All of the following actions could cause a universal life insurance policy to become a modified endowment except?
a. Reduction in the premium payment
b. Reduction in the policy death benefit
c. Withdrawal of policy cash value
d. Increasing the premium payment above the 7-year guideline annual premium
The correct answer and explanation is :
The correct answer is:
c. Withdrawal of policy cash value
Explanation:
A Modified Endowment Contract (MEC) is a life insurance policy that fails the 7-Pay Test, which is designed to ensure that a policy is primarily for life insurance purposes and not for tax-advantaged investment. If a policy becomes a MEC, withdrawals and loans are taxed differently and may incur penalties.
Let’s analyze each option:
- Reduction in the premium payment (Option A) – This does not typically lead to a policy becoming a MEC because lowering premium payments keeps the policy in compliance with the 7-Pay Test rather than exceeding it.
- Reduction in the policy death benefit (Option B) – Decreasing the death benefit can make the policy fail the 7-Pay Test. A lower death benefit means that previous premiums may exceed the limits set by the test, which could trigger MEC status.
- Withdrawal of policy cash value (Option C) – This is the correct answer because withdrawing cash value alone does not affect whether the policy passes or fails the 7-Pay Test. While excessive withdrawals could impact the policy’s performance, they do not cause it to become a MEC.
- Increasing the premium payment above the 7-year guideline annual premium (Option D) – Paying too much into the policy too quickly is the most common way a policy becomes a MEC. The IRS sets premium limits under the 7-Pay Test, and exceeding them results in MEC classification.
Thus, the only action that does not contribute to a universal life policy becoming a MEC is withdrawing cash value (Option C).