Oklahoma Life Producer Practice Exam

What happens to some tax benefits in Variable Universal Life policies classified as Modified Endowment Contracts (MECs)?

1. They increase

2. They remain unchanged

3. They are lost

4. They are transferred

The correct answer is: They are lost

Variable Universal Life policies classified as Modified Endowment Contracts (MECs) lose certain tax benefits that are typically available to traditional life insurance policies. In a MEC, the accumulation of cash value and the way premiums are structured can lead to significant tax implications. Under normal circumstances, life insurance policies allow the policyholder to grow the cash value on a tax-deferred basis, meaning they won’t owe taxes on the growth until it is withdrawn. However, once a policy is classified as a MEC, withdrawals and loans taken against the policy are subject to taxation on the gains first, and withdrawals can also incur penalties if the policyholder is under 59½ years old. Additionally, MECs do not allow for the same tax-free death benefit that is available in standard life insurance policies. Since these contracts are subject to different tax treatment, this results in a loss of valuable tax advantages that were otherwise available, making it important for policyholders to understand the implications of their policy designation.