There are a lot of claims for the ‘best’ credit card.
Really, finding the best rewards card is just about matching the right credit card rewards program to how you spend your money. Ideally, you should categorize your past transactions and compare that spend against each credit card’s rewards program.
For example, if you spent $1,300 on dining you would multiply that by the cash back or points rewards rate to see what the value of that card is to you. Do this for each card you’re considering so you can compare side-by-side by a simple dollar-value estimate.
If this sounds like too much work, there are sites that will do it for you for free. These sites finds the best card for you based on YOUR spending habits. While you do need to provide access to your bank and credit card statements, the data is secured by the same third-party service as other major fintech apps. It’s a surprisingly simple process.
Using Your Best Credit Card Really Matters
While lot’s of personal finance pundits will discourage you from using credit cards, the truth is that a credit card can be one of the most used and useful financial products you ever have. It’s true that you need to be diligent about paying your credit card off the right way, but if you’re responsible and play our cards right there are many ways that you can make credit cards work FOR you.
Using the best card for you results in hundreds – if not thousands – of extra dollars earned through the rewards.
Here’s the catch, the best card for you is likely different than the right one for your friend because everyone spends differently. To maximize your rewards, you can follow this simple process. If you do this correctly, you will earn enough rewards to book that dream vacation package, pay off debt, build your financial safety net, or begin working on any other goal that is important to you. All you need to do is follow some simple math.
First, some quick background.
Types of Rewards Credit Cards
There are hundreds of credit cards, each offering its own rewards and bonuses. It can get quite overwhelming at times picking out a card that best suits your needs.
However, it is vital for you to understand how different types of credit cards work in order to maximize your benefits and avoid debt accumulation.
Of course, the most desirable type of card is a rewards credit card. These typically come in three types. Cash Back, Points, or Miles. These cards give you rewards when making purchases and provide you with benefits for using that credit card more often.
In this article, we are going to cover the ins and outs of rewards credit cards: types of rewards, ways to earn rewards, and rewards redemption.
The goal is to find the value of how much a card is worth to you.
Rewards credit cards can generally be grouped into three categories: Cash Back, Points, and Miles:
Cash Back Rewards
The cash back rewards program is the easiest and most straightforward out of the three rewards categories. It allows cardholders to earn a certain percentage of cash based on the spending amount.
Some cards offer a flat-rate rewards program, meaning you can earn a specific percentage of cash back on all of your eligible purchases, regardless of the categories of spending. A common example is a flat 1.5% cash back rewards on all purchases.
On the other hand, some cards offer varying percentages of cash back depending on the spending categories. For example, 3% on dining purchases, 2% on groceries, and 1% on everything else.
Cardholders should note that not all cash back credit cards deposit cash rewards directly to your account for you to spend. Some programs only allow cardholders to redeem cash rewards as a statement credit to their account to reduce the account balance.
Another common way of earning credit card rewards is through a points rewards system. When cardholders make purchases with this type of credit card, they can accumulate points and redeem them for rewards such as hotel stays, cash back, gift cards, plane tickets, gift cards, and more.
Cardholders generally earn at least 1 point with each dollar spent on purchases. However, there are cards that offer bonus points for spending on specific categories. For example, 2x points per $1 spent on travel and dining.
Cardholders can also earn points in ways other than making purchases. Some credit cards offer bonus points when cardholders refer a friend to obtain the card, and some reward cardholders when they spend more than a certain amount within a few months of account opening.
The last type of reward credit card is specifically designed for hotels and travel. Banks typically brand the cards with an airline or hotel company and the rewards earned are redeemable specifically to these partner offerings.
Similar to the structure of points rewards cards, the travel rewards cards allow cardholders to earn miles through the associated frequent-flier program that can be redeemed later on as rewards such as hotel stays, theme park admission tickets, and airline tickets. The benefit of these cards tends to be higher rewards earned but less flexibility to redeem them. For example, 5x points back on any airline purchases and 1x points earned on everything else.
Ways to Earn Points
The key to maximizing rewards is to pick the right credit card that best fits your spending habits.
To order to maximize the amount of points you receive, you should:
1.) Analyze your past transaction history
2.) Figure out what categories you spent the most on
3.) Then apply for the credit card that rewards those categories the most
You can have this process done for you, for free as previously mentioned, or you can do it on your own. We will walk you through some examples. Don’t worry – it’s easy once you see it!
Generally, there are three ways in which you can earn credit card points:
You can be rewarded hundreds of dollars simply by opening a new credit card.
Typically, cardholders need to hit a certain spending target within a time frame in order to receive this welcome bonus. These thresholds can be as low as getting $300 after you spend $500 in the first 3 month you have the card. Some bonuses are big. There are a few premium rewards cards that offer over $500 if you spend $3,000 within the first 3 months of account opening.
To see if you’re likely to get these bonuses, look at your average monthly card statement. Simply multiply it by the number of months they give you to hit the welcome bonus threshold. If this number is higher than the threshold, you’re likely to get your big welcome bonus!
