Credit Card Spending for Your Nest Egg

The recent introduction of credit card reward programs by Fidelity Investments and Charles Schwab might raise a question for some consumers: Can you spend your way to a decent size nest egg?

The quick answer is no way, no how.

The spending you would need to do to accumulate a significant sum would swamp you with debt in the meantime.

But, still, these new credit cards that reward their use with cash funneled into investment accounts are developments worth noting in the personal finance realm.

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In both cases, the cards pay the user a 2 percent reward, or $2 for every $100 charged, subject to certain conditions, of course. The Fidelity Retirement Rewards American Express Card directs the cash into an IRA set up with Fidelity. Rewards paid on the Schwab Bank Invest First Card are sent to a taxable Schwab brokerage account.

In either case, it sounds like a good deal if you are capable of paying off the balance each month. There's no point in securing a 2 percent reward on each purchase if you then end up paying a 16.99 percent annual interest rate, the standard rate on the Fidelity card.

In introducing its retirement rewards card in December, Fidelity said 90 percent of its retail customers already use a rewards card. And two similar rewards cards it already offers have paid out more than $175 million in total to their owners.

I use the Fidelity 529 College Rewards Card, which pays 2 percent on purchases into a college savings account. I've used the card almost since it came out in early 2003. I love the benefits, but I'm under no illusion it's going to clear the path financially for my children to attend college.

Assume you manage the Fidelity or Charles Schwab cards well. What kind of retirement savings might you be able accumulate using one of them?

Let's run some numbers to find out.

Because the calculations are easier when you don't need to worry about the impact of taxes, I'm going to rely on the Fidelity card, which allows for tax deferral through the linked IRA account.

Charging Into Retirement

The maximum annual contribution to a traditional or Roth IRA is currently $5,000 ($6,000 if you're 50 or older). To earn $5,000 a year in rewards from the Fidelity card, you would need to charge $250,000 in expenses annually. There's no limit on the rewards you can earn on this card but, clearly, most consumers cannot afford to spend that much each year without ending up in bankruptcy court.

Even if you can afford to spend that kind of money year in and year out, the $5,000 set aside annually is not going to amount to enough to live on in retirement. At a 7 percent annual rate of return, $5,000 in annual contributions to an IRA would accumulate to about $338,000 after 25 years.

Sounds good. But 25 years from now, that $338,000 would be worth barely $160,000, assuming 3 percent annual inflation. For someone who spends $250,000 a year, that size nest egg is not going far.

I know this scenario sounds ridiculous, but that's the point. A credit card with an attractive rewards program is never going to make up for inadequate retirement savings. At best, it can serve as a nice supplement.

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