Goodbye, Membership Rewards

78

Let’s make a deal: right now you have 8 round trip airline tickets, but you have a chance to trade them in for a year of your retirement in relative comfort. Deal or no deal?

I love to travel. That love far predates my understanding of award travel, though my love of luxury travel is a direct result of countless hours spent studying miles and points. I have invested a lot of hours in this hobby and that investment has paid off with years of rambling down the yellow brick road of first class flights, 5-star hotels, and memories that will last a lifetime. Beyond the travel itself, one of my favorite things about miles and points is the feeling of freedom that comes from the knowledge that I have enough made-up funny-money currency to take off and go almost anywhere I want at the drop of a hat. The idea of giving up that freedom for 1.25c per point has never felt appealing, hence why there had never been a Schwab Platinum card in my household. That changed this week and I stand ready to pull the trigger on redeeming almost all of my Membership Rewards points. I can’t seem to kick the sadness in what feels like giving up future luxury travel dreams in exchange for something that won’t make any impact on my life for many years. But the magnitude of that future impact is too much to ignore, so I think I’m ready to say goodbye to my Membership Rewards points.

Thinking more about the 1.25c Schwab redemption

We recently reported on a long-standing rumor that the rate at which Membership Rewards points can be redeemed to a Schwab brokerage account would decrease from 1.25c to 1.1c per point on September 1st, 2021. In response to our post, a reader commented saying that redeeming points this way to a Roth IRA did not count against the annual Roth IRA contribution limit. We don’t know that this reader was correct, but we published a post about the concept yesterday after another blog highlighted the opportunity.

Of key importance is the fact that we don’t know that the interpretation offered by that reader and others we cited is correct. The fact that Schwab does not count Membership Rewards redemptions against the annual contribution limit tracker and does not account for those as contributions on the annual 5498 form it sends to the IRS and Roth IRA account holders does not definitively mean that Membership Rewards redemptions don’t count as contributions. And I believe the penalty for overcontributing is 6% of the overcontribution per year until it is corrected. I believe you may also be subject to a withdrawal penalty when correcting an overcontribution assuming you do not yet qualify to withdraw from your IRA. In other words, the penalty could be steep if you make a mistake here.

I am not a CPA, lawyer, financial advisor, or other wizard of tax and investment information, so take my interpretations here as not better than anyone else’s and certainly as being far less qualified than your own CPA, with whom I encourage you to confer before you make any decisions in this realm. This post is not legal, tax, or investment advice. Be entertained by my musings and do your own research.

I don’t know why Schwab doesn’t track Membership Rewards redemptions to a Roth IRA as contributions either in the activity tracker or on the form 5498 that they file with the IRS reporting contributions to the account. Maybe it’s poor IT and they don’t have it in the budget are too lazy to fix it. I imagine that Schwab has a CPA or two on its staff, but it is also certainly possible that they have just overlooked this. Maybe Schwab hasn’t noticed the fact that the amount of cash being deposited into IRAs somehow doesn’t reconcile with their accounting. Maybe they just don’t want the responsibility of figuring it out and expect the accountholder to do so. Maybe Schwab thinks that Membership Rewards redemptions shouldn’t count against the annual contribution limit but they are wrong (and they do disclaim that you should consult with your own tax professional about it in the terms). Ultimately, I don’t know why they handle it the way they do.

One explanation we see within the reddit thread to which I linked is that Schwab considers Membership Rewards redemptions like a bank bonus similar to a brokerage bonus for moving investments to a new custodian (which typically does not count against your annual contribution limit). While a Membership Rewards redemption feels different on the surface, I find the wording of the “Invest with Rewards” section of the application terms interesting for the way it refers to a Membership Rewards Invest with Rewards redemption. Bold here is mine for emphasis:

Invest with Rewards

This reward is only available to the Basic Card Member on a Platinum Card® from American Express Exclusively for Charles Schwab who maintains an eligible account at Schwab (an “eligible account”). An eligible account means (1) a Schwab One® or Schwab General Brokerage Account held in your name or in the name of a revocable living trust where you are the grantor and trustee or (2) a Schwab Traditional, Roth or Rollover IRA that is not managed by an independent investment advisor pursuant to a direct contractual relationship between you and such independent advisor. Additional Card Members and otherwise authorized third parties, including authorized account managers, may not redeem Membership Rewards points for this reward.

A Basic Card Member may redeem a minimum of 1 thousand and a maximum of 4 million Membership Rewards® points every 7 calendar days for this reward.

Redeemed points will be immediately deducted by American Express from your Membership Rewards® account. Schwab will deposit associated funds into your chosen eligible account within 4 to 6 business days, excluding bank holidays. Points are not refundable once redeemed.

This reward is subject to the Terms and Conditions of the Membership Rewards® program. Please consult with your tax advisor regarding the tax implications of any reward.

They repeatedly refer to this redemption as a “reward” and that they note that Schwab will make a deposit into your account. Does the fact that you are redeeming a “reward” with American Express and Schwab is essentially fulfilling that reward make the difference in terms of coding this differently than a contribution? I am certainly not qualified to answer that, but the terms drew my interest.  Elsewhere in the terms I noticed that it was worded similarly:

Invest with Rewards

Use Membership Rewards® points for deposits by Schwab to your eligible account.

Again, I don’t know that this means anything and I can’t emphasize in strong enough terms that you should consult with your own tax advisor. Please don’t make any tax or investment decisions based on the questions of a miles and points guy.

But let’s imagine for a moment that the hype is right and the naysayers are wrong: let’s imagine that Membership Rewards points can indeed be redeemed subject only to the program limitations above.  Is that enough to give up on my dreams of a family ANA round-the-world trip or one of ANA’s many other sweet spots?

Thinking about the long-term implications

I have had a Roth IRA for more than a decade and have always deposited the maximum amount with the hopes of my money growing for many years and simplifying my retirement with tax-free withdrawals, so I have a decade of experience with a Roth to give me perspective as to how it can possibly grow (though obviously past performance is no guarantee of future performance). On the other hand, I also have plenty of experience with award booking to know just how much fun it could be burning through my Membership Rewards points with travel.

