Modified Endowments (U.S.)
Modified endowments were created in the Technical Corrections Act of 1988 (H.R 4333, S. 2238) in response to single-premium life (endowments) being used as tax shelters. The Act of 1988 established the 7-Pay Test, which is a stipulated premium that would create a guaranteed paid up policy within 7 years from policy inception. If premiums paid to the contract go beyond (i.e. are higher than) the premium amount stipulated than the contract has failed the 7-Pay Test and is reclassified as a Modified Endowment Contract. The following new tax rules apply to Modified Endowment Contracts:
Distributions will switch from a First In First Out (FIFO) basis to a Last In First Out (LIFO) basis. This means that withdrawals will require the policy owner to withdraw taxable gain before withdrawing untaxable basis.
Policy loans will be realized as ordinary income to the policy owner and could be subject to income taxes in the year the loan is made.
Distributions (either withdrawals or loans) that go beyond the policy basis will be subject to a 10% penalty tax for policy owners under the age of 59.5 (this can be avoided by the use of a 72(v) distribution)
Once a contract has violated the 7-Pay Test the reclassification to a Modified Endowment Contract is irrevocable. Transferring funds from a Modified Endowment Contract to a new life insurance policy via the 1035 exchange privilege will render the newly issued contract as Modified Endowment Contract as well.
Read more about this topic: Endowment Policy
Famous quotes containing the words modified and/or endowments:
“Poetry presents indivisible wholes of human consciousness, modified and ordered by the stringent requirements of form. Prose, aiming at a definite and concrete goal, generally suppresses everything inessential to its purpose; poetry, existing only to exhibit itself as an aesthetic object, aims only at completeness and perfection of form.”
—Richard Harter Fogle, U.S. critic, educator. The Imagery of Keats and Shelley, ch. 1, University of North Carolina Press (1949)
“Women generally should be taught that the rough life men must needs lead, in order to be healthy, useful and manly men, would preclude the possibility of a great degree of physical perfection, especially in color. It is not a bad reflection to know that in all probability the human animal has endowments enough without aspiring to be the beauty of all creation as well as the ruler.”
—Caroline Nichols Churchill (1833–?)