The Risk of Over-Funding in Permanent Life Insurance (MEC and Tax Issues)

While aggressively funding a permanent policy (especially with PUAs) is a popular strategy to maximize cash value, there is a strict limit imposed by the IRS. Paying too much premium too quickly results in the policy becoming a **Modified Endowment Contract (MEC)**, which severely curtails its tax benefits.

The 7-Pay Test

The IRS applies the **7-Pay Test** to every life insurance policy. If the cumulative premiums paid during the first seven years exceed the sum of the net level premiums required to pay up the policy in seven years, it becomes a MEC.

• **The Tax Penalty:** The death benefit remains tax-free. However, cash value access flips to LIFO (Last-In, First-Out) taxation. This means **gains are taxed first** (as ordinary income), and withdrawals before age 59½ incur an additional **10% IRS penalty**.

Avoiding MEC status is crucial for those planning to use the cash value for tax-free retirement income or personal banking.

Disclaimer: This content is for informational purposes only and is not financial or legal advice. Consult a tax professional and your agent to ensure your funding plan stays within the 7-Pay Test limits.