Increase Cash Back Rewards Rates by Saving More for Retirement
I have previously described my affinity for cashing out points so that I can travel exactly the way I want. Many are cashing out more now thanks to Chase’s Pay Yourself Back feature. Specifically, you can get a cash back bonus of up to 50% at grocery stores, dining, and home improvement stores with this feature. Currently, this promotion ends on September 30th. But what if you could permanently redeem at an increased rate across all banks which offer cash back? You can! Here’s how to increase cash back rewards rates by saving more for retirement.
Is This You?
In my first path to financial independence article, I described saving up to the matching amount in my employer-sponsored retirement plan (401k, 403b, etc) right out of college. While I was happy at the time with my contributions, looking back I wish I had saved more in the plan. Perhaps some of you would like to save more for retirement but have not due to other financial commitments, whether they are necessities or extra stuff.
Or maybe you have more bank points, frequent flyer miles, and hotel points than you can use for the foreseeable future. More and more are in this position due to COVID-19 current events. Regardless, it’s worth knowing what your opportunity costs are, especially in cash equivalents.
What Can You Do?
Of course, you can cut your expenses in order to save and invest more for retirement. Also, you can cash out credit card rewards to cover your everyday expenses. By using cash back rewards to cover more expenses, you can instead take the saved income and contribute it to your employer-sponsored retirement plan or traditional IRA. And here’s the key: those contributions are pre-tax and not subject to federal or state income tax in the year they were earned. In doing so, your cash back rewards rates have indirectly increased thanks to your pre-tax contributions to your retirement plan.
How It Works
Here are the basic steps to increasing your cash back rates while saving more for retirement.
Step #1. Understand Your Situation
Determine what you currently contribute to your pre-tax retirement plan. Let’s say Sally Taxpayer is single, makes $75,000 per year, and contributes $5,000 to her 401k. The 2020 maximum contribution limit for 401k’s and other retirement plans is $19,500. That means she can contribute up to $14,500 more of her “earned income” to her 401k. There are two ways to obtain earned income: work for someone who pays you or own/run a business or farm. Why is this important? Because only earned income can be contributed to these retirement plans. This also applies to traditional and Roth IRA’s. Therefore, you cannot directly contribute credit cash back rewards to retirement plans. Using the above example, Sally can contribute up to $19,500 total to her plan in 2020 since she makes at least that much in earned income from her job. It’s also important to note that total employee contributions plus the employer match cannot exceed one’s earned income; also, there are other high end limits.
I recommend you look at options for cutting expenses in order to free up money for higher retirement plan and IRA contributions. But let’s say Sally doesn’t have any other options for cutting expenses. Using the previous numbers, Sally can cash out up to $14,500 in credit card rewards to cover her normal expenses (mortgage/rent, groceries, utilities, etc) and shift those savings to her retirement plan contributions.
Taking into account Sally’s situation, any cash back rewards she uses for normal expenses would allow her to contribute additional pre-tax earnings into her retirement plan that otherwise would be taxed at 22% (even taking into account the $12,400 standard deduction). Essentially, in this example, her cash back rewards are worth 22% more. Of course, if you already have money set aside in a travel budget, you can shift that money in the same fashion and instead use points/miles to cover the travel.
Step #2. Cash Out Your Desired Points Currencies
Next, cash out the points currencies of your choosing. Here’s a sampling of cashout rates:
- Chase Ultimate Rewards: 1 point = 1 cent, currently up to 1.5 cents
- American Express Membership Rewards: 1 point = 1.25 cents for American Express Platinum Card for Schwab holders
- Citi ThankYou Points: 1 point = 1 cent for cashout via mortgage check or for Prestige cardholders
- Discover (via Miles card): 1 mile = 1 cent
- Other direct cash back rewards based on certain banks’ cards, including PenFed PowerCash Rewards, Amex Blue Cash, Amex Blue Business Cash, Citi Double Cash, Chase Freedom, etc.
