1. Modified Endowments and the clients who love them…
Jerry Borrowman
CLU, ChFC, MSFS, CAP, LUTCF
Intermountain Financial Group, LLC
For Producer use only. Not for use with the Public
CRN#

2. Neither MassMutual nor any of its employees or agents are authorized to give legal or tax advice. Clients should consult their own personal attorney, legal or tax counsel for advice on specific legal and tax matters.
As a MassMutual representative, you are not authorized to provide tax advice. You should encourage your clients to speak to their tax advisors if they have specific tax questions about their policies.

3. Key Benefits of Life Insurance
Death Benefit—the primary reason to purchase life insurance.
Whether whole life, universal life, first or second-to-die, best practices dictate that clients should only purchase life insurance when there is a valid need to provide beneficiaries with a death benefit.
Cash values—a secondary benefit that may become important to clients as their needs and desires change.
Life insurance is a remarkable tool for helping families as business owners prepare for the financial loss of a loved one or key employee.
It is in the nature of whole life insurance and non-death benefit guaranteed universal life policies that the policies have the potential to accumulate cash values, both guaranteed and non-guaranteed, which may prove useful to clients through the years.
Cash values can generally be used by pledging policy values as collateral for a policy loan from MassMutual or by surrendering paid-up additions or taking cash withdrawals from a universal life policy. Withdrawals or dividend surrenders reduce benefits paid to beneficiaries. Loans also reduce to the net death benefit and can create a risk of lapse.
Clients should only buy life insurance when there is a valid need to provide the beneficiaries with a death benefit.

4. Non-MEC and MEC
In 1988 Congress passed TAMRA, legislation which included a new definition of life insurance:
Two categories:
Policies that are not considered “Modified Endowment Contracts” (Non-MEC)
Traditional premium paying policies are considered non-MEC policies. Generally, these are policies that are funded over a longer period.
Policies that are considered “Modified Endowment Contracts.” (MEC)
Policies that accept premiums that violate the “7-Pay Test” for early funding are classified as modified endowment contracts.
Because of perceived abuses of the tax-benefits accorded to life insurance, Congress passed legislation in 1988 as part of their omnibus TAMRA budget legislation that created a new classification for life insurance policies that received high early funding. All policies must be tested to see if they will be classified as Non-MEC or MEC policies as explained in this, and following slides.
Remember, these policies qualify as life insurance—but the taxation of lifetime withdrawals will be different. Many agents at the time erroneously believed that it was always to a clients disadvantage to use a policy that is deemed to be a MEC.
While nearly all agents are aware of the many and varied reasons that non-MEC life insurance is valuable, it is the purpose of this presentation to show that there are many valid uses for life insurance policies that are classified as Modified Endowment Contracts. Clients must be made aware of these distinctions before making any decisions as to how to fund their life insurance policies.

5. Key points about Non-MEC policies
Income tax-free death benefit paid to beneficiaries
Premiums are paid with after-tax dollars*
Cash values accumulate tax-deferred
Dividends used to purchase paid-up additions also accumulate tax-deferred.
Surrender of policy values (including paid-up additions) reduce basis and are not taxable until cumulative withdrawals exceed basis.
Policy loans are nontaxable when taken.
Net cash value and death benefit is reduced by outstanding loans
At surrender, the loan is treated as part of the proceeds distributed. A loan can create a taxable distribution even where there is almost no net surrender value.
* Pension plan owned policies can be non-MEC and are paid with pre-tax premiums.
Read the points on the slide.

6. A partial list of uses of non-MEC policies
Death Benefits:
Cash to pay bills at death; invest proceeds to provide income to survivors; estate liquidity; allow participants in a defined benefit pension to take a single life income for maximum income while maintaining a death benefit to provide an income to a surviving spouse; estate equalization; estate taxes; estate buy-sell; charitable bequests; family legacy through multi-generational trusts; key person for business, etc.
Cash Values:
Dividend surrenders or cash withdrawals to supplement other retirement income; tax-free policy loans for emergencies or opportunities; executive benefit planning, etc.
This is a summary of some of the reasons that people choose to buy life insurance. A variety of non-MEC policies may be used – for example survivorship policies for estate needs, whole life for personal and business, and guaranteed UL policies for key person or legacy. This list is not intended to present all reasons – rather a sampling.

