Overfunding IUL for a 35-year-old: the MEC line and the 7-pay test in plain English

Clients hear "overfund your IUL" on social media and come in asking for it. Overfunding is the right idea and the wrong word. What they mean is: put in as much premium as the tax rules allow relative to the death benefit. The rule is the 7-pay test.

The 7-pay test. The IRS defines a Modified Endowment Contract as a policy that takes in more premium in its first seven years than a level-premium policy would need to be paid up in seven years. Cross that line and the policy becomes a MEC: loans and withdrawals are taxed as income, gains first, plus a 10 percent penalty before 59 and a half. The death benefit stays tax free.

Why it matters for the pitch. The whole tax-advantaged retirement income angle depends on the policy not being a MEC. The illustration software will show you the maximum non-MEC premium for a given death benefit. Design to a few percent below that line so a premium increase later doesn't tip it.

The tradeoff. Higher death benefit means more room for premium but higher cost of insurance charges. Lower death benefit means cheaper insurance but a lower MEC limit. The design work is finding the death benefit that lets the client fund what they want to fund.

Reduce paid-up additions later. Some carriers let the client lower the death benefit after the first few years, which can trigger a recalculation of the 7-pay limit. Know your carrier's rules before you promise anything.

A real number. A healthy 35-year-old who wants to fund $12,000 a year will typically need a death benefit in the mid six figures to stay non-MEC. If someone shows them a $100,000 policy taking $12,000 a year, it's a MEC or it's a mistake.

How are you documenting the MEC discussion in the file?