When a life insurance policy exceeds certain IRS table values, what result is created?

When a life insurance policy exceeds certain IRS table values, it is classified as a Modified Endowment Contract (MEC). This designation is significant as it alters the tax treatment of the policy. Specifically, MECs lose some of the favorable tax benefits typically associated with life insurance policies, such as tax-deferred growth and tax-free loans or withdrawals. Instead, any distributions from a MEC are subject to income tax and may incur an additional penalty if taken before the policyholder reaches age 59½.

The threshold for determining whether a policy is classified as a MEC is based on the seven-pay test, which assesses whether the premiums paid into the policy during the first seven years exceed the limit set by the IRS. If the policy is deemed a MEC, it does not impact its validity as a life insurance product, but the tax implications significantly change.

In contrast, classifications such as tax-exempt status, permanent life policy, or universal life policy do not directly relate to this IRS threshold issue. Tax-exempt status refers to how the policy's death benefit is treated, while permanent life policy and universal life policy describe types of insurance but do not specifically address the tax implications associated with exceeding IRS values. Hence, the designation of a policy as a Modified Endowment