Massachusetts Life Insurance Practice Exam 2025 – Complete Study Guide

A life insurance policy classified as a Modified Endowment Contract (MEC) undergoes a significant change in its tax treatment compared to standard life insurance policies. When a policy is classified as a MEC, it loses the favorable tax treatment typically associated with life insurance. Under normal circumstances, the death benefit paid to beneficiaries is tax-free, and the cash values grow on a tax-deferred basis. However, for a MEC, any withdrawals or loans taken against the cash value can be subject to taxation, and they may also incur a penalty if taken before age 59½, similar to early withdrawals from an annuity.

This change is triggered when the premiums paid into the policy exceed the limits set by the IRS within the first seven years of the contract. Therefore, while a MEC still provides life insurance coverage, the tax implications can significantly affect the policyholder's financial strategy.

The other options, while they may suggest other characteristics of insurance policies, do not accurately reflect the impact of the MEC classification. A MEC does not remain tax-free during withdrawals, it does not automatically convert to term insurance, nor does it necessarily guarantee cash values outside of the conditions set forth in the policy. Understanding these tax implications is crucial for anyone managing a life insurance portfolio, ensuring