Cash Back

How cash back credit cards work


An explanation of how cash back credit cards work; overview of flat and tiered earning rate structures for cash back credit cards, three components – percentage cash back, where extra cash can be earned and how rewards are delivered.

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What could be easier than getting a little money back on the everday spending you put on your credit card? That is how cash back cards work and what makes them appealing to some consumers.

“The primary benefit of a cash back card is the simplicity,” says Roman Shteyn, owner and CEO of

“You don’t have to think too much about how much you’re earning while using the card, and when it comes to redemption, the best cash back credit cards are pretty straightforward. Most people just deduct their cash back from their statement balance or redeem for gift cards.”

Cash back cards come in a variety of flavors – bonus category, tiered rewards and flat percentage cash back cards – but they all pay you back. While a flat percentage cash back card is ideal for the “set it and forget it crowd,” bonus category and tiered rewards cards offer more rewards but require more work to maximize cash back in select spending categories.

How cash back cards work

How do all of these cash back cards work? Cash back is essentially a rebate of a percentage of the purchases you make on the card.

Card issuers can afford to pay cash back because merchants pay an interchange fee on each transaction. “When you pay a merchant $100 with a credit card, the merchant only receives about $97,” says Daniel Mahoney, a certified financial planner in Atlanta.

For example, a TV that costs $700 would net you $14 with a 2 percent cash back card. The merchant, meanwhile, paid a transaction fee of around $21 when you paid with your credit card.

“Rewards or rebates may also be funded by deals between the credit card issuer and specific merchants,” Mahoney adds. An example of this is cash back earned through card-linked offers.

With flat-rate cash back credit cards, every purchase earns the same percentage cash back. With category bonus cards and tiered bonus cards, different types of spending earn more cash back.

How do card issuers know what types of spending qualifies for which percentage of cash back? Merchant category codes are four-digit numbers denoting a business type, such as a gas station or grocery store. Merchant category codes are used by credit card networks to categorize and track purchases.

Cash back cardholders can redeem their rewards as a statement credit or deposit in a banking account, to purchase gift cards or merchandise, or donate their rewards.

Check with your card issuer’s rules on cash back redemption amounts and options. The Citi Costco Anywhere Visa, for example, issues rewards annually as a certificate with the February statement.

Why cash back cards? They trump bank account interest rates

With bank interest rates still low – a typical savings account earns a measly 0.06 percent annual yield – the ability to earn even 1 percent on every purchase trumps the best bank interest rates. Your return is even greater with cash back cards offering a flat 1.5 percent, 2 percent or more on every purchase.

And unlike the interest on your bank account, cash back comes tax-free.

“The IRS has historically viewed credit card cash back as a nontaxable rebate on the purchase price, rather than as a taxable form of income,” says Mahoney.

Something else to think about: Cash back, if loaded back on your card, also earns its own cash back when you spend it, adds financial planner Andrew Feldman of Chicago. “It’s a fraction, but it’s still a little more cash,” he says.

Factor in that some cash back cards offer sign-up bonuses of $150 or $250, and that is even more cash for you for using the card.

Let’s take a look at the three types of cash back cards, and the work (or simplicity) involved in using them to earn the maximum rewards. Spoiler alert: According to our cash back credit cards survey, complex is out and simplicity is in.

Types of cash back cards

3 types of cash back cards

1. Category bonus cash back cards

Category bonus cash back cards offer the lure of 5 percent cash back from revolving spending categories. Cash back cards with rotating bonus categories include the Discover it Cash Back and Discover More cards, the Chase Freedom and Citi Dividend cards.

Five percent back can be a nice haul if you’re able to max out the spending categories each quarter, but it takes a bit of work.

First, you have to register for the bonus categories every three months, and spending in the categories is capped per quarter. Since any purchase not in the bonus category earns 1 percent, you may not be getting the average return you think you are.

Also, with Discover, Chase Freedom and Citi Dividend, bonus categories are set by the issuer every quarter and are usually released a few months before the new quarter starts.

For 2018, Discover released its full year of bonus categories in November. Chase Freedom released its first quarter 2018 bonus categories in December.

The U.S. Bank Cash+ Visa Signature card is a variation on the rotating bonus category theme, but the cardholder picks the bonus categories that will earn the most cash back for the types of purchases they make most.

