Connecticut Life Producer Practice exam

What classification does a life insurance policy gain if it fails the 7-pay test?

1. Modified Endowment Contract (MEC)

2. Standard Life Age Policy

3. Tax-exempt Policy

4. Endowment Policy

The correct answer is: Modified Endowment Contract (MEC)

A life insurance policy that fails the 7-pay test is classified as a Modified Endowment Contract (MEC). The 7-pay test is a method established by the IRS to determine whether a life insurance policy is primarily a life insurance product or if it has characteristics of an investment vehicle. If the total premiums paid during the first seven years exceed the limits set by the 7-pay test, the policy will be deemed a MEC. This classification has significant tax implications. Distributions from a MEC, such as withdrawals or loans, are subject to taxation on the earnings first, and if the policyholder is under 59½ years old, a 10% penalty tax may also apply. Understanding this classification is crucial for life insurance producers and policyholders to ensure compliance with tax laws and to avoid unexpected tax burdens. The other classifications mentioned in the options do not directly relate to the failure of the 7-pay test. A standard life age policy, for example, doesn’t have the unique tax implications tied to MECs. Tax-exempt policies generally refer to those structured to provide certain tax benefits, but they are not defined by the 7-pay test. An endowment policy is a type of life insurance that pays a benefit after a specified period