Take a classic example of amazing value: round trip first class on ANA from Eastern/Central cities like New York, Washington, or Chicago to Tokyo would ordinarily cost upwards of $20,000, but when awards are available those same seats could be booked for just 120,000 Virgin Atlantic miles round trip (a 1:1 Amex transfer partner). With my collection of Membership Rewards points, my family of four could do something like that a couple of times (we’d never find award availability for four in first class, this is just an example). With 1,000,000 Membership Rewards points (just a theoretical large number of points), I could book 8 round trips like that. That’s $160,000 worth of first class flying. Each round trip from New York would be more than 24 hours of flight time — so we’re talking more than 8 days of first class flying with a million Membership Rewards points.

Alternatively, 1,000,000 Membership Rewards points could be redeemed for a $12,500 deposit by Schwab. If this idea of contributing it to a Roth IRA is correct, it could grow for the life of the account without ever owing taxes on the earnings. According to the Internet, average stock market returns over the long-haul have been 10% annualized (obviously this can vary wildly in reality and does not guarantee future returns). So how much could that $12,500 grow to become if returns over the next 30 years match historical returns?

According to an investment calculator, based on 30 years at 10% each year (and based on no other contributions), it would be worth….more than two hundred grand.

It’s not hard to imagine $218,118 funding an entire year or more of relatively comfortable retirement even assuming quite a lot of inflation over the next 30 years.

Let’s make a deal: Would you trade 8 days of first class flights to pay for a year of retirement?

Obviously that’s a question we face every day on some scale when we buy a coffee or a new iPhone or subscribe to HBO Max or open a new credit card with a $550 annual fee. And clearly there is no guarantee that money in any sort of investment account will actually compound at ten percent annually over the next 30 years. Goodness knows that invested money could drop to $0 in value, though if you’re investing broadly the chances of it being quite that dire seem low. At lower returns, the eventual value is less staggering. For example, a 6% annual rate of return only turns that $12,500 into $71,794. And what if it only averages 6% and I retire and need the money in 20 years? It would be just over $40,000. Those numbers are a lot less exciting.

Still, I had to stop and think about all that: even if that $12,500 only turned into $40,000 that I could use in my retirement tax-free, would that be worth the trade? If I were the type to ordinarily pay $20,000 per ticket for that ANA first class example, the answer would obviously be no. But I am certainly not that type of person. So if my options were:

  1. Use a million points to book ANA first class round trip to Japan 8 times
  2. Use a million points to put $12,500 into a retirement account

Which would I choose? As much as I love flying up front, when I look at those potential returns, I have a hard time justifying the ANA flights. Even if those 8 round trips only cost me $40,000 of retirement money — a pretty low-return scenario — we’re talking about $5,000 per round trip. Would I be willing to spend $20,000 to fly my family of four round trip to Japan? Heck no I wouldn’t. Sure, the price would be well below sticker price, but I’m not going to spend that kind of cash on flights alone.

Except that’s sort of what I’d be doing if I redeemed the points for travel. And I both love and vehemently hate the Schwab Platinum card and the Invest with Rewards redemption for forcing me to think about it. The truth is that if we completely throw out the Roth angle and we just assume depositing that million points into a normal taxable brokerage account and letting it grow for 20 or 30 years, we’re still looking at the returns shown above, just subject to tax on gains instead of being tax-advantaged. For all the talk about Roth to this point, ending up with a hopeful $100K-$200K in retirement represents a much wiser use of Membership Rewards points than all my fancy trips. The Roth angle makes a significant difference, but whether the money is invested in a Roth or a normal taxable brokerage account, the 1.25c redemption rate almost feels misleadingly low given that, at 10% annual growth, that money would stand to nearly double (though net would obviously be less than double if taxable, but still far more than 1.25c). That’s true about every cent in our hands today: they could all be worth a lot more in the future if we’re able to invest and hold and the market continues to perform. Obviously we all need to spend money to do things we want to do. Will my trip to XYZ be worth sacrificing a day of retirement? Will my new shoes today be worth an hour of retirement? Obviously I’ve made that type of trade plenty of times to enjoy the “here and now” and surely I will again several times by this afternoon. That concept is neither new nor original and I’m not going to turn into a FIRE-type person because of Schwab Invest with Rewards. Neither am I done with award travel, but I find it too hard to ignore the value of redeeming most or possibly all of my Membership Rewards points right now in exchange for a potential windfall in my retirement years. The potential growth is just too much to ignore.

Isn’t the same thing true with my Chase Ultimate Rewards points, Bank of America Premium Rewards points, and many other award currencies and/or cash back? It absolutely is. I have noted that Chase Pay Yourself Back has made me think of award redemptions in terms of the dollars and cents they will cost me since I could easily have cash at the grocery store with those points. The difference here with Membership Rewards is obviously the gamble as to whether or not one can indeed redeem the points for a Roth IRA reward. If true, it increases the long-term value of Membership Rewards points beyond the value of other transferable currencies. Indeed, it makes Membership Rewards points more valuable than the tangible currency in my pocket if I can redeem it for a tax-free reward that my money can’t buy. Indeed the funny-money is not so funny anymore. That’s the part of this that I couldn’t shake. Those luxury trips that felt like the goal of earning rewards pale in comparison to the potential future value with good old-fashioned saving for a raining day.

At the risk of being repetitive, I don’t know beyond a shadow of a doubt that the Roth angle is possible at a scale greater than the $6,000 you can ordinarily contribute in cash (subject to income limits), but if it is it makes it very hard to justify keeping Membership Rewards points rather than redeeming them. Even when the redemption changes to 1.1c per point it will be hard to ignore, though the current 1.25c rate and a healthy balance of points pushed me to open the Schwab card. I haven’t yet redeemed the points — despite all the logic of a couple thousand words and hours of contemplating this, I still haven’t been able to accept giving up on the travel and freedom that the points represent even though I don’t have impending travel to book. Membership Rewards have been my favorite transferable currency and it is hard to imagine a 0 balance. Maybe I won’t redeem all of my Membership Rewards points, maybe I won’t redeem any of them, or maybe I’ll clean house recognizing that by this time next year I could once again have a healthy enough balance of points and have bought myself a year of retirement by stepping outside my comfort zone with a 0-point balance. Truth be told, I have enough points in various airline and hotel programs that it’s not like I would be grounded for the year or two it would take me to build back up.

