A Modified Endowment Contract can allow you to make attractive rates of interest without any stock market risk and without having to tie up your money.
This unique low-risk investment uses a special life insurance contract called a Modified Endowment Contract (MEC), which is a life insurance contract used primarily for cash accumulation.
The idea is to view MECs not as insurance policies, but rather as tax-efficient alternatives to CDs, Bond Funds, Money Markets, or other “conservative” savings vehicles.
Here’s an example that highlights all the benefits of a MEC.
Let’s say you have $100,000 in a CD, Money Market, or Savings account. This is money you don’t plan to need right now, but you like the idea of having it available just in case. In a money market, you’re probably earning less than 0.70% a year. In a 1-year CD, you might get 0.90 – 1.00% but you will also have an early withdrawal penalty. Whether you use the interest you’ve earned or not, you will have to pay tax each year on the little interest you earn.
If you move into some type of Bond (Treasury, Municipals, Corporate etc.), you start to get into more risks — including interest rate risk and even default risk.
Now, what if you take that same $100,000 and put it into a custom designed MEC from Tekeno Financial?
What do the potential returns look like?
The most popular interest earning method is based on the annual upside performance of the S&P 500 index:
The MEC Interest credit is the percent gained in the S&P 500 index from the beginning of the policy year to the end of the policy year. There is a ‘Cap’ which is the most you will earn in a given year, even if the index performs better than the cap. The current cap is 7.4%. If the index goes down, there’s a 0% floor, so regardless how much the index goes down, you won’t lose.
Here’s an example: You started the MEC when the S&P 500 index at 4,000 points and it goes down to 3,000 points (25% loss) in year 1, and recovers back to 4,000 points (33% gain) in year 2.
You would not lose anything in year 1, because of your 0% floor on down years. However, in year 2, you would have earned 7.4%. If you owned the actual index you would have the same money you had 2 years earlier! When you take away the down years, you have an excellent upside potential using a MEC, often times better than the actual index itself.
The insurance companies can raise or lower the ‘Annual Cap’ at the end of each policy year. Historically, the Caps are higher in times of higher interest rates and lower in times of low interest rates.
What has this interest method averaged in the past?
Many clients have averaged over 5.5%, and your future exact interest earnings are not known. However, clients that choose these contracts are very satisfied that they understand the guarantees that they don’t have market downside exposure.
Other Attractive Benefits:
Life Insurance: You will have a large income-tax-free life insurance benefit from the start, that will increase as your account value grows. That means if an insured died right after funding the contract, their heirs would get more than the $100,000 back income-tax-free. Depending on your age, maybe $200,000, $500,000 or more, tax-free.
Tax Deferral: Your money will grow on a tax-deferred basis as if it is placed in a tax-sheltered account like an IRA or 401(k).
When you withdraw money from a MEC, the interest earnings are withdrawn first, and you’ll pay ordinary income tax on those gains. The money placed in a MEC is ‘after tax dollars’, so upon withdrawal you’ll only pay taxes on the gains. The gains that are withdrawn before the owner of the contract turns 59 ½, receives an extra 10% tax, just as if you withdrew money from an IRA or 401(k). There are NO required minimum distributions (RMDs) ever!
In offering these policies, the insurance companies that Tekeno Financial use for their MECs, do not charge upfront sales load fees. This is where the real game changer is, as you have excellent liquidity, if you would like to withdraw your money.
A few companies have realized that their MECs are so attractive, and investors rarely withdraw their money unless they need it. Therefore, they don’t need to charge a large load fee to force you to keep your money in long term.
The total fees of the contracts which includes the life insurance benefit cost, is typically between 0.80% and 1.5% a year, based on the age and health of the insured. Many contracts guarantee a minimum interest rate that exceeds these costs.
Insurance companies are permitted to adjust these costs. The trend has actually been lower costs as people tend to live longer than they used to. You would also get advanced notice and have the right to simply withdraw your money if you didn’t like the new fees.
The bottom line is, having a properly designed MEC, it is possible to achieve guaranteed positive returns net of all fees every year, while still having the ability to withdraw your money at any point in time.
There are still more benefits to consider.
Upon the policyholder’s death, the full proceeds of the MEC are left to an heir (or heirs) free and clear of taxes.
This can make MECs attractive for everything from estate planning to saving for younger family members’ college educations.
Many MECs offer a built-in Supplemental Long-Term Care (LTC) benefit that kicks in if the insured person is unable to perform two out of six daily living activities.
For someone concerned about soaring medical costs, this could be a nice feature. If you can’t perform 2 of the 6 activities of daily living, or you get a permanent cognitive impairment. The insurance company allows you to accelerate portions of your life insurance benefit while you are still living. In most cases this payout is tax-free.
The insured person must go through medical underwriting (Often a brief telephone/online health interview, and sometimes a physical examination).
While this won’t be a problem for many people, applicants in poor health, or with serious diseases, would not be able to be the insured of a MEC. However, it is still possible to be the owner of a MEC with the life insurance benefit on someone other than yourself, provided the owner has an insurable interest in the life of the insured person. (It is usually permitted to own a MEC on your spouse or adult children.)
MECs are not available if your only residence is in New York.
Residents of the other 49 states need to simply apply for the MEC. If you happen to live in New York, you may still be able to get a MEC if you have interests in another state, such as a second residence.
We are often asked if a MEC can be owned by a Trust, and the answer is YES. In fact, we have a large client base of trust owned MECs. In fact, many trusts have found our MECs to be their most superior investment.
We only recommend contracts from top rated insurance companies. These companies have been in business for more than 100 years and boast very diversified business lines.
If you think a MEC may fit in your portfolio, please contact Moshe Fishman at 732-806-0017 or fill out the form below.