How Credit Card Cashback Rewards Work

If you've never used cashback rewards, you may not be aware that many credit cards offer them. Some call them a "points" system rather than a "cashback reward" system. The points that you earn by using your credit card can still be redeemed for cash, sometimes as a monthly statement or sometimes at the end of the year.

Some credit card companies offer a cashback bonus, such as 1 percent, on everyday purchases. Many of the companies also offer a 5 percent cashback reward on select categories. These will usually rotate on a three-month basis. If you have a card with a 1 percent bonus and you purchase something that costs $100, you will get $1 back at the end of the month or the end of the year (or points that can be redeemed as cash).

One nice thing to know about cashback rewards is that they are not counted as income. Even if you earn a sizable amount of cash rewards from savvy credit card use, it won't cut into income limits for social security payments.

Understand How You Spend Money

One tip for maximizing your cashback rewards is to use a credit card that matches your lifestyle. If traveling is not a priority in your retirement, a travel rewards card wouldn't be very helpful to you. Consumers should shop around for a credit card with rewards that they will actually use regularly.

A card that offers cash back on everyday purchases can be a great option for things that you always buy, such as gas and groceries. Simply pay for these things at the store or the pump with the card and then immediately pay the balance off from your checking account when you get home. A nice thing about this method is that you're not using the credit for things you wouldn't ordinarily pay for -- but you're effectively getting a discount on those everyday purchases.

Another thing to keep in mind is that credit card companies include sales taxes when comes to awarding points or cash back. If you have a 1 percent cashback card and something costs $107 with sales tax included, you'll get a reward of $1.07 on that purchase. It's like using a coupon and getting a small tax break at the same time, although you won't get the cashback until later.

Do Not Carry a Balance on a Cash Rewards Card

Credit card interest rates will negate any cashback rewards that you earn, so it's vital that you pay off the balance owed on your card every month. Interest rates are tied to your credit score and the credit card companies are allowed to charge compound interest on any debts you carry. The effective interest rate that you will pay on a credit card is generally tied to your credit score:

• 620 - 659 credit score: 20 percent
• 660 - 719 credit score: 18 percent
• 720 - 799 credit score: 15 percent
• 800 - 850 credit score: 9 percent

Even if you have the highest possible credit score, the interest that you would be paying on a balance will end up being more than the 1 to 5 percent you'd be earning in cashback rewards. Unless you have a card with an introductory interest rate of 0 percent, you should always pay the balance off each month before it can accrue interest.

Pay Attention to Special Offers

Most credit card users do not take full advantage of the quarterly special offers that credit card companies provide. These are higher rewards (usually 5 percent) that are used for three months from select stores or vendors before being swapped out with a different cashback deal. If you regularly shop at those stores anyway, take advantage of this! It will maximize the amount of points you receive without purchasing anything out of the ordinary.

For example, credit card companies will occasionally bump their everyday bonus from 1 percent cashback to 5 percent on utility bills. This is a great way to get a discount on your power, water, and gas bills if you use the card to pay for them. The easiest way to monitor the quarterly deals that credit card companies offer is through your online account with them.

Pay for Expensive Items on a Rewards Card

If you've been saving up to pay for a more expensive item that is not part of your regular monthly budget, take advantage of the cashback reward. Purchase the item on your card and then pay it off before any interest can accrue. This can be a good way to rapidly build up points or cash back.

Shop Around for a New Card

Many cards that offer cash back have an introductory bonus period when you can earn even higher rewards. For example, you might get a $75 cashback reward if you spend $750 on purchases during an introductory three-month period. One word of caution about this tip, however. Applying for too many credit cards in a short period can hurt your overall credit score. A good rule of thumb is to only apply for a new credit card once every two years.

Those are just a few tips to help you maximize your cashback rewards. As long as you are proactive about paying off your credit card balance immediately, cashback rewards can be a great way to help offset inflation during your retirement.