Which of the following statements is INCORRECT concerning Modified Endowment Contracts (MECs)?

A Modified Endowment Contract (MEC) is a specific type of life insurance policy that fails to meet certain funding criteria set by the Internal Revenue Service. The 7-pay test, which determines whether a policy is classified as an MEC, assesses if premium payments over the first seven years exceed the total amount of premiums that would have been paid under a 7-pay whole life policy. If a policy fails this test, it is considered an MEC.

The statement about an MEC always needing to pass the 7-pay test is incorrect. In fact, the opposite is true: an MEC does not pass the 7-pay test, which is why it is given that designation. This misinterpretation of the MEC definition distinguishes it from other standard life insurance policies.

The other statements accurately reflect the characteristics and implications of MECs. The classification of a policy as an MEC is specifically meant to curtail the use of life insurance policies as both investment tools and tax-advantaged savings, thereby incentivizing more appropriate life insurance practices. Moreover, distributions from an MEC do indeed come with tax implications and potential penalties if taken before the age of 59 ½, aligning with IRS regulations.