Question

A "premature" distribution from a modified endowment contract (MEC) incurs a penalty tax of

A. 5%
B. 10%
C. 17.5%
D. 20%

Answer 1

A premature distribution from a modified endowment contract (MEC) incurs a 10% federal penalty tax. This is in addition to regular income taxation on the gains from the distribution.

Step-by-step explanation:

A "premature" distribution from a modified endowment contract (MEC) incurs a penalty tax of 10%. A modified endowment contract is a tax qualification of a life insurance policy where the premiums paid exceed the amount allowed to keep the full tax benefit of a normal life insurance policy.

Withdrawals from a MEC are treated differently for tax purposes, especially if they occur before the contract holder reaches the age of 59 ½. If one takes a premature distribution, it is subject to income tax on the gains and, additionally, a 10% federal penalty tax for distributions taken before the age of 59 ½, unless an exception applies.