Did you know that the IRS does not consider credit card rewards as income? Because you must make a purchase to earn your rewards (travel miles or cash back), they are considered “rebates.” This is great news for cardholders looking to maximize their cash back rewards especially. If you are someone that is trying to achieve savings and retirement goals as well, this can be a great way to grow your rewards even further.
Grow Your Rewards After Redemption
The concept of growing rewards after redemption is fairly simple. First, you need to maximize your cash back rewards by using a credit card that matches your spending habits. Picking a card like the Capital One Quicksilver Cash Rewards Credit Card or Chase Freedom Unlimited® can make building your cash back rewards easier. We’re all about the path of least resistance over here.
It’s important to pick a cash back card that allows you to send yourself a check or direct deposit your rewards to another account – a statement credit, such as the ones U.S. Bank and American Express provide, won’t work in this scenario.
Once you have banked enough cash back rewards, you simply transfer your cash value rewards to your brokerage, IRA, or high yield savings account. Some people will build their rewards all year long and do one big transfer, but making this a monthly habit might be best to avoid the temptation of spending the rewards elsewhere.
By transferring your cash back rewards to a brokerage, IRA, or high yield savings account, the rewards (rebates) you have earned tax free can now go to work for you thanks to compound interest.
Compound interest is the eighth wonder of the world. He who understands it, earns it – he who doesn’t … pays it.”
– Albert Einstein
How Cash Back Rewards Can Compound Over Time
Compound interest is the interest on savings from the original balance and accumulated interest over time. That might sound a little boring at first. We’ve found that to understand and actually get excited about compound interest, it’s best to see the results.
Here’s a scenario:
- Amy picks out one of our favorite cash back cards, which earns unlimited 1.5% cash back rewards.
- She spends $2,500/month on her card, and pays the balance off every time.
- Amy accumulates $450 cash back each year ($37.50/month).
- Each month, Amy transfers her rewards to her brokerage (investment) account and buys 1 share of her favorite ETF (exchange traded fund).
- Amy is disciplined, and does this for 10 years.
- The historic annualized average return of the S&P 500 stock index since 1957 was around 11.88%. For this example, we’ll use 8%.
| Years | Cash Back Added | Total Future Value (8%) |
|---|---|---|
| Year 0 | $0 | $0 |
| Year 1 | $450 | $463.68 |
| Year 2 | $900 | $965.58 |
| Year 3 | $1,350 | $1,508.86 |
| Year 4 | $1,800 | $2,096.92 |
| Year 5 | $2,250 | $2,733.45 |
| Year 6 | $2,700 | $3,422.46 |
| Year 7 | $3,150 | $4,168.26 |
| Year 8 | $3,600 | $4,975.54 |
| Year 9 | $4,050 | $5,849.37 |
| Year 10 | $4,500 | $6,795.22 |
Here’s the breakdown of those numbers:
- Amy contributed: $4,500 from cash back rewards to her investment account.
- Her total interest earned, at 8%, was $2,295.22
- With just her cash back rewards, Amy took $4,500 and turned it into $6,795.22.
As you can see, by simply using her cash back rewards, our make-believe-friend, Amy, was able to grow her money significantly. These numbers can get even more exciting if Amy decides to match her cash back rewards with extra savings each month. Over time, compound interest and discipline can help her (and you) reach your financial goals.
Time is your friend; impulse is your enemy. Take advantage of compound interest…”
Warren Buffett
A Recap of How to Multiply Your Rewards
These are the simple steps you need to follow to make your cash back rewards multiply:
- Find the right cash back card for you.
- Make sure that card company allows you to transfer your rewards or send yourself a check.
- Use your rewards to invest or add them to your high yield savings account.
- Let compound interest and time work their magic.
These are simple, small ways to make a dramatic impact on your personal finances over the years. Subscribe to our free weekly newsletter to make sure you do not miss our favorite articles from the previous week.
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