All of the following statements are true regarding modified endowment contracts (MECs) EXCEPT

An MEC, or Modified Endowment Contract, is a type of life insurance policy that has surpassed the limits set by the IRS, specifically the 7-pay test, which assesses the maximum amount that can be paid into a policy during its first seven years. If a policy fails this test, it becomes classified as an MEC and therefore is subject to different tax implications.

The third option states that an MEC may be exchanged for another policy that is not an MEC. This statement is inaccurate because while 1035 exchanges allow for the transfer of policy values from one life insurance policy to another, when an MEC is exchanged, the new policy will also be classified as an MEC if it continues to exceed the 7-pay test limits. The tax treatment and implications do not permit a difference in classification simply through an exchange.

In contrast, the other statements are accurate reflections of MEC characteristics and their tax treatment. Policies that pass the 7-pay test are not classified as MECs, funds withdrawn from an MEC indeed follow last in, first out (LIFO) taxation, and MECs are indeed subject to less favorable tax treatment than standard life insurance policies, which allows for tax-deferred growth and other benefits. Hence, the understanding of what constitutes an MEC and