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Under IRC §7702A, a life insurance contract becomes a Modified Endowment Contract (MEC) if:
AThe policy's accumulated cash value comes to exceed the net amount at risk or death benefit during any one of the first 7 contract years following issue
BThe owner fully surrenders or lapses the policy for its cash value within the first 7 years following the original date of issue
CThe policy is issued to a proposed insured age 70 or older carrying a total face amount of under $50,000 at the time of issue
Cumulative premiums paid in the first 7 contract years exceed the net level premiums that would have paid up the policy in 7 years
Why this is the answer
IRC §7702A was added by TAMRA 1988 to curb single-premium and limited-pay life policies being used as tax-deferred investment vehicles. The 7-pay test compares actual cumulative premiums against a hypothetical schedule of seven level annual premiums that would fully fund the policy. If actual premiums exceed that benchmark at any point during years 1-7, the contract is a MEC for life and loses favorable distribution taxation. Material changes (e.g., increase in death benefit) restart the 7-pay clock.
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