Bottom line

I never before considered redeeming Membership Rewards points at 1.25c each. At FTU’s Virtual Seminar this past weekend, Stefan Krasowski of Rapid Travel Chai said that redeeming points like that felt to him like giving up and I completely connect with that sentiment even as I write this post. Yet the long-term potential of a Roth IRA redemption is so compelling as to make me re-think travel redemptions. That’s a problem I’ve come to with Ultimate Rewards over the past year as well, though the sizable bump here if the Roth angle works puts the Schwab angle over the edge in terms of making it so compelling that I feel like it’s time to say goodbye to my current Membership Rewards balance and start over from scratch in building up. On the one hand, I suppose this push comes at the right time since I still don’t have much travel booked and have enough points in other programs to cover my travel needs for at least a year while I work on rebuilding the Membership Rewards balance. I can’t help but feel sad to say goodbye to the yellow brick road I’ve been paving with Membership Rewards points for years, but the future impact is too much to ignore. I’ll still enjoy luxury travel, just a little less than I may have and with other currencies for a while. That seems like a trade I can’t refuse. You win, Schwab. Deal.

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[…] of all, there were numerous commenters on that Frequentmiler post who said they wouldn’t do it. Additionally, there was a response article written that […]

rich

This is a case of Nick simply being wrong and should just admit it and move on.

I think people have made it clear it isn’t legal (which should have been obvious from the start).

[…] for to manipulate the last opporunity,  frequentmiler blog writer recommended to squander MR right into a Roth Individual Retirement Account, […]

Mike Chicago

As a tax and estate planning lawyer to the 1% for over 30 years, including with 2 of the largest law firms in the US, this is a really interesting post to me. There are many different intertwined issues here. I will comment on a few of them. I am a lawyer, but not your lawyer, so the following is not legal/tax/financial planning or any other kind of advice.

As others have pointed out, the limit on IRA contributions is not source dependent. Funds can be contributed to an IRA essentially by anyone – including the IRA owner’s spouse, parents, employer, etc. I don’t see how Amex (or Schwab) could possibly be the contributor here, but even if it was, it would not change the contribution limit. So for this hack to work, the MR award cannot constitute a contribution by anyone

The only argument I see that the MR award redeemed to a Roth isn’t a contribution is that it constitutes investment return. But is it? I do believe that to be Schwab’s position, at least with respect to their brokerage bonuses. I personally earned one with Schwab last year on a taxable account (it was a private offer due to the size of the asset transfer involved, but their position would equally hold for their public offers). I was advised by Schwab at the time that the bonus would be taxable, and in fact, the bonus was reported on a 1099 as interest income. The fact it was reported as interest income confirms Schwab’s apparent view that it constitutes an investment return. I don’t disagree that the bonus is taxable income, but I don’t really see it as investment return. I believe Schwab and the other brokerages have gravitated to this approach because that is how banks typically handle their account bonuses. However, the banks in most cases are required by federal regulations to treat their bonuses as interest. I do not believe there are any comparable regulations governing brokerage account bonuses. These account bonuses seem to me to be more in the nature of compensation income for services – i.e. perform the following services (open account, transfer assets and leave in account for a certain time, set up direct deposit, use debit card, etc) and we will pay you X via deposit to your new account. Of course, for taxable accounts, it doesn’t really matter whether the bonus is classified as interest income or services income, it’s non-preferentially taxed income either way. But it could make a big difference if the account was an IRA (Roth or otherwise). If it is compensation for services, it would be both taxable income to the service provider followed by a contribution by the service provider to the IRA. So how the bonus is classified by the IRS would make a big difference in whether it’s treated as a contribution. I’m not aware of any IRS guidance on this issue.

But even more importantly, I think there is a big difference between the typical bank or brokerage bonus and the redemption of MRs to a Schwab account. One can easily convert the MRs to 1.25 cents in cash by redeeming to a regular taxable account at Schwab, so effectively the cc holder is directing Amex to send the cash to a Roth instead of to him/her. I believe the IRS would treat that election as a contribution to the Roth. I think Fidelity is right and Schwab is wrong on this issue.

I agree with those who have mentioned you don’t want a dispute with the IRS. Even if you eventually win, the costs of defending the position will far exceed any benefit from a transaction of this relative size. The IRS doesn’t really have the time or resources to deal with things like this. That is until someone gets abusive, like the people who generated $300K on the old Blue cash. Would the IRS view a $12.5K contribution to a Roth as abusive? Would it matter if it was made in addition to the regular $6K? Who knows? But if Schwab wakes up one day and decides to change their position and report these to the IRS as Roth contributions on Form 5498s, at a minimum the IRS computers will automatically kick in and start sending bills for the overfunding penalties, which as Nick mentioned are significant.

How much are the MR points worth if this Roth hack is successful? Well, this is going to vary substantially from one person to another and is based on many assumptions, the main ones of which are (a) assumed investment returns, (b) assumed tax rates on that return if held in a taxable account, and (c) assumed length of time the funds would remain in the Roth. The higher/longer these are, the more the Roth hack is worth, and vice versa. None of these are easy to predict, even with the simplifying assumption that the entire amount is invested directly in domestic stocks and held for 1 year or longer, thus resulting in taxable income consisting entirely of qualified dividends and long-term capital gains. 

