Why MEC rules exist: people were stuffing large single premiums into life policies and then borrowing the cash out tax-free, using life insurance as a tax shelter. Congress responded in 1988.
The rule (IRC §7702A): a life insurance contract entered into on or after June 21, 1988 becomes a modified endowment contract if it fails the 7-pay test. The test: if the total premiums paid at any time during the first 7 contract years exceed the sum of the net level premiums that would have paid up the policy in 7 level annual premiums, the policy is a MEC. Put simply: fund it too fast, and it is a MEC.
What changes for a MEC:
Withdrawals and policy loans are treated as distributions, taxed income first (gain comes out first and is taxable).
Before age 59½, the taxable portion also carries a 10% additional tax, with exceptions for disability and substantially equal periodic payments.
Once a contract is a MEC, it stays a MEC.
What does not change: the cash value still grows tax-deferred, and the death benefit is still income-tax-free to the beneficiary. A MEC is still life insurance; it just loses the tax-free access to cash while living.