Texas Life Agent Practice Exam

A Life insurance policy that exceeds IRS cash value guidelines is referred to as?

1. A Modified Endowment Contract

2. A Standard Life Policy

3. A Participating Policy

4. An Overfunded Contract

The correct answer is: A Modified Endowment Contract

A life insurance policy that exceeds IRS cash value guidelines is referred to as a Modified Endowment Contract (MEC). The IRS has established specific criteria that determine how much cash value can be built up in a life insurance policy without it being classified as a MEC. These guidelines are intended to ensure that life insurance is primarily used for protection rather than as an investment vehicle. When a policy surpasses these cash value limits, it loses certain tax advantages typically associated with life insurance. This includes the potential for tax-free withdrawals and loans against the policy's cash value. Instead, any distributions from a MEC are generally subject to taxation and may incur penalties if taken before the owner reaches age 59½. Understanding the definition and implications of a Modified Endowment Contract is essential for agents in order to guide clients effectively and ensure that their policies align with their financial goals. Other options like Standard Life Policy, Participating Policy, and Overfunded Contract do not specifically refer to the IRS cash value guidelines or the tax consequences that arise from exceeding them.