Estate Planning Means Protecting Your Last Resources

 

A modified endowment contract (MED) is also a money value life insurance contract within the United States in which the total premiums paid on a policy has exceeded the amount stated in the contract so that the policy is now worth less than the actual premium paid. The value of the modified endowment contract may differ each year, as well as the face amount (the amount stated in the contract). For example, in some contracts, the actual cash surrender value is not affected if the total premiums paid during the year are higher than the value of the policy (in other words, the excess premiums are repaid over time). In other contracts, the excess premiums are repaid only when the actual cash surrender value is higher than the premium paid. It is important to understand that the modified endowment contract differs from a pure life insurance product in that it offers two different methods for making payments, with both methods having significant financial benefits and implications for the policyholder and the plan.

One of the key features of the modified endowment contract involves a "cash surrender value" or CPR. This is an amount equal to the difference between the face amount of the policy and the actual cash surrender value of the policy. If at any point during the term of the policy, the face amount or the actual cash surrender value is greater than the value of the modified endowment contract, the policy becomes useless and no tax consequences will apply to the policy owner. When the policy becomes worthless, the policy owner has the option of renewing the policy for a new term beginning on a new date, thereby effectively renewing the passed down policy with a face amount equal to the CPR of the current modified endowment contract. Any additional payments that are made under this renewal provision will be taxable as ordinary income.

It should be noted that in all states, there are additional financial consequences to failing to pay the appropriate taxes on the modified endowment contract. With respect to the federal tax laws, these consequences generally include a 10 percent penalty on the overall gross revenue of the insurer and/or a 25 percent penalty on the payment of the premium. In addition, there are potential tax credits that the insurer may receive if it properly reported its death benefit or if it provided the proper death benefits for the named beneficiary. The federal tax laws also provide that, if the modified endowment contract was purchased within the applicable year, a pro rata share of the premium is paid by the insured to the insurer.

One of the advantages to the modified endowment contract versus a whole life insurance policy is that the premium payments are deferred until dispersal. With a whole life policy, premium payments are based on the death benefit level at the time of coverage. In most cases, whole life policies have very high guaranteed returns because they pay out large amounts of upfront. However, if the insured were to stop paying premiums, the death benefit would decrease and the amount remaining to be paid would be less than the face amount of the modified endowment contract.

Some states also require an insured to take a seven-pay test if the modified endowment contract has been terminated. Under the modified benefit plan, the premiums can be spread over a seven year period. If a person stops paying premiums during the first year, the death benefit does not increase and therefore does not trigger the seven-pay test requirement.

Modified endowments can be valuable tools for estate planning. However, understanding the financial risks associated with the plan is necessary. It is recommended that anyone who is planning a modified endowment contract should obtain the assistance of an experienced financial planning attorney. An attorney can make certain that the plan complies with all applicable state and federal laws. An attorney can also ensure that the wishes of the insured are met and that the plan is properly maintained. Because estate planning is complex and legally complex, it is important to work with a highly qualified attorney who specializes in estate planning. Find out how to no longer be tax-free here.

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See other useful information at https://www.huffpost.com/entry/time-to-check-your-life-insurance-policy_b_59c1d4a4e4b0f96732cbca49 .