Which of these describes the result of a modified endowment contract that failed to meet the seven-pay test?

• A. Distributions after death are tax-free
• B. Pre-death distributions are typically taxable
• C. Policy terminates policy automatically
• D. All premiums are fully refunded

Answer: (B)

A MEC changes how withdrawals are taxed. If the seven-pay test isn’t met, the contract is treated as a MEC, and any distributions taken during the policy owner’s life are taxed as ordinary income to the extent of the policy’s earnings (the gain). If a distribution is taken before age 59½, a 10% early withdrawal penalty may apply. The death benefit itself remains generally tax-free as life insurance proceeds, but that doesn’t affect the tax treatment of distributions made while alive. So the result is that pre-death distributions are typically taxable.