pretty widely known and discussed my agents…ourselves included. So, why in the world would anyone want to intentionally make the cash value taxable by using a MEC?

Good question. Losing the tax benefits can be a negative thing…especially if creating a MEC was not your intention.

But there are times when intentionally owning a modified endowment contract might make sense.

Here are a couple examples of that:

* You are disappointed with the interest rates offered in fixed annuities and CD's presently. (Honestly, I think everyone is).  A lump sum paid into a permanent life insurance policy could produce a better return with a similar risk profile to a fixed annuity or CD.

* You have no intention of spending the money and have a definite plan to leave some amount of money to loved ones and/or a charity of your choice. The death benefit paid by a MEC (like life insurance) passes to your beneficiary(s) without an income tax consequence to them.

And if you'd like to follow along with the number that Brandon uses as an example, here is the data that was compiled for comparison:

Now, before I have to delete a bunch of nasty comments and field the hate mail, I'd like to say that we're not advocating the use of MEC's as an absolute. It's an alternative and it should only be used by someone who has a firm grasp of the ramifications of doing so.

Income Case study

Deferred Income Annuity (DIA) vs. Modified Endowment Contract (MEC)

55 y/o male $150,000 that he would like to convert to an income at 65

DIA produces $1,505.70 monthly income

MEC produces $1,907.25 monthly income (non-guaranteed)

Legacy Play Case Study

Lump sum of cash that you don’t want to give up, but plan to leave behind to loved ones and/or charity

70 y/o male with $500,000 lump sum

Immediately worth over $800,000 at inception

By age 85 over $1.1 million that’s nearly a 5.5% return on the money.  Find me a CD or annuity that can produce that sort of growth and don’t forget that the transfer of cash is income tax free because it’s a death benefit

If you'd like to hear us talk more about these examples in detail plus more, listen to the full episode.

Note: The podcast is fresh and new but the written post below is a re-post of information that Brandon wrote a few years back on modified endowment contracts: Anyone who has looked into cash value life insurance has probably come across the term Modified Endowment Contract (MEC). Those with flexible premium policies may have ... Keep Reading

 

 

Note: The podcast is fresh and new but the written post below is a re-post of information that Brandon wrote a few years back on modified endowment contracts:

Anyone who has looked into cash value life insurance has probably come across the term Modified Endowment Contract (MEC). Those with flexible premium policies may have noticed a portion of their statements that stipulate whether or not the contract is a Modified Endowment Contract.

You may have even seen numbers indicating the amount of money that can go into a policy before it turns into an MEC. What does it mean, and why do we care? We’ll explain that and more today as we cover MECs in their entirety.

First a Little History

Modified Endowment Contracts were created by the Technical and Miscellaneous Revenue Act of 1988 as yet one more way of quelling the use of cash value life insurance as a tax shelter. The Tax Equity and Fiscal Responsibility Act of 1982 and the Deficit Reduction Act of 1984 were two prior pieces of legislation that affected life insurance contracts with non-forfeiture – that is, cash value – provisions.

Since life insurance cash values grow tax-free and can be accessed without being realized as income for income tax purposes, TAMRA posed a new hurdle for those seeking to place large amounts of cash into life insurance policies solely for the purpose of accumulating cash (those with no real desire for death benefit).

TAMRA did this by creating what is known as the 7 Pay Test, which is a maximum premium amount based on the assumed cash values those premiums would create relative to the death benefit on the contract. The do-not-cross line is the amount needed to make the contract guaranteed paid-up within seven years.

After 7 Years…

A common mistake agents (and some life insurance company home office employees) make is assuming that after seven years, there is no more need to worry about the reclassification of the contract as a Modified Endowment Contract. This is incorrect. Any time the contract undergoes a material change, the 7 Pay Test clock is reset. Material changes include the following:

* Any increase in the death benefit

* Any change in a benefit under the contract (e.g., the addition of a rider)

So, if one is constantly placing paid-up additions into a contract, the 7 Pay Test is constantly resetting.

 Why You Might Want To Avoid MEC’s

If the contract is reclassified as a Modified Endowment Contract, the following new rules apply:

* Withdrawals are no longer taken on a first-in, first-out (FIFO) basis but rather a last-in, last-out (LIFO) basis. So, any (taxable) gain in the policy will be withdrawn before the basis (non-taxable) is withdrawn (such as a standard annuity withdrawal).

* Loans are now recognized as ordinary income to the owner and are taxable.

