The main downside to reward checking accounts is the debit card usage requirement. The typical requirement is 10 debit card purchases per month to qualify for the high interest rate. For those who have cash back credit cards like those from Charles Schwab, Fidelity or PenFed, every time you use a debit card, you lose out on some cash back. One common strategy is to make big purchases using the cash back credit card, and then use the debit card for smaller purchases. For those who want to keep things simple without switching back and forth, the question becomes which will give you the most rewards: the reward checking account or the cash back credit card?
The best rewards will depend on how much you spend and how much savings you have that you want to keep liquid and safe. I thought it would be interesting to compare some different spending and balance scenarios.
In the comparison I list the credit card cash back rewards from spending a certain amount per month. I'll assume a 2% cash back rewards. You can sometimes do better than this with certain cards in certain categories, but it's rare to go above this for all categories.
For reward checking accounts, I'll assume that you are receiving a reward checking rate that's 2% higher than what you could have received if you just had used a high-yield savings account. This rate spread could be higher if you're comparing the 4.09% reward checking account at Bank of the Sierra vs. ING Direct's 1.10% savings account. But for simplicity, I'll just use 2% which is a reasonable estimate based on my experience.
One thing that helps credit card cash back rewards is that it's generally believed that credit card rewards are not taxable income. However, the higher interest from reward checking accounts are fully taxable. In the comparison, I assume a 25% tax bracket.
Yearly Earnings from a 2% Cash Back Credit Card
|Monthly Purchases||Yearly Cash Back|
Extra Yearly Earnings from a High-Yield Reward Checking Account
|Checking Balance||Extra Yearly Interest||After Taxes (25% rate)|
So if you spend $2,000 a month, you'll earn $480 cash back assuming a 2% cash back credit card. If you have $25,000 in liquid savings and replaced all of your credit card purchases with debit card purchases, you'll make an extra $375 from the reward checking account over a high-yield savings account. So you'll be better off keeping your $25K in a high-yield savings account and using the cash back credit card rather than switching to the reward checking account.
However, if you only spend $1,000 a month, you'll earn $240 cash back. The $25,000 balance in the reward checking account will allow you to earn an extra $375. So for this case, the reward checking account is the better option.
As I mentioned above, those who are willing to spend the time will want to use the cash back credit cards for big purchases and the reward checking debit cards for the smaller purchases. One thing to keep in mind is that some banks have threatened to close accounts for those who were not making enough purchases per month. So it's best not to reduce your debit card purchases by too much.
Are the benefits from reward checking accounts big enough for you? How much rate spread do you require over the best high-yield savings accounts? How do you optimize using cash back credit cards and reward checking debit cards? Please share your experience in the comments.
High-Yield Reward Checking Account Resources