What primary effect does a Modified Endowment Contract (MEC) have?

A Modified Endowment Contract (MEC) primarily affects the tax treatment of policy loans and withdrawals. When a life insurance policy is classified as a MEC, it alters how the distributions from the policy are taxed. Specifically, distributions from a MEC are subject to a Last In, First Out (LIFO) tax treatment. This means that any withdrawals or loans taken from the policy are considered to come from the earnings first, which are taxable, rather than the principal, which is not taxable.

Additionally, withdrawals from a MEC can incur a 10% penalty if the policyholder is under the age of 59½, similar to early withdrawals from retirement accounts. This provision emphasizes the importance of understanding the implications of a policy's classification as a MEC, especially for clients who may need to access their cash value.

The other choices do not encompass the primary effect of a MEC. For example, while death benefit taxation is relevant in other contexts, it is not directly linked to the MEC classification itself. Beneficiary designations and contestability periods pertain to different aspects of life insurance policies and are not influenced by the MEC rules. Thus, the primary impact of a MEC is indeed in the realm of tax treatment for loans and withdrawals.