25
May
How can Modified Endowment Contracts in Life Insurance be Helpful?
When deciding upon a permanent life insurance policy, there are many variables to consider. The importance of each of these variables really depends on the overall goal of the purchase. We have to ask ourselves, “Why are we buying this life insurance policy?”
Some people buy life insurance to financially provide for a spouse or children in the event of an untimely death. This is a traditional view of life insurance.
What is a modified endowment contract?
Some life insurance agents encourage people to buy life insurance because of the ability to over-fund the policy. The excess cash value is then available to use for many different reasons in later years. (Keep in mind that this only works in much later years. There is no real benefit during the first 15 or 20 years.)
One of the challenges with over-funding life insurance policies is the way the IRS views the policy. There are limits as to how much money can be added to the cash value portion of the life insurance policy before it is no longer considered a life insurance policy.
If too much additional cash is added, the IRS views the policy as a savings vehicle rather than as life insurance. The term most commonly used for this type of policy is “modified endowment contract.” At that point, gains on any withdrawals taken are considered taxable.
How is this helpful?
While the idea of paying more in taxes is not normally seen as a benefit, let’s go back to the original question posed: “Why are we buying this life insurance policy?”
If the intent was to have cash available during retirement years, then this is not a good option. The additional taxes start as soon as withdrawals begin.
However, if the intent was to transfer funds to beneficiaries income tax free, then this option can work. The IRS only views this as a savings vehicle for withdrawals. It is still considered life insurance if not tapped until after the insured dies.
The modified endowment contract allows the cash value to grow on a tax deferred basis, and the death benefit is completely income tax free. Since the beneficiaries are named, there is no probate, offering complete privacy to the deceased and the heirs.
Many life insurance policies now offer additional features that allow the insured to control the distribution of the death benefit so that the heirs cannot misuse the life insurance proceeds.
Research shows that most beneficiaries spend the entire death benefit in less than one year, regardless of the amount of money received. Policies can be designed to control the payouts. Some even offer to make monthly payments to the beneficiaries for the rest of their lives.
What if I need access to the money?
Even though it is a modified endowment contract, the policyowner will always have access to the cash value. The main caveat is that gains are taxable.
However, if there is a critical or terminal illness, many life insurance companies offer some type of long term care benefit. Terms vary, so it is important to research the options before purchasing the policy.
Read more: http://www.articlesbase.com/finance-articles/how-can-modified-endowment-contracts-in-life-insurance-be-helpful-4106769.html#ixzz1N1nIF0GR
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