Annuities vs. modified endowment contracts

Although tax-deferred annuities will delay the due date of tax liability, taxes will eventually be due at some point because eventually the non-spousal beneficiaries will be required to take the money out of the contract and pay taxes.

Modified endowment contracts (MECs) are life insurance contracts that were created by an act of Congress in 1988, and can be designed to grow like deferred annuities — but with several advantages.

The biggest advantage is the tax treatment. Modified endowment contracts have an income-tax-free death benefit.

Secondly, they tend to be much more liquid than annuities. Advisers commonly recommend deferred annuities that typically allow for annual penalty-free access of up to 10 percent of the account value. MECs typically allow for access of up to 90 percent of the account value without any penalties.

Additionally, some insurance companies, such as TIA CREF, will — for no additional cost — allow penalty-free access to 100 percent of the account value. Like other fixed deferred annuities, MECs pay interest based on either a fixed rate, or a portion of the increases — but not the decreases of a stock index. For those looking for attractive growth potential without the risk of stock market loses, a fixed index MEC could be a viable alternative.

Many insurance companies are now offering MECs that not only provide safety, liquidity and growth potential but are also offering sizable tax-free death benefits that can be accelerated and accessed during one’s lifetime if there is a long-term care need.

This could be a more palatable way to plan for potential long-term care needs than a traditional LTC policy. These insurance benefits typically cost between
1 and 2 percent per year of the account value, depending on one’s age.