Under a Modified Endowment Contract, which item is not subject to income taxation?

Under a Modified Endowment Contract, which item is not subject to income taxation?

• A. Death benefit
• B. Cash value growth
• C. Policy loans
• D. Withdrawals

Answer: (A)

Modified Endowment Contracts change how distributions from a life insurance policy are taxed. The money you take out during the insured’s life—whether as withdrawals or loans—is taxed as ordinary income to the extent the policy has earned value, and may also incur penalties if taken before age 59½. The cash value inside the policy grows tax-deferred while it remains in the policy, but distributions trigger taxation on the gains under MEC rules. The death benefit, however, remains free from federal income tax when paid to beneficiaries, regardless of MEC status. So the item not subject to income taxation is the death benefit.

Modified Endowment Contracts change how distributions from a life insurance policy are taxed. The money you take out during the insured’s life—whether as withdrawals or loans—is taxed as ordinary income to the extent the policy has earned value, and may also incur penalties if taken before age 59½. The cash value inside the policy grows tax-deferred while it remains in the policy, but distributions trigger taxation on the gains under MEC rules. The death benefit, however, remains free from federal income tax when paid to beneficiaries, regardless of MEC status. So the item not subject to income taxation is the death benefit.