2. Tiered rewards cash back cards

Like category bonus cards, tiered rewards cards offer more cash back in select spending categories, but to maximize your earnings you have to think about which card to use with each purchase.

For example, the Blue Cash Preferred® Card from American Express offers 6 percent cash back at U.S. supermarkets (up to $6,000 in purchases per year, then 1 percent), 3 percent cash back at U.S. gas stations and 1 percent cash back on all other spending.

The Uber Visa card from Barclays, meanwhile, offers 4 percent cash back at restaurants and bars, 3 percent on airfare and hotels, 2 percent on online purchases and 1 percent on everything else.  

Feldman puts all his business expenses on his tiered rewards American Express SimplyCash Plus business card and his own personal expenses on a Citi Double Cash Card that delivers a flat 2 percent (1 percent when you buy and 1 percent as you pay for your purchases).

His AmEx business card rewards 5 percent on office supply stores and wireless telephone service, 3 percent on gas (cardholders choose from eight categories for this tier), and 1 percent on everything else.

At the end of each year, Feldman calculates the rewards delivered on the total amount he spent. He says both of his cards end up delivering the same cash back on average.

“The AmEx works out to about 2 percent, maybe slightly under,” Feldman says. “I just don’t spend enough on office supplies to max out that 5 percent category.”

“Could I get back another couple dollars at the end of the year by using a credit card targeted to each category of my spending?” Feldman asks. “It’s possible, but I’d have to think about which card to use every time I made a purchase and that would make my life crazy.”

3. Simple cash back cards

With simple cash back cards, you earn a flat percentage with every purchase. There’s no need to track and activate bonus categories. You earn the same cash back on every purchase.

Mahoney carries the Bank of America Travel Rewards Visa which earns 1.5 percent cash back plus a 75 percent bonus for being part of the bank’s Preferred Rewards Platinum Honors program.

“That’s effectively 2.625 percent cash back,” Mahoney says. “The caveat is the cash back must be used as a reimbursement for travel purchases, but lots of things count for that, even Uber and Lyft.”

Feldman recently switched from Capital One’s Quicksilver 1.5 percent cash back card to the Citi Double Cash card which earns 2 percent cash back (1 percent when you buy and 1 percent as you pay for your purchases).

Why did he switch? “Two percent is better than 1.5 percent,” he says.

Also, “I miss the convenience of being able to log in and get my rewards in one sweep or set it up for an automatic $25 or $50,” he adds. “I like to cash in my points immediately so I don’t forget about them.”

Frequent-flyer expert Gary Leff likes the Fidelity Rewards Visa and Citi Double Cash cash back cards.

With the Fidelity Rewards Visa, cardholders earn 2 percent on all purchases, but you need to be a Fidelity account holder with excellent credit to qualify for the card.

“Most people aren’t going to beat 2 percent cash back, even with travel rewards,” says Leff, who blogs at View from the Wing.

Simple or complex? A closer look at cash back rewards

Which cash back card is right for you depends on how much thought you want to put in to which card to use where.

We ran the numbers based on an average American’s spending, based on the Bureau of Labor Statistics’ 2016 survey:

Flat cash back versus bonus category versus tiered bonus cards

2 percent flat percentage5 percent category bonus*6 percent tiered bonus**
$20,645*** at 2 percent$14,645 at 1 percent ($14.65)$16,596 at 1 percent ($16.59)
$6,000 at 5 percent ($300)$4,049 at 6 percent ($242.94)
$412.9 total cash back per year$314.65 total cash back per year$259.53 total cash back per year
* This assumes the category bonus cardholder maxes out the $1,500 in qualified quarterly spending, which is difficult to do every quarter.
** The Blue Cash Preferred from American Express offers 6 percent cash back at U.S. supermarkets and other tiered rewards, so total cash back will be higher.
*** This includes expenses on food, gas and oil changes, vehicle expenses, apparel and services, entertainment and other expenditures
– research, January 2018

See related: Best cash back credit cards, Best flat-rate cash back cards for 2018Cash back credit card reviews, 4 dangers of a rewards credit card, Cash back cards: The key to off-the-grid travel and adventures

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The editorial content on this page is based solely on the objective assessment of our writers and is not driven by advertising dollars. It has not been provided or commissioned by the credit card issuers. However, we may receive compensation when you click on links to products from our partners.

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