Collateral Assignment of Modified Endowment Contract: An Overview
A modified endowment contract (MEC) is a type of life insurance policy that has been funded with a large sum of money in a short period of time. MECs are typically used for estate planning and wealth transfer purposes, as they offer tax-deferred growth and a death benefit to heirs. However, MECs also come with certain restrictions, such as an early withdrawal penalty and limited access to the cash value.
For individuals who have an existing MEC, but require additional funds, a collateral assignment of the MEC may be a viable option. In this article, we will explore what a collateral assignment of MEC is, its benefits, and how it works.
What is a Collateral Assignment of MEC?
A collateral assignment of MEC is a legal agreement between the policy owner and a lender, where the MEC is used as collateral for a loan. The lender has a lien on a portion of the death benefit, which serves as collateral for the loan. The policy owner retains ownership of the MEC, and still has access to the cash value of the policy. The death benefit is paid to the lender first, and any remaining balance goes to the policy owner`s beneficiaries.
Benefits of a Collateral Assignment of MEC
There are several benefits to using a collateral assignment of MEC, including:
1. Access to additional funds: By using the MEC as collateral, policy owners can access additional funds to meet their financial needs.
2. Tax advantages: The loan proceeds are not taxable, as they are not considered income. Additionally, the interest paid on the loan may be tax-deductible.
3. Retain ownership of the policy: Policy owners retain ownership of the MEC, and can still access the cash value of the policy.
4. No impact on death benefit: The death benefit is only affected in the amount of the collateral assignment, which is typically only a portion of the overall benefit.
How does a Collateral Assignment of MEC work?
The process of obtaining a collateral assignment of MEC involves several steps:
1. Identification of lender: Policy owners must identify a lender who is willing to offer a loan using the MEC as collateral.
2. Agreement: The policy owner and lender enter into a legal agreement outlining the terms and conditions of the loan, including the amount of the loan, interest rate, and repayment schedule.
3. Collateral assignment: The policy owner assigns a portion of the MEC`s death benefit to the lender as collateral for the loan.
4. Disbursement: Upon approval, the lender disburses the loan funds to the policy owner.
5. Repayment: The policy owner is responsible for repaying the loan, including the principal amount and interest, according to the agreed-upon schedule.
A collateral assignment of MEC can be a beneficial option for policy owners who require additional funds. It allows them to retain ownership of the MEC while accessing the cash value of the policy. Additionally, the loan proceeds are not taxable, and the interest may be tax-deductible. As with any financial decision, it is important to consult with a financial advisor and consider all options before pursuing a collateral assignment of MEC.