When does a Modified Endowment Contract make sense?

Lots of agents learn very early in their career that a Modified Endowment Contract is a bad thing. Perhaps it's because they hold the first-in-first-out and tax free via loan distribution privileges in such high regard that losing those benefits seems to kill the whole thing. I'll admit that these benefits are certainly coveted and optimal, but there are times when intentionally owning a modified endowment contract might makes sense, in fact a lot of sense.

I've stated before that MEC's might make a lot of sense as an alternative real estate play for older individuals and those looking for immediate income while not looking to give up complete control of their money as they would with most annuities that trigger an income benefit.

And that was one example of times when it might be a good idea. But we'd be super remiss if we didn't acknowledge that there are several other circumstances that might warrant the use of a modified endowment contract.

Check out this Fixed Annuity

Since MEC's have similar tax implications to annuities, it could make perfect sense to use one over a fixed annuity. Whole life and universal life insurance tend to yield higher than your traditional fixed rate annuity, and indexed universal life tends to have much more attractive cap rates compared to indexed annuities.

CD's are Guaranteed! To Lose Money…

Oh the certificate of deposit. A once common savings tool used by our grandparents back in the day when the local bank was owned by someone who lived in town. When the loan we took out stayed put and if we bailed on the payment we had to face our neighbors.

I'm not trying to deride banking modernity. But if you think the fractional reserve system the banking industry uses is safer than the reserving system the insurance industry uses you're going to have a bad time. That paltry interest rate coupled with the non tax deferred status makes CD's a bit of a dog. And what do you get for that near zero rate of return? The FDIC…(insert lack of enthusiasm here).

Let's not also forget that CD's not held in joint accounts, or a trust, need to go through the Probate process to transfer to your heirs.


Rich people tend to love them. Not as much as muni-bonds, but relatively speaking they are way safer, and who doesn't want to claim the the U.S. government owes them money?

The problem? Treasuries have almost always lagged life insurance yields, and they too come with the same less than optimal tax treatment certificates of deposit have. They also require the same probate process to transfer to heirs.

When it Does NOT Make Sense

It's good to take a moment and make a point of where this should be avoided. While there are more examples on this side than the other, I'm highlighting a few specific examples for which dumb/nefarious agents have been notorious.

College Planning

This suggestion drives me nuts. The suggestion is that a family with assets stuff liquid assets in a MEC in order to avoid disclosure on the FAFSA. While they are technically correct about this, there's a few problems.

First, if the family plans on using the funds for college, any gain will need to be withdrawn first and realized as income, this could seriously impact (hurt) financial aid eligibility down the road.

Second, if the owner is under 59.5 a distributions would be subject to the same 10% penalty tax that hits all retirement savings plans unless the owners uses a 72(v) distribution, which could result in way more distributions than desired.

Muni Bond Alternative

I know what your thinking. He likes it as an alt to treasuries but not muni bonds? While the safety and reliability play side of this makes sense. The tax free income does not. And people don't buy muni's for safety alone (or at least they shouldn't). Regular life insurance contracts can make a great alternative muni play, but modified endowment contracts do not.

Money Market Accounts

This one sort of splits on two possibilities for good idea/bad idea depending on intended use. If someone is storing cash in money markets simply as a safe place to store cash, than this could conceivably work.

But that's not how most people do it. Or at least that's not how they used to do it. Money markets have been a great beneficiary of the 2008 crash (despite the scare concerning their possibly losing value), but they largely represent high yielding checking accounts for people. Most money market accounts will issue check books (though they admittedly have restricted check writing), which is a feature life insurance contracts do not enjoy.

Now, if you're the type with a large money market position solely because you like that it doesn't go down, a modified endowment contract might make sense, but you can kiss the checkbook goodbye.

All Around Safety

The big take away is simple, a large liquid position could be a great candidate for a MEC. Especially if time isn't really on your side.

It also works exceptionally well when trying to leave a legacy, or simply a little money behind. For those of you with money in the bank you plan on leaving to someone or something, this strategy augments the money, and avoids a lot of legal wrangling and a good deal of tax headaches.

While regular life insurance is usually the more optimal approach, one should not fear modified endowment contracts simply for the sake of fearing modified endowment contracts.

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