TAMRA - MEC taxation

[Elaine Benes]

For UL policies that are considered MEC's - Modified Endowment Contracts. I know that all distributions including loans and withdrawals are taxed on a LIFO basis (as opposed to a normal life insurance contract that is taxed on a FIFO basis). My question is whether loan interest capitalization should be taxed each year, even if they don't take a new loan. Any comments would be appreciated.

[Numbers Nerd]

Yes. Loan interest is expected to be paid in cash. If instead it is capitalized, that is the equivalent of taking out a new loan equal to the amount of interest that was due.

Note that this distribution is still only taxable to the extent there is untaxed gain in the contract.

[Old Timer]

Don't forget the 10% penalty tax if the policy owner is under 59.5.

[Anonymous]

Yes to the loan interest cap question.

Query ...

You have a currently issued limited pay ( 10 yr. ) fixed premium whole life contract which satisfies the MEC test at issue. Assume a material change takes place at the end of policy year 6. Also, assume the necessary premium exception is not applicable. With only 4 policy years remaining in the premium paying period, is the new MEC premium still calculated assuming 7 level annual payments ?

Any thoughts would be appreciated.

[urysohn]

Assuming you really mean "material change" (and not a face decrease), then yes. You would only count the four payments. But you also need to factor in that your seven pay premium is going to be very low because of the adjustment rules [i.e. adjusted 7-Pay premium = 7-pay for newly-issued-contract minus Cash Value divided by a 7-pay annuity]. Have 6 out of 10 payments made should mean the cash value is relatively very high.