Life Insurance Broker Explains Modified Endowment Contract
As a skilled Life Insurance Broker, I often get questions from physicians and dentists about the modified endowment contract. A modified endowment contract, think of that as a limit the IRS puts on your contract. Something to think about is, you put money in your 401(k)s, IRAs, and you get certain deductions on your tax return, but all that is limited on the income you make. The IRS also has limits on life insurance contracts. Basically what that is, is there has to be a corridor between the death benefit you get and the premiums you put in the contract. What people were doing when life insurance was created was buying a small life insurance contract and over-funding at the high levels because of the tax benefits to it.
Now they run tests every year which is called the modified endowment contract test. You always want to pass that test and you do not want to fail. The reason being is because there are two ways you can take money out of your life insurance. There is the FIFO method; first in, first out you can withdraw your money. Then there’s the other side which is LIFO method, last in, first out for your money. The reason it’s important to pass the endowment contract test for the FIFO method is because you can first withdraw your basis, the first money you put in your contact and you don’t have to pay taxes on that. Then once you exceed your basis from taking money out, that’s when you can start borrowing money and get those tax advantages.
If you do not switch that test and get switched over to the LIFO method what’s going to happen is you’re going to have to take out the earnings first and that’s where taxes come into play. The big thing about life insurance contracts especially with a cash value is there are a lot of tax benefits and you don’t want to give that up. Make sure you don’t have a modified endowment contract.
If you are a physician or dentist and have questions about modified endowment contract, contact our professional Life Insurance Brokers for guidance. Let our experience work for you.