* Withdrawals and loans are subject to the same early withdrawal penalty found on retirement vehicles, meaning loans or withdrawals prior to age 59.5 incur a 10% penalty tax (except in cases making use of a 72(v) distribution).

Considering, it’s typically advisable to avoid MEC status; however, there are times when intentionally setting a policy up to become an MEC is completely reasonable. One such situation has already been discussed on our beloved Insurance Pro Blog.

How Will I Know I Violated The 7 Pay Test and What Happens If I Do?

Insurance companies typically perform MEC testing once a month (or whenever premiums are paid to the contract). In fact, some of the limitations companies put on the frequency of placing

In light of the recent developments with Wells Fargo opening accounts for people without consent and their CEO, John Stumpf, being skewered by Senator Elizabeth Warren… We decided it would be a great day to point out how many times a life insurance company CEO has been trotted out to testify in front of Senate or House ... Keep Reading

 

In light of the recent developments with Wells Fargo opening accounts for people without consent and their CEO, John Stumpf, being skewered by Senator Elizabeth Warren…

We decided it would be a great day to point out how many times a life insurance company CEO has been trotted out to testify in front of Senate or House investigative panel.

Do you remember how many life insurance companies made big news for causing or playing a role in the last financial crisis?

Let me skip the suspense…zero.

In fact, the United States Governmental Accountability Office (GAO) published a report in 2013 titled, Insurance Markets: Impacts of and Regulatory Response to the 2007-2009 Financial Crisis

If you'd like to read it I've linked to the pdf here:

GAO Report of Insurance Markets–http://www.gao.gov/assets/660/655612.pdf

To get our take on why the life insurance industry in particular hasn't had these problems, go listen to the full episode.

Enjoy!

P.S.  I know some of you are thinking…”but what about AIG?” Listen to the episode to hear the truth about the role AIG played in the last financial crisis. 

We're drawing a line in the sand here. It's time for insurance agents to get over Dave Ramsey. He has his crowd, his fans, his followers or whatever you want to call them. And that's okay…get over it. Seriously. How many articles can you write about one guy who hasn't really said anything different in ... Keep Reading

 

We're drawing a line in the sand here.

It's time for insurance agents to get over Dave Ramsey. He has his crowd, his fans, his followers or whatever you want to call them. And that's okay…get over it.

Seriously.

How many articles can you write about one guy who hasn't really said anything different in the last 15 years?

Mind you, there's a lot of what he says that's absolutely spot on. You'll never hear us be totally dismissive of any financial entertainer who suggests that spending less than you make is a good idea.

It's called being financially responsible and that's a good message.

Now, we diverge when it gets into the particular tactical advice that Dave gives but so what. We also disagree with lots of our counterparts in the financial services industry.

And to be totally honest, most of what he says about life insurance is not too far off. The truth is that term insurance is appropriate for a vast majority of the people out there.

It's particularly appropriate for those who are beginning on their own journey to right their financial ship. And that's exactly who Dave Ramsey is targeting.

People who don't have any money, need the most affordable life insurance protection they can get.

Period.

Using any type of cash value life insurance becomes appropriate down the road when there's extra cash to deploy.

Our advice: stop worrying about what Dave Ramsey says. He's not hurting your life insurance business or anyone else's for that matter.

In exploring what we should talk about in episode 44, we realized that we've somehow gone almost an entire year without dedicating an episode to a discussion of taxes in relation to life insurance. Oops! Sometimes we get caught up in focusing on finer points and miss the big picture. But we are correcting that ... Keep Reading

 

In exploring what we should talk about in episode 44, we realized that we've somehow gone almost an entire year without dedicating an episode to a discussion of taxes in relation to life insurance. Oops!

Sometimes we get caught up in focusing on finer points and miss the big picture. But we are correcting that today.

We've actually published quite a bit of information on the topic over the last 5 years and for those of you who prefer the written word…carry on. You'll be please with what you find in the proceeding paragraphs.

Rather than re-inventing the wheel I'm going to pull from a piece that Brandon published a few years back.

Full disclosure: at no point is Brandon or Brantley referring to life insurance as an investment. That gets certain regulatory agencies in a dither and ain't nobody got time for that

With the current wave of companies lowering the caps on indexed universal life contracts, we thought it would be good idea to share our thoughts on that today. Honestly, we've been “low balling” expectations on IUL contracts since we started offering them to our clients five'ish years ago. And that was back when some policies ... Keep Reading