7. What is a Modified Endowment Contract?
A policy becomes a Modified Endowment Contract (MEC) when it meets all requirements of Code Section 7702 but fails the 7-Pay Test of Section 7702(A).
The 7-Pay test applies to all policies issued after June 21, 1988*
In other words, it qualifies as life insurance, but with different tax treatment for lifetime withdrawals.
* A policy issued before that date can lose grandfathering for certain increases in or additions of benefits.
This is the classic definition of a MEC policy. By meeting the requirements of 7702(A) the policy enjoys tax-deferral of cash values and income tax-free death benefits. In failing the 7-Pay test the taxation of lifetime withdrawals will be modified as shown in the following slides.

8. The 7-Pay Test
The 7-Pay test involves a 7-pay limit also known as the “TAMRA Limit” or MEC limit.
This is an annual amount that if violated reclassifies the policy as a MEC
It is cumulative – if the client pays less than the limit in the first year s/he can catch up in later years. The reverse is not true.
MassMutual tests policies when premiums are received and on certain events to determine if the policy will become a MEC.
A warning is created if a particular premium pattern creates a MEC.
If the client chooses not to withdraw excess premiums the policy will be identified as a MEC on company records with future taxation of lifetime withdrawals reported as such. The client must agree to this in writing.
Once classified as a MEC, the classification cannot be reversed
Material changes may cause a policy to be re-classified as a MEC. Material changes include changes in the face amount, addition or termination of a term rider, etc.
Read and discuss the bullet points

9. Opportunities to use a MEC
Periodic Premiums
Periodic Premiums to the ALIR Rider to enhance cash accumulation and net death benefit.
Single Premium
Final expense multiplier
Single premium policies as gifts of a paid-up policy on the lives of grandchildren
Clients who need insurance for traditional reasons but hate to pay ongoing premiums
A large single premium to the ALIR Rider in whole life or survivorship whole life policies to enhance cash accumulation and death benefit
A single premium to a UL-Guard 2 or SUL-Guard to create a large guaranteed death benefit for beneficiaries with nominal cash value.
Periodic and Single Premiums to the ALIR Rider or additions beyond the minimum or guarantee premium in UL policies to supplement retirement income: Life insurance provides multiple benefits, including death benefit protection for dependents as well as cash accumulation for emergencies and other income needs. If the impact of early extra premiums (than those required to maintain the policy) on future net cash value and net death benefit, including non-guaranteed dividends, in a MEC is of interest to the client, then the change in taxation of lifetime withdrawals may be outweighed by the potential for enhanced policy values. Te ability to pass all gain in the policy via the income tax-free death benefit and to accelerate benefits for terminal illness may also be of interest. Withdrawals will be taxed from gain first, basis second, with a 10% penalty for lifetime withdrawals or loans taken before age 59 1/2. This is similar to other products that enjoy the benefit of tax-deferral during the accumulation period.
Final expense multiplier: Older clients often set aside a sum of money for their final expenses, including funeral, medical bills, small debts, etc. By placing this money in a MEC they can increase the amount available to heirs, shelter future growth from current taxation, and allow their executor to pay final expenses with the income tax-free death benefit.
Single premium legacy assets: Clients who have single premium assets that are not earning as high a long-term interest rate as desired may be ideal for a MEC. A MEC enjoys tax-deferral during life, but with a tax-free death benefit and accelerated benefits for terminal illness which may increase the tax-efficiency of using these assets for personal needs and transferring funds to heirs.
Single premium gifts for grandchildren: Some clients wish to provide a gift of life insurance on their grandchildren, but don’t want to make ongoing premiums. Universal life or whole life policies funded as MECs provide excellent cash accumulation and growing death benefits that can provide coverage for a lifetime. The 10% penalty on pre-59 ½ withdrawals provides a disincentive for the grandchild to take withdrawals until they reach age 60 or later.
Clients who need life insurance but hate to pay ongoing premiums: We often receive request for help in closing a sale with a client who has a need for insurance protection, but who is philosophically opposed to incurring a lifetime commitment to paying out-of-pocket premiums (example: I hate paying life insurance premiums!). A MEC may be ideal for this client. Solve for the single premium necessary to keep the policy in-force for life using the Coverage Guarantee provision and then tell the client to tuck the policy away and never worry about the premium again.

