When a life insurance policy does not pass which test, it is classified as a MEC?

A life insurance policy is classified as a Modified Endowment Contract (MEC) if it does not pass the 7-pay test. This test is specifically designed to measure whether the total premiums paid into the policy during the first seven years exceed the net level premium that would have paid up the policy within the first seven years. If the premiums surpass this limit, the policy loses some of its tax advantages, which is an important consideration for policyholders.

The significance of the 7-pay test lies in its ability to ensure that policies are maintained primarily for life insurance coverage rather than as investment vehicles. If a policy is categorized as a MEC, it will be subject to different tax treatment, including the potential for taxation on withdrawals and loans against the cash value, which can have financial implications for the policyholder. Thus, understanding the mechanics of the 7-pay test is crucial for anyone involved in life insurance to ensure compliance and optimal financial planning.