In calculating the $218K figure, Nick has stated an assumption for (a) investment return of 10%, and (c) time in Roth of 30 years. What about (b) tax rates if held in a taxable account? This is really a product of the nominal tax rate and the realization rate. Currently, our assumed components of return, qualified dividends and long-term capital gains, are generally taxed at rates of 15% or 20% depending on overall income. There is a long history of preferential tax rates on long-term capital gains, but not so much for qualified dividends. There is currently talk of eliminating these preferential rates for taxpayers with higher incomes. And these nominal rates could change at any time, although any changes are likely to be increases rather than decreases (tax increases would increase the value of the Roth hack). The largest component of the return is long term capital gains, and the taxes on those will depend on the realization rate. If someone never sells winners, then their realization rate is zero. OTOH, someone who likes to grab gains and move on quickly (but after one year), their realization rate will approach 100%. So it will vary widely from person to person. Also what happens at the end of the projection period? Currently we have tax basis adjustment to date of death value (the so-called “step-up”, although it can also result in a step-down), so for those who don’t plan to spend these funds during life, there is no cap gains tax in the taxable account at the end of the projection period, due to the basis adjustment at death. OTOH, if someone intends to use these funds in retirement, the investments will likely be sold triggering realization of all gains, for simplicity assumed to occur at end of the projection period.  I’m not sure where Nick comes out on all of this, but let’s assume 15% nominal tax rate, 50% paid annually and the other 50% paid after full liquidation at the end of the projection period.  Under these assumptions, $12,500 would grow to about $160K in a taxable account after a full liquidation and all income taxes paid at the end of the 30 years. So with the Roth at a value of $218K, we can calculate the value of the MR points if contributed to a Roth under these assumptions, as follows: $218K / $160K x 1.25 = 1.70 cents.

So this leaves 2 questions for Nick and anyone thinking of doing this hack:

1. Is it worth taking the tax risks for the difference between 1.25 cpp and hack value of 1.70 cpp (under the above assumptions, or another cpp based on your individual assumptions)? .45 cpp is $4,500 on 1 million MRs.

2. Is it worth it at all to cash in the MRs at a hack value of 1.7 cpp or even at 1.25 cpp? If the assumption is the 1 million MRs will buy 8 flights, are those flights personally worth at least $2,125 each (1 million MR @ 1.7 cents = $17,000 into 8 flights = 2,125 per flight).  Don’t forget to add in your personal value for the joy of free!  If yes, don’t do this hack, unless you are confident you will never need these MR points to meet your travel needs (in which case it makes sense to cash them, although personally I would not do the Roth hack).

Al K

Don’t do it to Roth
Do it to taxable
Money will still grow and will be worth more than most money or points or any travel hacks worth doing in the long run. Live local save money travel meagerly but enjoyably.

d*

Thanks Mike, I appreciated the analysis!

I agree that Schwab’s position is wrong and if the amount is not high, the IRS doesn’t care / have time to find you, but if Schwab changes their position and starts cutting paperwork, you’re screwed so why hassle with the IRS?

Mike Chicago

I just wanted to add that there are other solutions that would achieve your goals without the tax risks inherent in this Roth hack. One option that seems closest would be a Roth 401(k). It has the primary advantages of a Roth IRA (no tax on distributions generally, but no deduction going in), but with much higher annual contribution limits (more than the $12.5K being discussed). A disadvantage is that it’s more complicated to setup than just opening a Schwab account. Also, it cannot be setup by employees, it has to be setup by the employer (which includes a self-employed person). There are many other details which go well beyond the scope of this post.

Derek

Excellent analysis, Mike. I also want to point out that it’s possible to withdrawal money from a taxable account with effective long term tax loss harvesting and also withdrawing money when you are in a lower marginal tax bracket.

If you have a low enough taxable income (take the standard deduction, have a frugal lifestyle, live on cash and tax-deducted passive income), LTCG tax rate is 0% and you can withdrawal that money tax free 🙂

Kafka

How is this not the top comment? Excellent.
I’d point out that Schwab does advise keeping the amount “nominal.” Getting in a tussle with the IRS is never a good idea, but they seem much more reasonable than putative, especially when you’re talking about a smaller fraction (say, 10% of the limit, not over 200% of the limit).

“At Schwab, we’ve historically taken the view that these types of promotions and bonus awards deposited to an IRA, should be treated as bonus earnings and not a contribution. To address Internal Revenue Code prohibited transaction concerns, we have advised that such awards/gestures should be nominal (in relationship to the value of the account) and where possible, to avoid offers, promotions or account gestures that exceed the IRS maximum contribution limit applicable to IRAs for the year in question.”

Christian

I think that one aspect that wasn’t raised here is that many people don’t have 30 years to watch their investments grow. For you it’s great but cashing out a million points likely won’t have the growth potential for someone five years away from retirement where there’s a lot less time for compound interest to make the money grow.

Kafka

Agreed. Many people also don’t have time to go take first class flights.
I could see a shorter term value to this if you need money for education or a house down payment. In 10 years we expect a year of college to cost $75,000. If you’re selling that much stock from a regular brokerage, you’re likely pushing your regular income into an 8% higher tax bracket, especially if you have two kids.

[…] for to take advantage of the final opporunity, frequentmiler blogger instructed to money out MR right into a Roth IRA, reasonably than a brokerage account. […]

[…] to exploit the last opportunity, FrequentMiler suggested to cash out MR into Roth IRA account, instead of a brokerage account. This action has an […]

[…] to exploit the last opportunity, FrequentMiler suggested to cash out MR into Roth IRA account, instead of a brokerage account. This action […]

[…] to exploit the last opportunity, FrequentMiler suggested to cash out MR into Roth IRA account, instead of a brokerage account. This action has an […]

[…] 如此背景下,近日FrequentMiler的博主建议兑换MR时将存入账户选为Roth IRA。有Reddit数据点显示,Schwab会将存入金额算作account incentives,而不是算Roth IRA regular contribution并报告给IRS。这样一来,MR->Schwab Platinum->Roth IRA的方式似乎可以突破Roth IRA每年的存入限制。 […]

Robert

Wow – a firm’s failure (in this case Schwab) to report a contribution to a retirement account in your name doesn’t release you from the obligation to report that transaction. The very same issue has happened in the last few years with crypto and the IRS has come down on people despite the complexity of finding those people. https://www.coindesk.com/irs-seize-cryptocurrency-property-us-tax

In this case, you’ll be reporting distributions from a Roth IRA for which you don’t have related deposits. Per the IRS:

Taxpayer must report a Roth IRA distribution as an IRA distribution, regardless of how much, if any, is taxable. If you’re using Form 1040, it goes on line 15a; if using Form 1040A, it goes on line 11a.

In this case, Schwab will be reporting your withdrawls on a 1099. Not much effort required here for them.