10. Key Points about MEC policies
A policy may be re-classified a MEC anytime during its existence. Special restrictions on cumulative premiums apply in the first seven years and after any material change.
MEC contracts still enjoy the benefits of tax-deferral and a tax-free death benefit.
Taxation of MEC’s is different from non-MEC Life policies as follows:
Withdrawals or loans are taxed on a “Last In – First Out” basis (LIFO). This means that any gains are withdrawn first.
Gains are subject to ordinary income tax in the year of withdrawal. If there is no remaining basis in a non-MEC, withdrawals are taxable as gain.
Taxable gains taken prior to the owner’s age 59 ½ are subject to a 10% surtax (penalty) in addition to the full amount being included as taxable income.
Loans are considered distributions and are taxable to the extent of gain.
Taxable loans increase basis to make sure that, if repaid, the gain is not again taxed.
Interest that accrues to the loan is considered a new loan and may be subject to taxation to the extent of gain remaining in the policy.
Review and discuss these key points.

11. 7-Pay Test: Cumulative
It is the purpose of this slide to show a 7-Pay cumulative test. Explain the slide to agents, and then move onto variations in premium funding that would not create a MEC as opposed to those that will.

12. 7-Pay Test: Okay to catch up
This slide shows how it is possible to under-pay the 7-Pay test in years 1-3 and then pay more than the annual test in year 4 because the total is less than the cumulative for four years. In other words, the limit has some flexibility.

13. 7 Pay – Does this pass MEC test?
In this example the client pays $4,000 in the first year, even though the 7-Pay Annual Limit is just $3,811. This causes the policy to be classified as a MEC, even though in subsequent years the cumulative premiums paid are less than the 7-pay cumulative limit.
TO EMPHASIZE. You cannot violate the Cumulative Funding limit in any year without having the policy classified as a MEC. In the first year it is the 7-Pay Annual Limit X 1. That’s it.
This slide shows why a premium that violates the annual test in Year One will be classified as a MEC. It also demonstrates why virtually any policy that is funded as a true Single Premium will invariably be treated as a MEC.

14. Single premium policies…
A single premium policy will always fail the 7-Pay test and therefore be classified as a MEC
Clients should be fully informed of what this means.
In many instances this remains a positive way to solve the specific need identified.
Single premium policies are one way to fully utilize the benefits of life insurance in a MEC policy. There is a positive effect on future non-guaranteed cash values and net death benefit by using the ALIR premium at the outset of the policy.
In guaranteed universal life type policies a first year dump-in may create the largest total death benefit for a given total premium.

15. Who fits a MEC
There are generally two distinct types of clients looking to purchase life insurance:
Maximum cash value
Clients who typically hold their cash assets in guaranteed accounts and who do not want to risk losing principal.
The primary purposes of the MEC policy is to maximize cash accumulation with an income tax-free transfers to heirs.
Maximum death benefit with little or no cash value
These are often created using a secondary guarantee universal life policy or second-to-die universal life policy with little or no cash accumulation.
There are generally two distinct types of clients who consider MEC’s:
those who want maximum death benefit for a single premium, without regard to cash accumulation. These are often created using a secondary guarantee universal life policy or second-to-die universal life policy with little or no cash accumulation.
Clients who typically hold their cash assets in Certificates of Deposit or Fixed Deferred Annuities, and who do not want to risk losing principal. The primary purposes of the MEC policy is to maximize cash accumulation and the amount of after-tax money that transfers to heirs.
Remember – if they don’t’ need life insurance, this is not a good client fit.

16. How to design a MEC For those who want cash Non-Guaranteed Dividends
Typically, these clients will select a whole life policy with the minimum face amount, so that most of the single premium is applied to the ALIR (Additional Life Insurance Rider) to purchase Paid-Up Additions. ALIR paid-up additions have guaranteed cash value in addition to the base policy and that is eligible for non-guaranteed dividends, as declared.
Second-to-die whole life policies can also be used to enhance cash accumulation.
Non-Guaranteed Dividends
Purchase additional paid-up additions,
Paid out in cash to the client each year to provide a modest income, while preserving the life insurance cash value and benefits for future needs and for heirs, subject to gain-first taxation and 10% if the owner is under age 59 ½ when the withdrawal is taken.
Let’s start with those who are interested in keeping their cash, with a secondary focus on life insurance protection. Typically, these clients will select a whole life policy with the minimum face amount, so that most of the single premium is applied to the Paid-Up Additions Rider, which has a guaranteed cash value and that is eligible for non-guaranteed dividends, as declared.
To be a true, guaranteed single premium, the cash value of paid-up additions should be sufficient that by surrendering paid-up additions there is enough available to pay the small premium on the base policy each and every year for the life of the contract. Dividends earned simply increase policy net cash value and net death benefit, but are not required to keep the policy from lapsing.
Dividends can be used to purchase additional paid-up additions, or can be paid out in cash to the client each year to provide a modest income, while preserving the life insurance cash value and benefits for future needs and for heirs.

