What test does the IRS use to determine if a life insurance policy is a modified endowment contract?

The IRS utilizes the Seven-Pay Test to determine if a life insurance policy qualifies as a modified endowment contract (MEC). This test entails measuring the cumulative premiums paid on the policy against a calculated limit over the first seven years of the contract. If the total premiums paid at any point during those first seven years exceed the sum of the seven annual premium payments permitted under the policy, it is classified as a MEC.

A policy categorized as a MEC has different tax implications compared to non-MECs, particularly concerning the taxation of withdrawals and loans from the policy. Understanding this classification is crucial for policyholders, as it can influence financial strategies and tax responsibilities.

Other options may reference different testing methods or concepts but do not align with the IRS's specific criteria for identifying a modified endowment contract. The focus on the Seven-Pay Test is essential for anyone working with life insurance policies and their tax implications.