Another Jeff

You just gotta get Greg to give you access to a Mega Backdoor Roth so you can have your cake and eat it too Nick. Y’all are big tech right? https://www.madfientist.com/after-tax-contributions/

Eric

Here’s what you should do: book those flights, then put $160k into retirement investments (tax free or not, the final vale will be a lot larger than the 200k you cite).

If you’re not willing to do that, those $20k first class flights were never worth $20k to you in the first place.

My crazy idea just illustrates that these outsized values people claim for premium travel are pure fantasy and should be disregarded. If you wouldn’t pay cash for it, it’s not “worth” that.

RD DD

I’m not 100% on this but I’ve seen comments online where ppl spoke to an EA and a CPA and they agreed it’s more of a rebate/investment return so makes sense that it is not taxable. That makes sense to mess As a CPA myself it just seems too hard/grey area so just going to pass on this one

mojo

So much unnecessary drama….

Why not simply look at it this way:

A. Keep the 1million Amex MR’s and spend them on future flights, or

B. Cash out via Schwab and fund your Roth IRA with those points instead of the cash you would *normally* use to fund your Roth IRA (up to the normal, published IRS limits). Use that now freed-up cash for something else (like funding your kids’ Roth IRA’s).

easy peasy 🙂

d*

see my above comment about the world not being binary. …or maybe it is now with all the polarization?

Sad to live in a total black and white world. I like greys and colors, too.

Last edited 1 year ago by d*
Kafka

You can’t fund your kids’ Roth IRAs beyond their earned income. If they have income, that would already be an option regardless of having MR on hand.
The benefit being discussed in this post is potentially having Schwab put a bonus into your Roth in addition to your own $6k/yr contribution. You’re talking about replacing part of your contribution.

John

1 MR cashed out at 1.25 cpp to a Roth IRA, assuming a 15% capital gains tax savings is 1.47 cpp, comparable to Chase PYB.

As you note, compounding would also apply to cashing out at 1 cpp to a taxable account. While this can be a helpful way to think about the opportunity cost of spending vs. saving, we don’t normally think this way. Nobody looks at a Starbucks menu and thinks “That’s $4 coffee is $30 in 30 years.” If we did, we’d live in a shack eating only rice and beans. It’s less anxiety inducing to set a savings rate and treat the rest as truly disposable. E.g., save 25% or $25k a year, whichever is more. The rest, you can do spend, save, whatever you want. If that level of savings requires cashing out points, cash out points. If it doesn’t, don’t.

Gaurav

Is being able to roll them all into a Roth this year crucual? Could you invest 6k this year and the balance next year? Or split 6k in each of your accounts? Or are you thinking of contributing your normal 6k and then adding on your MR redemption?

d*

wait, why are all the suggestions that this problem isn’t binary getting downvoted?

life isn’t binary. we don’t have to cash out all MR points at 1.25x. Cash some out if it makes sense to you at that redemption value and use it to fund whatever you need.

Gaurav

Not sure. It was an honest question but maybe I’m missing something obvious. Would have appreciated an explanation.

John R Power

Thanks for the article but I see several issues with what you said:
1) you have obviously never crossed swords with the IRS on anything. The uncertainty of the tax treatment should cause you to see huge red flags. Even if you turn out to be right on the interpretation, if you even become engaged in any type of dispute with the IRS you will lose….money, time, serenity at a minimum. “You don’t mess with the IRS” as the radio commercials say for good reason.
2) I disagree with your comparison. You are essentially mixing apples and oranges. These are two separate questions…..
a) is a 1.25c per mile “cash-out” a good use of my points vs. traveling? This is the same question you have commented on so well so many times for so many different uses of points. Using the points to fund a Roth IRA is simply an alternative to the millions of other uses of points…like buying goods from a web portal.
b) The other, separate question is whether an investment in my Roth IRA a good idea right now in light of my current financial picture. The investment in the Roth IRA has separate and additional qualifiers and results and doesn’t get any better or worse because it was done with points not cash.

Andrew Clark

This is exactly right. If the idea is that points aren’t worth accumulating for any other purpose than cashing out a huge core purpose of this site is lost. What you do with the cash is a separate issue. If you’re still planning to travel it seems that there is still utility in having points. I’d much rather be able to take an ANA round the world in J nowish than have 10k-30k in the bank in 30 years.

John

If one wouldn’t redeem their points for 1.25 each today, then this is a play for people bad at math / finance. $218k 30 years from now (assuming the given 10% CAGR) is worth $12,500 today. This is no different than trading / selling your million points for $12,500 today.

If you would anyway trade / sell your points for 1.25 cents today, then this is a good play.

But don’t think you’re trading $12,500 (or whatever you value the points at today) for $218,000. You’re trading $12,500 (or whatever you value the points at today) for $12,500.

Mark

I disagree with Nick’s posting of this article all together and it contains numerous issues, not the least of which that the headline clearly implies that Nick is ready to cash out all of his MR to do this right now.

With that said, if we accept Nick’s logic, I don’t think it’s fair to say that this is a play for someone bad at math or finance. According to Nick, this is a loophole that lets you exceed the $6K contribution cap. If that is the case *and you’re already maxing out*, then the points cannot be valued at $12.5K—these points are more valuable, arguably, because they can be placed into a Roth IRA unlike the rest of your money.

PeterSFO

No argument on the logic of your article of cashing out points for retirement savings but I do have an issue with the argument that MR is the first point you should cash out.

Assuming that there are no tax repercussions, which it doesn’t look like everyone agree with, in your example, you use 1,000,000 MR cashed out to $12,500 into a Roth IRA. After 30 years, at 10% annual compound growth, you end up with $218,118 tax free.

However, you could also pay yourself back with UR at 1.5 cents and take the money you save and invest it into a regular investment account. In the same scenario, you cashed out 1M points for $15,000 which ends being $261,741 after 30 years at 10%. I believe the base capital gains tax on investments sold after 1+ years is 15% which ends up with $222,479.

