What is the penalty for early withdrawal from a Modified Endowment Contract?

In the context of a Modified Endowment Contract (MEC), the IRS imposes a 10% penalty on early withdrawals made before the age of 59½. This penalty applies to the taxable portion of the distribution and serves as a deterrent for individuals to access their funds prematurely. MECs are specific types of life insurance policies that are funded with more premiums than allowed by law, resulting in certain tax implications, including the early withdrawal penalty.

This penalty is significant for policyholders who may need access to their funds before retirement age, and understanding this is crucial for assessing the long-term implications of taking money out of a MEC. Additionally, withdrawals from a MEC can also be subject to income taxes on the gains as they are considered a return of investment rather than a life insurance benefit.