Which of these describes the result of a modified endowment contract that failed to meet the seven-pay test?

A modified endowment contract (MEC) is a life insurance policy that has failed to meet the seven-pay test, which is a measure established by the Internal Revenue Code to determine whether the premium payments on the policy have exceeded certain limits within the first seven years. When a policy becomes classified as a MEC, it alters how withdrawals and distributions are taxed.

The correct answer indicates that pre-death distributions from a MEC are typically taxable. This is significant because, unlike traditional life insurance policies, which allow for tax-free death benefits and certain tax-advantaged withdrawals, MECs treat distributions differently. If the policyholder withdraws funds or takes loans against the policy, the amount of those distributions is subject to income tax, particularly on any gain in the policy. Furthermore, if the policyholder is under the age of 59½, an additional 10% penalty tax on the earnings may also apply.

In contrast, other options do not accurately reflect the implications of a MEC. Policy loans are still permitted even if the contract is classified as a modified endowment, so option about loans being disallowed is not accurate. Premium payments are not tax-deductible in this context; they are generally made with after-tax dollars. Finally, while withdrawals may