There are also some tips and tricks to meeting the minimum spend for a sign-up bonus, especially when you’re trying to earn multiple bonuses in a short amount of time. For instance, the Southwest Companion Pass requires you to collect 120,000 miles in a calendar year, which can easily be met by signing up for Southwest cards and earning the bonuses.
These are rewards that you earn only when you use your card for this type of purchase. Common examples: 3% on dining, groceries, or travel. Multiply the rewards rate by the amount you spend on these categories.
Think of this as the ‘base rate’ of rewards earning. No matter what you purchase, you earn this rewards rate when you use that card. Common Examples: 1.5% flat cash back on all purchases or 1% on all non-category purchases.
If the card offers a single flat-rate reward on all purchases, then simply multiply that rate on all your credit card spend. If this is the base-rate (i.e. 1% cash back on all other purchases) then multiply this rate on all purchases that haven’t already qualified for a specific category rate.
NOTE: a transaction only gets counted once toward your rewards. If you buy a $100 plane ticket, you don’t get 3x points on the ticket and 1x points for that purchase.
(Bonus) Friend Referral
Another way to score extra credit card points is to refer a friend to join the credit card program.
You can usually create your personalized referral link through the credit card website/mobile app and share it with friends and family to apply. Once they are successfully approved for the credit card, you will receive bonus points for bringing in new customers for the card issuers.
These bonuses are usually around $100 for each friend you refer!
Once you accumulate points, you must redeem them in exchange for several types of rewards. Simply log into your rewards portal to see your various options for redeeming points.
Here is a list of typical points redemption options that are offered by most rewards credit cards:
Redeeming points for gift cards is a great way to use your credit card rewards, as it offers flexibility and point-to-dollar value. Additionally, many credit card companies partner with retail stores to throw you an extra perk when you redeem your points from gift cards. For example, $10 worth of points could be redeemed for a $15 gift card.
You may find gift card options ranging from restaurants to department stores to entertainment services.
You can also redeem these miles for actual flight tickets. However, before redeeming your miles, you should compare the dollar value of the flight with the miles you are spending to ensure you are receiving a good deal.
Sometimes directly redeeming points with a specific airline’s frequent flier program is a better deal than redeeming points with your bank.
While traveling, overnight stays can be more expensive than flights. In such cases, it is wise to redeem your rewards for accommodations. Sometimes, the rewards can also be applied for upgrades or extra charges like meals or spa appointments during your stay.
Online Shopping and Subscriptions
If you are expecting a discount on your next online shopping spree, use rewards points to pay for all or some purchases made at online stores. Rewards points can also be used to purchase things like subscriptions and various other services.
Charity Donations and Transfers
Some cards let you donate your points to charities partnering with the program. Such instances are most suitable during times of crises or natural disasters as you can help without paying a single penny. You can also transfer your rewards points to another individual, family member, or a friend if they are part of the same rewards network.
Using your rewards for depositing money into your bank account or obtaining a statement credit is a solid option. In this manner, you can use the money to pay your bills, add to your savings, or reduce your credit debt. Additionally, you can also pay off part of your existing debts or transfer the money into an account that pays you interest.
Before you start spending and accumulating credit card points, there are several things that you should remember about reward points:
- Reward points usually come with expiry dates, so you should redeem them before they expire
- Remember that points are just a bonus perk; do not fall into a cycle of making purchases on your credit card just to collect points. This will accumulate credit card debt unnecessarily
- In the case that your card has some outstanding balance, converting your points to cash would be a wise choice, as it saves you money that you would have to take out towards your credit card bill
How to Calculate the Value of a Rewards Credit Card
The best way to evaluate card options is to quantify their value for how you spend your money.
Use this formula to find the annual value of each credit card:
Welcome Bonus + [ (Rewards Rates x Amount Spent in such category) x Point Redemption Rate ] + Statement Credits – Card Fees
To illustrate this method, we will be using American Express Gold Card as an example: (check the link below in case information has been updated)
Go to the card’s review page where it lays out all the details you need including welcome bonus, rewards rates, statement credits, and card fees.
For American Express Gold Card:
Welcome Bonus – 60,000 points upon spending $4000 in the first 6 months
– 4x points on purchases at U.S. restaurants and supermarkets,
– 3x points on flights booked directly with airlines,
– 1x points on all other purchases
Statement Credits – $120 Dining Credit
Card Fees – $250 Annual Fee
Go through your past transaction history and total up the amount you have spent on each rewards category mentioned above within the past 12 months. For illustrative purposes, we are going to using the spending amount by an average American according to the U.S. Bureau of Labor Statistics’ 2018 Consumer Expenditure Survey:
- Purchases at Restaurant: $3,459
- Purchases at Supermarkets: $4,464
- Purchases on Flights: $513
- All Other Purchases: $8,433
Multiply the spending amount on each category by their respective reward rates to find out the expected amount of points from this card. For this example:
- Purchases at Restaurant: $3,459 x 4 = 13,836 points
- Purchases at Supermarkets: $4,464 x 4 = 17,856 points
- Purchases on Flights: $513 x 3 = 1,539 points
- All Other Purchases: $ 8,433 x 1 = 8,433 points
Total Points Expected = 13,836 + 17,856 + 1,539 + 8,433 = 41,664points
NOTE: this card has no rewards cap. If it did, we would need to apply those limits.