17. An example:
Male Age 65 with $250,000 of non-qualified money and wants life insurance.
Qualifies for life insurance
Desires tax-deferral and guarantee of principal
Doesn’t anticipate spending money from this fund, but wants to keep it “just in case”
The following comparisons look at a high early cash value whole life policy, survivorship whole life.
Read the bullets

18. High Early Cash Value Whole Life as of 10/15/2009
High Early Cash Value Whole Life as of 10/15/2009. $100,000 base, excess to buy paid-up additions (ALIR) in the first year. Premiums on the base policy are paid with APO/ALIR surrenders in subsequent years. Yr
Age
Out-of-Pocket Premium
Current Cash Value
Current Death Benefit 1 66
$250,000
$243,689
$523,830 5 70 $0
$303,606
$554,303 10 75
$389,887
$605,810 20 85
$628,325
$765,457 35
100
$1,194,809
This slide illustrates the potential cash accumulation and gross death benefit that can be earned under current interest rates and assumptions using a High Early Cash Value Whole Life. Reduced dividend scale is as of 10/20/2009 and dividends are NOT guaranteed.
PLEASE NOTE: To be a true single premium, the amount of premium paid to the ALIR in the first year should be sufficient to provide APO/ALIR surrenders in subsequent years that can fully offset the base policy premium even at a zero % dividend assumption. In this case shown there is sufficient cash value in ALIR to assure that.
This is important to understand because a lower premium to the ALIR in year 1 could result in required out-of-pocket premiums in subsequent years if non-guaranteed dividends are insufficient to fully offset the base policy premium using APO/ALIR surrenders. In that case you could not state with confidence that the policy is a Single Premium policy.
This slide is not approved for use with the public and is provided for the sole purpose of agent training.
HECV Whole Life Male Age 65 – Ultra Preferred. $100,000 Base Face Amount, balance to ALIR. Hypothetical Current Values which assume premium is paid with Alternate Premium Option in Year This slide must be accompanied by a complete MassMutual policy illustration and distribution of this slide to the public is prohibited. Dividends are NOT guaranteed. Values as of October, 2009

19. Survivorship Whole Life as of 10/15/2009
Survivorship Whole Life as of 10/15/ $100,000 base, excess to buy paid-up additions (ALIR) in the first year. Premiums on the base policy are paid with APO/ALIR surrenders in subsequent years. Yr
Age
Out-of-Pocket
Premium
Current Surrender Value
Current Death Benefit 1 66
$250,000
$242,965
$671,334 5 70 $0
$304,668
$714,499 10 75
$406,774
$788,480 20 85
$710,877
$1,023,329 35
100
$1,369,906
$1,559,387
This slide illustrates the potential cash accumulation and gross death benefit that can be earned under current interest rates and assumptions using a Survivorship Value Whole Life policy. Reduced dividend scale is as of 10/20/2009 and dividends are NOT guaranteed
PLEASE NOTE: To be a true single premium, the amount of premium paid to the ALIR in the first year should be sufficient to provide APO/ALIR surrenders in subsequent years that can fully offset the base policy premium even at a zero % dividend assumption. In this case shown there is sufficient cash value in ALIR to assure that.
This is important to understand because a lower premium to the ALIR in year 1 could result in required out-of-pocket premiums in subsequent years if non-guaranteed dividends are insufficient to fully offset the base policy premium using APO/ALIR surrenders. In that case you could not state with confidence that the policy is a Single Premium policy.
This slide is not approved for use with the public and is provided for the sole purpose of agent training.
Male and Female Age 65 – Ultra Preferred. $100,000 Face Amount. Hypothetical Current Values. This slide must be accompanied by a complete MassMutual policy illustration and distribution of this slide to the public is prohibited. Dividends are NOT guaranteed. Values as of October, 2009

20. Maximize Death Benefit
Clients who are not concerned about cash accumulation can apply the single premium to universal life or survivorship universal life.
Consider two examples:
This slide indicates the amount of guaranteed death benefit that can be purchased for a single premium, assuming client Male Age 65 Ultra-Preferred and for Survivor universal life a Female Age 65 Ultra-Preferred as well.
This slide is accurate for the age and risk classification indicated as of 10/20/2009. It is for comparison purposes only and should not be shared with the public. For Agent Training only.