Step #3. Use Cash Back Rewards to Cover Expenses
This one is fairly self-explanatory. After receiving your cash back rewards, apply these funds directly to your necessary expenses and bills. Keep records, of course, so that you can track how much extra you can contribute to your retirement plan. Additionally, I would like to reiterate again to additionally work to cut your expenses to allow more saving for retirement.
Step #4. Make Additional Retirement Plan Contributions
Based on your extra savings via cash back rewards and cost-cutting, make additional retirement plan contributions. Based on your cash reserves and the flexibility of your financial situation, Steps #2 through #4 can be conducted in any order and repeated at your convenience. The key is to line up all of these activities in the same tax year to avoid potential tax surprises.
Reflecting On Increased Cash Back Rewards Rates
In Sally’s situation, her per point cashout rates for Chase, Citi, Discover, and direct cash back cards increase from 1 cent to 1.22 cents. For Amex Membership Rewards, her per point cashout rate increases from 1.25 cents to 1.52 cents.
And it gets even better! This doesn’t take into account her state income taxes. So, the additional tax savings due to having a lower state taxable income can also be incorporated into the increased cash back. State income tax rates vary widely, and some states do not tax employment income, so ensure to use the proper rates for your situation.
Let’s now review the points-earning side. Consider the elevated cash back rates in conjunction with the credit cards you hold or aspire to obtain. Here are just a few examples for Sally’s situation (again, I’m not including any additional state income tax savings):
- Discover It Miles: 3% cash back becomes 3.66% cash back on all spend, uncapped
- Chase Freedom/Chase Ink Business Cash: 5% category cash back becomes 6.1% cash back; $1.5k quarterly Freedom cap, $25k cardmember year Business Cash cap
- Amex Gold: 5% grocery cash back (via Schwab) becomes 6.1% cash back, up to $25k spend annually
- Amex Blue Business Plus: 2.5% cash back (via Schwab) becomes 3.05% cash back on all spend, capped at $50k annually
- All 2% Cash Back Credit Cards (PenFed, Citi Double Cash, etc): 2% cash back becomes 2.44% cash back, uncapped
Plus All of the Usual Investment and Tax Benefits
Besides increased cash back rates, you are enjoying investment and tax benefits of contributing more to your pre-tax retirement plan. Your investments grow tax-deferred, further contributing to potential exponential growth of your investments over the long term. Also, you are maximizing the pre-tax nature of the contributions today and have bought time to optimally determine how and when those investments are taxed. The taxable events could be when you are retired, or in other situations when your tax liability is low or zero.
Increase Cash Back Rewards – Other Considerations
Of course, this all presumes that a person is not already contributing the maximum to his/her pre-tax retirement plan. Also, you can apply this same process to maxing out your annual Roth IRA contributions, but these contributions will not be at the elevated cashout rates since those contributions are after-tax. But, in that case, the growth is all tax-free. In a sense, this is a double-dip, since you are indirectly using tax-free money (cash back rewards) to enable increased contributions of earned income to a tax-free growth account (Roth IRA). And if you already max out your retirement plan and Roth IRA contributions, you can always use your cash back for investing via your brokerage account.
To be clear, this overall process is not for everybody. Based on your goals and guiding principles, you may be more interested in redeeming your rewards (points, miles, or cash back) for travel. But if you are interested in your credit card rewards enabling more saving and investment opportunities, I think this play is worth consideration. Also, if you have points coming out of your ears, why not find ways to maximize cash back?
Finally, at the risk of stating the obvious, do crunch the numbers for your specific situation. I have hit the main points in this article but cannot possibly take into account every possible personal consideration. And, of course, use the appropriate updated tax rates, contribution limits, and other related information as you make your calculations.
Increase Cash Back Rewards – Conclusion
I’m writing this now because I wish I took advantage of this opportunity right out of college (or before). To many of you, this play to increase cash back rewards rates may not apply. But if this benefits just a handful of people (or maybe just even one person) out there, this has been a worthy exercise. What other ways have points and miles enabled you to save and/or invest more?
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