Convert reward points into dollar value.
Credit card points are generally worth approximately one cent each. However, this value can vary depending on the card issuers and points redemption category. Be sure to check out the specific terms of the credit card on its website and find out the exact point values.
For illustrative purposes, we are going to assume each point is worth one cent. Therefore, the dollar value of the expected points from our American Express Gold Card example would be:
41,664 x $0.01 = $416.64
Don’t forget about the Welcome Bonus of 60,000 points too!
60,000 x $0.01 = $600
Lastly, use the formula above to calculate the expected value you will get from the credit card.
$600 (Welcome Bonus) + $416.64 (Rewards Amount) + $120 (Statement Credits) – $250 (Annual Fee) = $886.64
The final value means that according to our spending patterns, we can expect a total reward of $886.64 if we choose to use American Express Gold Card!
Taxable Credit Card Rewards
As the tax season approaches, a lot of cardholders begin wondering whether the cash back and points that they earned in the past year are taxable or not. Credit card rewards are usually considered rebates rather than income, so that’s why credit card rewards for individuals are usually considered non-taxable. Typically, if you make a purchase with your credit card and earn rewards, this is not taxable. If you earn a signup bonus upon meeting a spending requirement, this is also not taxable. However, if your provider gives you rewards for opening or switching a bank account, this is considered taxable.
Additionally, there are differences to keep in mind between using a business credit card and a personal credit card. Let’s take a closer look at some of those differences.
Personal vs. Business
Business credit card rewards are generally non-taxable, but there are certain exceptions. If you receive the rewards outside of normal spending or without having to meet spend requirements, business cards may be taxable. Additionally, those rewards lower your purchase price, affecting how much of a deduction you can claim for qualified business expenses.
On the other hand, business credit cards offer a huge amount of benefits that you should keep in mind when you are preparing your tax return. With your business card, you can keep large expenses off your personal credit report and get access to many more accounting benefits as well.
Also, keep in mind that with business cards you must eliminate the value of rewards when claiming deductions on your tax return. For example, if you make a $700 purchase and pay for it partially with $200 in rewards, you are eligible to deduct $500. If you spend $700 on a purchase and earn $25 in rewards, you can now claim a deduction of $675.
If You Received Credit Card Points, Cash Back or Miles
The credit card points, cash back, and miles that you earn are generally considered non-taxable by the IRS. That is because they are treated as rebates or discounts on what you purchased.
No credit card rewards are taxable if you are required to spend a certain amount of money to receive them.
Taxable Bank Bonuses
Although credit card rewards and sign-up bonuses are non-taxable, bank bonuses are taxable.
Many banks offer a bonus if you meet a requirement of funding when you open a new account. This type of bonus is generally considered taxable because there is no spending requirement involved to earn it. If you do sign up for a bank bonus you are likely to receive a type of 1099 form, whether it be a 1099-MISC (if income is $600 or more) or a 1099-INT (if the interest income is $10 or more). If 1099 is issued to you, you should report the income on your tax return so the IRS can match the income to the recipient’s tax return. Even if no 1099 form is issued, you should still make sure to report all income.
Credit Card Referral Bonuses are Also Taxable
Credit card referral bonuses are also taxable if you didn’t have to purchase anything with your card to receive the bonus. For example, if your card provider gives you a $100 bonus because you opened an affiliated checking account, that $100 is taxable as income.
Similarly, if you earn any airline miles or credit card rewards points from referring friends or family members to get a new card, these rewards will be taxable. Therefore, you can say that any type of bonus or reward that you earn without spending any money is considered taxable.
Credit cards, although risky for many, can also be a great way to game the system and turn your consumerism into frugalism. However, not every credit card will give you great value. It all depends on the spending you do and the rewards you are hoping to earn.
Using the steps above, decide what rewards you want to earn and the categories your most spend in. Then you can begin to narrow down your options to find the cards that will be best for you and start getting rewarded for spending you’re doing anyway.
Tawnya is an elementary special education teacher by day and co-blogger at Money Saved is Money Earned by night.
She holds an Honors BS in Psychology from Oregon State University and an MS in Special Education from Portland State University. She has had a pretty successful writing career, first as a writing tutor at the Oregon State University Writing Center, and in recent years, as a freelance writer.
Tawnya and co-blogger Sebastian have a wealth of knowledge and information about personal finance, retirement, student loans, credit cards, and many other financial topics. They teach people how to save money, make money, and understand money.