Under a Modified Endowment Contract, which feature is generally not taxed?

Under a Modified Endowment Contract, which feature is generally not taxed?

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

Answer: (A)

Death benefits from life insurance are generally income tax-free to the beneficiary. A Modified Endowment Contract changes how amounts you take out during the insured’s life are taxed, not the payout at death. When cash value is accessed in a MEC—through withdrawals or policy loans—the portion that represents earnings is taxed as ordinary income, while a return of the principal is not taxed. Therefore, the feature that is generally not taxed is the death benefit. If the policy is surrendered, any gains become taxable as ordinary income as well.

Death benefits from life insurance are generally income tax-free to the beneficiary. A Modified Endowment Contract changes how amounts you take out during the insured’s life are taxed, not the payout at death. When cash value is accessed in a MEC—through withdrawals or policy loans—the portion that represents earnings is taxed as ordinary income, while a return of the principal is not taxed. Therefore, the feature that is generally not taxed is the death benefit. If the policy is surrendered, any gains become taxable as ordinary income as well.