If a life insurance policy is deemed a Modified Endowment Contract (MEC), how are the withdrawals treated for taxation purposes?

When a life insurance policy becomes classified as a Modified Endowment Contract (MEC), the tax treatment of withdrawals differs from that of a standard life insurance policy. Specifically, withdrawals from a MEC are treated on a last-in, first-out (LIFO) basis. This means that any amount withdrawn is considered to come from the most recent premiums paid into the policy first.

Under this LIFO approach, any withdrawals are subject to taxation to the extent that they exceed the total contributions made by the policyholder. For instance, since the earnings (or gains) on the policy are considered to be withdrawn first, they are taxable as ordinary income. This contrasts with non-MEC policies, where withdrawals typically come from the cost basis first and can be tax-free up to the amount of premiums paid.

In summary, the treatment of withdrawals from a MEC as LIFO results in a taxation mechanism where the earnings in the policy are taxed upon withdrawal, aligning with tax regulation rules governing Modified Endowment Contracts.