So if you used UR, you don’t have to take what seems like a pretty huge risk on what looks like an oversight or loophole for Roth IRA contributions and you end up with more money at the end of 30 years. (Not counting the tax you have to pay for cashing out the points since the difference will be minimal in the overall scope of things). Additionally, unlike any retirement savings where you suffer a penalty for withdrawing early, a standard investment account funds are more readily available.

I guess if you have more MR or like UR more than MR, it would make sense to take advantage of the Schwab deal before it turns to 1.1 cents/MR but if you are really making the argument of sacrificing on points redemption for luxury travel in favor of retirement planning, cashing out UR makes more compelling sense.

rallydave

Don’t forget those imaginary 10% returns on the market are based on the indices and are NOT net of fees. If you actually buy and sell the stocks, fees are almost gone however most invest in funds, ETF’s and the like and there are fees involved which reduce the return by several percent. Bad Bad Idea!!!!

anonymous

Some ETF expenses are under 0.03% and can be bought and sold fee-free.

Last edited 1 year ago by anonymous
MickiSue

This argument is too black and white for my taste. I AM retired. And the reason I still travel hack is to TRAVEL.

At your age, you certainly have any number of ways to slice and dice that pile of MRs. Instead of first class, fly J to Japan, use 1/4 your points on a family trip and invest 3/4 of them.

Divide them up some other way.

When I invest, and reach a threshold, I take out my investment and keep the rest growing. Obviously not in the Roth.

But if you already have a good investment plan for your retirement, than gilding the lily doesn’t make it more beautiful. It puts you in the position of denying yourself the experiences that give you joy for the possibility that you will have much more than enough in the far future.

OTOH, if you do not have a good retirement plan in place, then a windfall should be invested, and you don’t need to think about it.

ed k

I gave up on MR points after I tried to use their own charity program and they goofed big time in a number of ways. I had done it before with no problems. They didn’t even care that it was all going to charity. I use other cards now, but that’s just me.

BGoode

I’ve cashed out $20,000 in 2021 so far, all into my index funds. Definitely give and take but hoping in the end, it’s more take.

anonymous

Nick, I’m convinced that you get paid by the word, buddy. Lol! 😀

Jags

Here is what Fidelity says about depositing rewards from their 2% card into an IRA/Roth IRA/529. TLDR: it counts as a contribution even if it’s not being tracked by the brokerage house.

  • How does the Fidelity Rewards Credit Card work if I elect to deposit my rewards in a tax-advantaged IRA or a 529 plan at Fidelity? 
  • Here are some things to keep in mind if you want to deposit your Fidelity Rewards into these accounts:
  • All IRA and 529 plan contributions resulting from the card will be considered current-year contributions. The ability to contribute to an IRA or 529 college savings plan account is subject to IRS rules and specific program policies, including those on eligibility and annual and maximum contribution limits.
  • To the extent that you are not eligible to make an IRA or 529 plan contribution or have already made your maximum IRA or 529 plan contribution for the year, any additional contributions can subject you to IRS excise taxes. It is your responsibility to ensure that any deposits to your Fidelity account are eligible contributions and do not violate the terms of your Fidelity accounts, applicable IRS contribution rules, or limitations or other applicable laws or regulations. Consult your tax advisor concerning tax consequences.
  • Prior to accepting the transfer of Points from Elan Financial Services, Fidelity will verify whether you have reached your maximum contribution amount with Fidelity for that year. If we determine that you have fully contributed to your Fidelity IRA accounts for that year or reached the maximum contribution limit on your Fidelity-managed 529 plan account, Fidelity will not accept the Points transfer, and your Points will continue to accrue at Elan Financial Services. Customers can continue to let Points accrue until the next year, or they can redeem these Points for other rewards, such as travel, merchandise, gift cards, or statement credit.
  • Under IRS rules, individuals who do not have earned income are generally not eligible to make IRA contributions. Spousal IRAs are not eligible.
  • IRS rules also prohibit IRA contributions from being made to Traditional and Rollover IRAs for the year an IRA owner reaches age 70½ and beyond.
  • If you are also making contributions to another company’s IRA, Fidelity is unable to monitor whether you have maximized your total annual IRA contributions, and we will not be able to stop the reward contribution from going to your Fidelity IRA.
Emily

So cash out what you have in MR but then use a cash back card like Citi Double Cash and invest the money you save. No annual fee. If you invest in a cheap index fund you’ll save on fees and have more control and fewer tax issues. Yes, it doesn’t have the fun of your rewards going directly into the account but how much are you willing to leave on the table?

Adam

I’ll just leave this link to the Fidelity Cash Rewards FAQ for how Fidelity handles redeeming it’s cash rewards into an IRA. The pertinent question is the 3rd one down. I don’t think Schwab knows something Fidelity doesn’t.

“All IRA and 529 plan contributions resulting from the card will be considered current-year contributions. The ability to contribute to an IRA or 529 college savings plan account is subject to IRS rules and specific program policies, including those on eligibility and annual and maximum contribution limits.

To the extent that you are not eligible to make an IRA or 529 plan contribution or have already made your maximum IRA or 529 plan contribution for the year, any additional contributions can subject you to IRS excise taxes. It is your responsibility to ensure that any deposits to your Fidelity account are eligible contributions and do not violate the terms of your Fidelity accounts, applicable IRS contribution rules, or limitations or other applicable laws or regulations. Consult your tax advisor concerning tax consequences.”

https://www.fidelity.com/cash-management/faqs-rewards-credit-cards#

rallydave

Believe your 10% rate of return on a Roth investment is extremely overstated. Historically stock market investments have averaged below 5% and with the markets now all at all time highs you could lose your shirt investing your points into your rogh.

John

7% is what most people use when talking about historical real (inflation-adjusted) equity returns. Kind of useless to use nominal (non-inflation-adjusted) returns.

CAPE is currently 37. Historically, it’s 17. Assuming reversion to the mean, it would be a 4.3% annual real return over 30 years.

loungeabuser

There’s a reason for the requirement that “Past performance is no guarantee of future results.” Just ask people from other countries.

