Final answer:
A Modified Endowment Contract (MEC) is a cash-value life insurance policy that is over-funded beyond legal limits and therefore proceeds from the policy may be taxable. MECs retain the death benefit feature, but are treated differently for tax purposes, especially if funds are withdrawn before age 59½.
Step-by-step explanation:
The correct answer to the question is A. Modified endowment contracts (MECs). A modified endowment contract (MEC) is a type of cash-value life insurance policy that has been funded with more money than allowed under the federal tax laws. If a policy is classified as a MEC, it retains the death benefit feature of life insurance, but the tax treatment of the cash value differs from the treatment of non-MEC policies. Funds withdrawn from a MEC policy, including loans and partial surrenders, are taxable to the extent of gain in the policy, and may also be subject to an additional 10% tax if the policyholder is under age 59½. This is unlike traditional life insurance policies where the cash value can be accessed tax-free through policy loans and withdrawals up to the basis (the amount paid into the policy).