21. UL Guard-2 as of 10/15/2009. Yr
Age
Premium
Current Cash Value
Current Death Benefit 1 66
$250,000
$188,432
$856,831 5 70 $0
$151,848 10 75
$45,322 20 85 35
100
This slide indicates the amount of guaranteed death benefit that can be purchased for a single premium, assuming client Male Age 65 Ultra-Preferred.
This slide is accurate for the age and risk classification indicated as of 10/20/2009. It is for comparison purposes only and should not be shared with the public. For Agent Training only.
UL-Guard 2 Male Age 65 – Ultra Preferred. Solve for Face Amount using a $250,000 single premium. This slide must be accompanied by a complete MassMutual policy illustration and distribution of this slide to the public is prohibited. Dividends are NOT guaranteed. Values as of October, 2009

22. Survivorship Universal Life-GUARD as of 10/15/2009.Yr
Age
Premium
Current Death Benefit 1 66
$250,000
$203,043
$1,295,389 5 70 $0
$213,493 10 75
$197,848 20 85 35
100
This slide indicates the amount of guaranteed death benefit that can be purchased for a single premium, assuming client Male Age 65 Ultra-Preferred and for Survivor universal life a Female Age 65 Ultra-Preferred as well.
This slide is accurate for the age and risk classification indicated as of 10/20/2009. It is for comparison purposes only and should not be shared with the public. For Agent Training only.
Male and Female Age 65 – Ultra Preferred. Face Amount Solve with $250,000 Single Premium This slide must be accompanied by a complete MassMutual policy illustration and distribution of this slide to the public is prohibited.

23. Single Premium MEC Alternatives $250,000 Single Premium: Male Age 65 UP. Female 65 UP.Rates as of 10/2009 Yr
Age
HECV WL NSV
Survivor WL NSV
UL Guard 2
NCV
SUL Guard NCV
HECV
NDB
Surv. WL NDB
UL Guard 2 NDB
SUL Guard NDB 1 66
$243,689
$242,965
$188,432
$203,043
$523,830
$671,334
$856,831
$1,295,389 5 70
$303,606
$304,668
$151,848
$213,493
$554,303
$714,499 10 75
$389,887
$406,774
$45,322
$197,848
$605,810
$788,480 20 85
$628,325
$710,877 $0
$765,457
$1,023,329 35
100
$1,194,809
$1,369,906
$1,559,387
This is a comparison of the four single premium alternatives previously noted. Values are as of October, 2009 and include non-guaranteed policy values, including cash value and death benefit purchased by non-guaranteed dividends.
Dividends are NOT guaranteed so actual performance will vary. It is illustrative of the power of the tax-free life insurance death benefit to transfer value to beneficiaries.

24. MEC vs. Non-MEC
Many producers and clients continue to ask a very basic question about MECs, “How much does it matter if a policy is classified as a MEC?” Although there is no way to answer this question definitively, the following may help to clear up some misconceptions and explain why virtually all clients should carefully weigh the pros and cons, and consider potential unanticipated events, before deciding to accept a MEC. Basically, two areas require some clarification regarding the impact of MEC status:

25. MEC vs. Non-MEC Taxation Tax Penalty
There are two key disadvantages of a MEC that apply without regard to the owner’s age. First, unlike non-MECs, distributions come out as income-first, making them taxable for any policy having gain. Second, policy loans are treated as distributions, as distributions, again making them taxable for any policy having gain. This taxation significantly reduces the value of the MEC policy’s accumulated cash value to its owner.
Tax Penalty
Taxable distributions from a MEC are subject to a 10% additional tax unless an exception applies

26. Conclusion
Life insurance creates a death benefit. That is the primary purpose to purchase life insurance.
Whole life policies have guaranteed values and are eligible for non-guaranteed dividends that clients may value.
Secondary Guarantee UL policies create a fully guaranteed death benefit where cash accumulation is nominal.
Taken together, these products can help clients reach their financial objectives.
In today’s troubled economy clients are interested in safe places to put their money. Assuming that a legitimate need for life insurance exists, life insurance policies funded as Modified Endowment Contracts offer additional choices for clients to consider.
Whole life policies provide a guaranteed death benefit and cash value with the potential to qualify for non-guaranteed dividends that will enhance net cash values and net death benefits. They may be an attractive policy for clients to consider.
Guaranteed UL policies offer a guaranteed death benefit that will be of interest to clients who wish to transfer money to heirs with the tax benefits that are enjoyed by life insurance policies.
Consider your clients – are there any with whom you should have a discussion about policies classified as a MEC?

27. Questions?