The modified capital agreement is mostly an unfavorable reclassification of a life insurance contract that removes it from most tax benefits as cash value as life insurance has.
There are several subtle but important tax consequences of owning an MEC. A large and often overlooked is the taxable income that is reported on outstanding loans for capitalized loan interest. This means that when you take out a loan, it will bear interest. When you have an MEC and your cash value is greater than the sum of the premiums you paid, you create a loan taxable income. The additional loan interest rate can be additional taxable income if you allow the interest rate to become part of the outstanding loan. <! – ->
So many agents learn very early in their careers that MECs are bad, and most people who study life insurance come with the same impression.
Although not all situations involving a modified capital agreement necessarily mean doomsday, the reasons for owning are small and long in between. That said, how easy is it to actually have one?
How do you avoid a modified capital agreement?
You avoid the modified capital agreement by either not paying a premium that violates the 7 salary test or not reducing the death benefit from a level that violates the 7 salary test while you are still in a 7-year test period. This sounds simple, and in truth it is. But for the layman, this is a much more daunting task. <! – ->
We address this because many people worry that their life insurance will be a MEC. Many people get away with the impression that it can happen by mistake and then they are up in the proverbial sewer without means of propulsion.
But is this fear justified? Our vast experience says no.
Everyone should understand that all life insurance companies test cash value life insurance for MEC compliance with each premium received. If a breach occurs, the insurer notifies the insurer. In fact, most insurers return the premium to the insurer or keep the premium in limbo pending instruction from the insurer on what he or she wants to do with the access premium.
So even if you do not pay much attention to your policy and you cross the line that violates the 7 Pay test, the insurer will intervene and make sure that you really intend to do what you are doing.
We have never seen a situation where an insurance company allowed someone to pay a premium, break the MEC test and no warning occurred. On the contrary. Lots of alarm bells go out.
So there is really good news here, it is really the policyholder's responsibility to find out if he / she has a member. The insurance company will take care of this for him / her.
But what about life insurance ledgers that say the police will eventually become an MEC?
This is based on planned premiums in the future. There is nothing you can do about policy issues that will ensure that your policy eventually becomes an MEC. In other words, the form can not be thrown at you when it comes to MEC violation. You must either pay a premium or reduce the death benefit during the estimated violation. This means that you can avoid the future estimated violation simply by not doing what the general ledger assumes you will do that year. <! – ->
But what about people who buy an MEC in question without knowing it?
Hard to do. Very difficult to do. The industry adopted abundant information that does not allow the prospective policyholder to move forward without signing the fact that he / she is buying a modified capital agreement.
Here is an example of such disclosure from a large mutual insurance company: 
I highlighted the section that specifically calls the purpose of this disclosure. Also note that the title of this bold document at the top right reads: Modified Endowment Contract Notice and Acknowledgment .
Any MassMutual policyholders (current or potential) who take action against a life insurance policy issued by the company that violates the 7 Pay Test must sign this form.
Can an amended capital agreement be reversed? Pay for tests and prevent the creation of a modified capital agreement. You do this by requesting that the insurance company repay the premium you paid that violated 7 salary limits. You have up to 60 days after the end of the policy year in which the infringement took place. This is quite a lot of time for most situations, and this takes me to my next point.
Given all the warnings and time you have to avoid / reverse a 7 Pay violation, the notion that you can accidentally create one MEC, do not know, and then do nothing about it becomes more questionable by the other. <! – ->
We have even encountered a few situations where the insurance company made a mistake and thought a breach occurred when it did not. Several warning letters were issued and we were more than welcome to cancel the payment that created the violation. When the company recognized its fault, it turned out that there was nothing to do. A minor inconvenience, but also peace of mind knowing that the system is triggered.
Conclusion: It's not that easy to create an MEC
So some of the MEC horror stories you can read about on interwebs are largely overwhelmed by financial "gurus" who either want to cast a shadow over cash life insurance or who do not really know much about the subject. It is extremely difficult or not impossible to accidentally create an MEC and you really have to go out of your way just to buy one.
Of all the people I personally met an MEC, they either ended up with one when they first bought the insurance (eg a life insurance premium) or they intentionally paid the premium to a insurance that created a modified capital agreement. I can tell you more than a handful of times where our clients crossed the threshold of 7 payments and received an adequate warning that this premium is turning their policy into MEC.