Last week's missive started a discussion about single pay designs and the fact that they can create a MEC (and last week's design was, in fact, a MEC). For most of us, a MEC is something we have been conditioned to avoid at all costs. However, as last week points out, sometimes a MEC can be not just OK, but the most appropriate design.

So let's clear up some confusion about what does and does not happen when a contract becomes a MEC:

• All cash value coming out of the contract will receive LIFO tax treatment
• All distributions will be taxable to the extent the exceed cost basis, even if taken out as a loan
• Any taxable distribution made prior to age 59 and a half will be subject to a 10% penalty

Sounds like we have given away all the tax advantages of life insurance by doing this, right? Technically that may be true when you consider just the cash value (we will deal with the death benefit in a minute), but there are a couple things to keep in mind:

• The only taxes due will be on the gain in the contract. No gain, no tax!
• The taxes are only paid when the money is taken out of the policy. Leave it in, never pay tax.
• The 10% penalty only applies to the taxable portion of distributions. No gain, no penalty!

So if we are buying the insurance for the death benefit (as we were in last week's discussion), the MEC issue is really a non-issue. Unless, of course, it impacts the death benefit. In last week's design the only role that cash value played was as an exit strategy. For those of you who asked for the illustrations, you already know that the cash value growth was minimal to non-existent. It was more about cash preservation than growth. No growth = no gain = no tax or penalties.

So now the last question for today: what about the death benefit? No impact whatsoever. It still passes tax free to the beneficiary. This makes sense if we examine the reason these rules exist. Prior to 1988 policy holders could stuff extremely large amounts of cash relative to the face amount into a life insurance policy. The tax deferral on inside build up made it an attractive option for high net worth individuals.   The IRS, however, wanted their cut, and legislation enacted in 1988 put the current limits in place.

Of course, there have been many additions to the limitations on premium funding over the years, and they all have acronyms just like this one. While many of them are hard limits, the MEC rules are simply something we need to account for in policy design. If the tax changes do not negatively impact the client based on their stated objective, then single pay away!