By Potential loophole of cashing out MR into Schwab Roth IRA [DON’T] – US Credit Card Guide
One of the perks of Amex MR is the convenient way of cashing out at 1.25 cents/point using Schwab Platinum card. Unfortunately, there have been rumors recently that Schwab will lower the redemption rate in the near future.
Seeking to exploit the last opportunity, FrequentMiler suggested to cash out MR into Roth IRA account, instead of a brokerage account. This action has an additional benefit an expanding the Roth contribution limit, as discussed on Reddit that Schwab will label the contribution as “account incentives”, rather than the Roth IRA contribution reported to the IRS. Thus, the route MR->Schwab Platinum->Roth IRA appears to effectively break the Roth IRA annual contribution limit.
We analyze the tax consequence of this operation in the format of Q&A. Our conclusion is that we do not recommend this operation, either for the purpose of expanding the Roth space, or doing regular Roth contribution.
For simplicity, we will not regard this operation as the intermedia procedure of an indirect rollover.
We believe the answer is yes, according to the tax code.
Without considering rollover, there are two parts in the Roth IRA accounting for the tax purposes:
| Roth IRA | Source |
| regular contribution | cash deposit |
| earnings | gain/loss within Roth IRA |
The regular contribution is what you deposite into the Roth IRA, which is subject to the annual contribution limit. The earnings are what remains — it is the gain or loss resulting from the investment in the Roth IRA.
The MR, either from rebate or account openning bonuses, are benefits outside the Roth IRA investiments. Therefore they can in no way be regarded as Roth IRA earnings.
There could be exceptional cases. For example, the MR is the bonus of opening Schwab Roth IRA, or the gain of a particular investiment inside Roth IRA. Then they are earnings. A similar (and conventional) example is the cash bonus of opening an IRA. The cash bonus is not a Roth IRA regular contribution, rather it is regarded as the income deriving from opening and depositing funds into the Roth IRA, and therefore is the gain. Obviously, MR is obtained through business with American Express, not the Roth IRA investments under the custody of Charles Schwab. These exceptions do not apply.
One thing to note is that MR can not be directly deposited into Roth IRA. This is because the only way to make regular contribution is through cashIRC Sec. 408(a)(1)). So for tax purposes, cashing out MR into a Roth IRA should be regarded as constituting two steps:
- MR -> cash outside Roth IRA via Schwab Platinum
- cash -> Roth IRA
So if the total amount exceeds the annual contribution limit, the excess amount is the excess contribution of the Roth IRA. We will discuss the penalty below.
According to our analysis above, Schwab should report this contribution on Form 5498 after each tax season when the contribution amount is fixed. Form 5498 will be sent to IRS and the IRA owner, informing both parties the nature of this transaction. Yet, data points show that this is not the case. Schwab, due to various reasons, does not report this contribution on Form 5498, and the IRS is unaware of this transaction through the means of Form 5498.
However, we emphasize that the tax forms provided by the third party such as the brokerage firm are only meant to assist the taxpayer. It is the taxpayer has the liability to classify the nature of all the transactions (taxable/non-taxable, etc), and report on the tax form. Once the IRS finds out the transactions of depositing excessive amount of MR into a Roth IRA, Schwab may not be liable for this operatration; the taxpayer will be. And there will be penalties retrogressively for the passing years.
The IRS can certainly find out throught the transaction history of the Roth IRA, although they do not monitor it regularly. They could ask request taxpayer to prove that this transaction (depositing MR) is not a regular contribution, should they find any suspicious behaviors.
There is a 6% percent excise tax (penalty) for each year on the excess contribution remains inside the Roth IRA. Note it is 6% of the excess contribution, not 6% of the gain deriving from it.
We do not recommend this operation.
If it is within the annual contribution limit, the contribution by depositing MR will not be reported by Schwab. Thus from the IRS persective, it is not a regular contribution. Remember, the regular contribution of Roth IRA can be withdrawn at any time without tax or penalty. You do not want to lose that status by the Schwab’s erroneous reporting.
If it exceeds the annual contribution limit, then there is chance that the IRS will find out and retrogressively collect the 6% excise tax for each year.
Let us do a simple calculation to see if it is worth the benefit of tax free withdrawal of the earnings. Assumming the excess contribution to be M, then the excise tax for Y years is
M * 6% * Y
Assuming an 8% annual growth rate of the investments (the SP 500 value), the gain for Y years is
M * ( 1 + 8% )^ Y - M
If we regard the excise tax as an effective captial gain tax, then then rate is
6% * Y / ( ( 1 + 8% )^ Y - 1 )
We have ploted the effective rate vs the number of years of paying the penalty. It takes more than 30 years to reduce the effective rate below 15% — the current long term captial gain rate. It takes more than 20 years to reduce it below even 30%. And you cannot control the number of years. The IRS may start to collect the penalty next year. We believe this is not a good deal.
We do not recommend any form of excess contribution, considering the cost of dealing with IRS, and their additional attention on your tax form due to this challenge. Even if you want to deliberately break the law and pay the excise tax, it is not worth it.
Some people believe it is legitmate, see reddit discussion。
They are not tax/legal professionals, neither am I.
Proceed on your own risk.
We analyze the tax consequence of cashing out MR into the Roth IRA, and categorize it as regular Roth contribution.
We do not recommend this operation, even though Schwab does not appear to report this contribution on Form 5498. The annual 6% excise taxes applied on the excess contribution outweigh the benefits of avoiding the 15% long term captial gain tax, rendering this strategy not useful.
Please consult an tax/legal expert if you insist on using this strategy.
Reference ：frequentmiler comment section
Disclaimer: This article and any content herein are general introduction for readers only, and shall not constitute nor be relied on as legal opinion or legal advice in any form. We assume no liability for anything herein. If you need help about tax, please talk to a tax, legal or accounting advisor immediately.