Peter

If you just count the price tag of the indices, returns have indeed been below 10%… but once you factor in dividends it gets to about 10%.

loungeabuser

As a former CPA friends are always asking me about taxes. The most frequent question I get is . “can I deduct XXXXX?” I always answer: ” You can deduct anything you want. However, that does not make it deductible”

The most recent question was from a vendor whose wife deducts all their personal trips to Costco. I told him to stop talking because I didn’t want to be required to testify against him.

I’d recommend to reads of this blog they concentrate on getting their income to a point where they cannot make Roth contributions.

Dima

There’s always backdoor Roth contribution option…

loungeabuser

Correct, assuming you have earned income or an existing IRA. Now, go do some root canals if you’re the Dima I’m thinking of.

loungeabuser

Or a 401k

Cavedweller

L
All my money spent on CPA’s and Lawyers has been well spent . Mine I can get a reply in mins. or hours because I Pay .
Keep posting and the good work .
Soon or later they will Tax points so spend while u can !!!

Ben

Even if you have to pay 15% capital gains, cashing out UR at 1.5cpp is better than MR at 1.25cpp (1.5 * (1-15%) = 1.275).

Your opportunity cost point is correct and should be in the back of your mind throughout this hobby. But the Schwabb deal is not so magical you need to test tax laws.

Jags

It’s a false equivalency. You can earn so many more MR than UR that it’s unfair to compare the cash value when you don’t consider the volume of points involved.

SC Parent

If you’re considering cashing out your MR points at 1.25 cpp, I hope you’ve already cashed out your UR points at 1.5 cpp with the CSR. I’ve done that over the past year and am very happy about that decision. It’s so easy to earn more!

DSK

+1 to Reader’s comments. As a retired attorney with every different type of retirement account you can imagine, it would never, ever, EVER occur to me to contribute more than the IRS limits on a retirement account and depend on a lapse in reporting by Schwab. Suppose two years from now Schwab picks up the problem and sends corrected forms. Now you need to amend your tax return and pay penalties that would destroy the value of what you were trying to do. Again, this is not legal advice and I am only giving my personal opinion of what I would do. I don’t mess with the IRS, especially in the hyper-technical area of retirement accounts. I love the HOBBY because it lets me slide carefully through holes in the rules, not completely break the rules. Also, losing airline miles or an AMEX bonus is totally different than dealing with the IRS and losing retirement savings.

Stvr

I made a similar decision to cash out my 2 million Amex points in may 2020 when I was angry that my Summer travel had all been canceled. I didn’t know about the IRA angle. I just made regular investments. That money has now doubled. Which obviously buys me a lot more flights with cash than the rewards would’ve achieved in the last year

Robert Jones

I’m with you Nick. I wouldn’t play this game with the IRS but cashing out MR made more sense to me. I’ll be moving the money I put in the Schwab brokerage out to get the annual fee discount and closing it. Along with closing the Schwab Platinum and Gold card. I still might look into the Morgan Stanley Platinum for the lounge access but this will be the end of me collecting MR. Time to stop kidding myself that this coupon book of a credit card setup is worth holding onto.

david

Lol this can’t be considered “gaming” anymore. This is negligent at best, criminal at worst. And an estimated 10% CAGR for the next 30 years? From current peaks? Lmao you’re crazy, Nick Buffett.

Larry K

If (big if) you could contribute 1,000,000 MR points as $12,500 to a Roth without regard to the annual cap or even if not qualified for Roth by the income limits, this is the biggest no brainer since buying coins from the mint for anyone more than a year or two from retirement. The joy of free posts from last year were interesting for analyzing close calls but this is not a close call. Ten percent is not realistic but even more modest returns make this an incredible value for wealth creation. (Not tax or accounting or investment advice.)

Last edited 1 year ago by Larry K
Reader

While I agree with the overall dilemma in this article regarding the keep vs. cash out question, I think it’s reckless to suggest taking advantage of Schwab’s flawed IRA contribution tracking.

Don’t take this internet comment as professional advice, but as a licensed CPA I feel the need to clarify you’re not absolved from reporting a taxable event just because you didn’t receive the proper tax form. If you choose to ignore total contribution rules for the IRA you’ll be required to file Form 5329 with your individual taxes next year and you’ll need to report this excess contribution. There will be penalties involved and the excess will need to come out of the IRA. Failing to file will only make things worse if and when the IRS finds out.

Nevertheless, if you were to instead reframe this article as choosing to keep vs. cashing out to a regular taxable brokerage account I think it’s still an equally intriguing question. You’d of course need to factor in expected 15% capital gains tax on any gain but assuming you held until retirement the net profit would still be fairly high.

Reader

Okay, I understand you, as the author, think this is a gray-area. However, I assure you I wouldn’t even bother commenting if I thought this was open to debate.

I highly encourage you to at the very least add a footnote to the article explaining this is highly likely to cause tax complications. In support of this, I’d refer you to Pg 9 of IRS Publication 590-A which clearly states that unlike 401(k)s (certain 401(k) contributions are not subject to normal limits), there is no distinction in how a contribution is made to an IRA in determining whether or not it’s subject to the limit – you cannot exceed the IRA contribution limits under any circumstances. Please additionally refer to Lines 9, 10, 18, and 19 of Form 5329.

Reader

I can tell you’re not really interested in changing your mind so this will be my final comment.

Double check the “How Much Can Be Contributed” subparagraph on 590-A Pages 8 (traditional IRA) and 38 (Roth IRA).

Keep in mind we’re talking about about total dollars contributed to the account during the calendar year. It’s irrelevant how these dollars are classified. If you’re still unsure, I encourage you to read the remainder of the 590-A as well as the instructions to Form 5329.

ATTN Other Readers: please do your own due diligence if following the IRA advice in this article.

Peej

Correct. Nick is just not getting it or refusing to. Schwab’s lack of reporting isn’t a hack or trick to let you exceed IRA contribution limits legally.

No one is stopping anyone from contributing $6000 to an IRA at Fidelity and $6000 to Schwab in the same year. That would be does exact same as what Nick is talking about: exceeding the $6000 limit.

