Which policy loses the tax advantages of life insurance due to rapid cash value accumulation?

Modified Endowment Contracts (MEC) lose the tax advantages typically associated with life insurance because they accumulate cash value too rapidly. Under IRS regulations, life insurance policies that meet certain criteria are eligible for tax benefits, such as tax-deferred cash value growth and tax-free death benefits. However, when a policy is classified as a MEC due to excessive funding, it alters these tax advantages.

In particular, with a MEC, any withdrawals or loans taken against the cash value are subject to taxation, and if the insured is under 59½ years old, a penalty tax may also apply. This is in contrast to standard life insurance policies, where cash value can be accessed without immediate tax implications under certain conditions.

This rapid cash value accumulation often results from the premium payments being significantly higher than the federal guideline premium limits. Hence, a policy can inadvertently become a MEC, leading to a taxable situation that defeats the purpose of using life insurance as a tax-efficient savings and protection tool.