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Minimum non-MEC Face Amount / Maximum non-MEC Premiums

A minimum non-MEC face amount is the initial death benefit on an IUL policy providing the least death benefit possible for a given premium and not have the policy be classified as a Modified Endowment Contract (MEC) for income tax purposes. The reason to the limit the death benefit is to cut down on cost of insurance (COI) charges levied against the policy by the insurance company, so as to allow the biggest possible amount of the premium to be applied to cash value accumulation. This assumes that the policy is designed using the Guideline Premium Test (GPT) to qualify as life insurance for income tax purposes. Alternatively, one could use the Cash Value Accumulation Test (CVAT). This would allow an even greater amount of premium to be contributed in relation to the early death benefit. However, in later years, the CVAT design forces relatively higher amounts of pure insurance as compared to the GPT and, thus, higher COI charges. Most plan designs stick to the GPT.

Maximum non-MEC premiums for a GPT policy involve both an annual test and a 7-Pay Test. In other words, there is a formula limiting the maximum annual premium and another formula limiting cumulative premiums during the first seven policy years. If there is a "substantial change" to the policy after the seventh year, such as a change in death benefit or death benefit formula, a new seven-pay period can occur.

When considering using IUL as a tax-favored capital accumulation vehicle, the advantage of  these tests is that one may take advantage of the catch-up privilege for any prior years in which the maximum allowable premiums were not paid in. This differs from IRAs or 401(k)s, where the opportunity to contribute the maximum amount expires each year with no ability to make up the difference in future years..

A smaller amount of death benefit can be used if the policy is designed with the increasing death benefit option as compared to the level death benefit option. (Back to IUL Table of Contents)

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