Larry K

I am not a CPA and this is not advice. To me the issue is not whether the contribution is made by “another entity.” I think the question of bonuses is a gray area that the IRS has not really been too concerned about to have anyone test it. But to the extent it’s defensible as not being an excess contribution I think the basis for that decision is more supportable as recognizing it simply as investment income. It is not just that it is paid by another but that it is paid based on activity involving a balance in the investment account and thus at least arguably can be described as ROI. I think it’s much harder to conceptualize conversion of points to cash in that manner and I think there’s a substantial risk that the IRS would look at the economic reality of the situation. Again, I am not a financial planner or CPA. The tenor of the comments here seem to be that in gray areas involving taxation and possible penalties the far more sensible approach is to err on the side of caution. This is my personal approach but obviously everyone’s different.

Mark

I think Larry hit the nail on the head with his analysis. I’ve also been struggling to understand how a transfer bonus can qualify as ROI but the Membership Rewards conversion would not, and the answer seems to be whether you can characterize the money as coming from activity in the IRA account. The transfer bonus is based on how much you move, so it passes the test. Also, for example, Etrade lets you count multiple accounts toward the transfer bonus, but distributes the bonus into the accounts proportionally to how much you bring in from each one. So this further demonstrates that the bonuses are based on activity in the account. However, with the Schwab conversion, even though the conversion is advertised as being a feature of your Schwab account and Schwab Amex card, you are able to convert points that were not earned with the Schwab Amex. That makes it harder to argue that the points are some sort of bonus from your Schwab account activity.

PeterSFO

I think the argument that the reader is making is that the cap is $6k regardless of where that money is coming from. It’s not Schwab that’s contributing to your Roth, it’s you converting your MR into cash and then making a contribution. Your Merrill brokerage argument isn’t equivalent because you still have to make the contribution into your Roth IRA.

Or put it this way, would you consider contributing $6k to your wife’s Roth IRA after she’s at her limit? According to your argument, you are a different entity from her so you should be able contribute the same amount. Another scenario is if you get to exceed your 401K contributions if you changed jobs midway through the year, the two companies are different entities – it’s $X TOTAL, not $X from a source.

I’m usually a big fan of articles on this site but this goes beyond the typical YMMV posts. In those, the worst that can happen is you end up without points and with something you didn’t really need, while this has long-term financial impact. I think the article should be written with cashing out to a normal investment account as the focus (which is still a lot of money) and maybe reference the Roth IRA loophole for those who like to live dangerously, not the other way around. Hell, cash out $1250 to your Roth and then only contribute $4750 for the rest of the year and put the remaining $1250 towards college funds or something. There are so many other ways to go about this without trying to pick at the letter of the law.

stoppingBY

I think the misinterpretation is that “Merrill” or another entity is contributing to the Roth account. The flow would work as if you cashed out the points, the cash hits your account, then “Merrill” deposits that into your account. Steps might be combined or removed, but from an ownership of the money standpoint, I think this is how it works.

Even employers can’t contribute to an employee’s Roth account.
Can my employer match my designated Roth contributions? Must my employer allocate the matching contributions to a designated Roth account?Yes, your employer can make matching contributions on your designated Roth contributions. However, your employer can only allocate your designated Roth contributions to your designated Roth account. Your employer must allocate any contributions to match designated Roth contributions into a pre-tax account, just like matching contributions on traditional, pre-tax elective contributions.”

Source:https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts

Robert

You did not read page 38 very carefully. It is made explictly clear:

If contributions are made to both Roth IRAs and traditional IRAs established for your benefit, your contribution limit for Roth IRAs is
generally the same as your limit would be if contributions
were made only to Roth IRAs, but then reduced by all contributions for the year to all IRAs other than Roth IRAs.

The IRS uses language specifically talking about accounts established for your benefit in language on other accounts (401k, SEPs, etc) as well.

Whether you open and establish an account or someone else does for your benefit, it must be reported. Period.

For example, IRS Publication 17, page 87

https://www.irs.gov/pub/irs-pdf/p17.pdf

Roth IRAs and traditional IRAs. If contributions are made to both Roth IRAs and traditional IRAs established for your benefit, your
contribution limit for Roth IRAs is generally the
same as your limit would be if contributions
were made only to Roth IRAs, but then reduced
by all contributions for the year to all IRAs other
than Roth IRAs. Employer contributions under a
SEP or SIMPLE IRA plan don’t affect this limit.

But, yeah good luck arguing against the IRS that the $12,500 deposit in your name into a Roth wasn’t for your benefit… You might not get caught, but you certainly can’t claim compliance with the laws if you do.

Mr. K

This is crazy talk. Just imagine what the world would be like if what you are proposing was actually true. Every bank would be doing this. They would be advertising it. Suzie Orman would be doing shows about it. It would It would be financial malpractice not to do it.

YoniPDX

Please consult Peter Thiel CPA – Thiel has over $5B in his Roth And only has to wait til 4.2027 to withdrawal tax free.

Now if you had converted 480,000 MR into $6K and bought $6K of Doge coin in an early January through a ROTH and Sold it at the near the peak….

Peter

I am even more interested in the question of… if not a contribution, then does the MR conversion count as a capital gain at time of distribution? I mean if we don’t report it as a proper contribution on tax forms now, would it be entirely missing from the cost basis of the account? If so, the entire amount plus gains would be subject to tax when withdrawn? Curious about Reader CPA’s take on this (as a potential outcome) as well…

John

It’s a Roth. There’s no tax at distribution.

Robert

It most certainly is a contribution. ANYONE making a contribution on your behalf, whether an employer, a financial institution or a relative. Any contribution to an account on your behalf counts against the limit and must be reported.

Cavedweller

Reader
Good for u my points are funny money no points no Travel ever. My CPA I show everything ,I’m still trying to figure out why he doesn’t do this .
I sleep well at nite and my CPA loved his 100% bonus last year too, not this year. He once saved me from Tax on $250K.
Take Care

JL100

I don’t think you can compare first class flights and a Roth contribution. I get that they can be alternatives, but an exaggerated comparison. A better comparison would be spending cash now for domestic flights, or using Amex rewards, which would basically be equal. If you give up the amex rewards and spend cash on flights you would be taking anyway, in other words, not luxury flights but basic trips, you haven’t gained anything for your retirement. That is how I use my membership rewards, and I contribute the max to the Roth.