Gift Cards: How They Work, Pros, and Cons

Search Fintrev

Search our guides, reviews and glossary.

Gift cards are prepaid cards that hold a fixed amount of money for future spending. The buyer pays up front, and the recipient spends that balance at one retailer or, for network-branded cards, anywhere Visa, Mastercard, American Express or Discover is accepted. Each purchase draws down the balance until it reaches zero. A gift card is quick to buy and lets the recipient choose what they want. The drawbacks are fees, spending restrictions and balances that go unused or get lost.

How Gift Cards Work

Behind the card is an electronic record of a balance, held by the retailer or by the bank that issues a network-branded card. The card number, barcode or code is the key to that record. The process runs in three steps:

1. Purchase and load. The buyer pays for a chosen amount or a preset denomination, and the card is activated at the register or when the digital code is issued.
2. Storage. The value sits in the issuer’s system until it is spent.
3. Redemption. Each transaction subtracts the purchase amount from the balance, and anything left over stays on the card for later.

Because the money is prepaid, using a gift card is neither a credit charge nor a withdrawal from a bank account. There is no interest, no credit check and no effect on a credit score.

Retailers like gift cards for two reasons. They receive the cash before any goods leave the store, and some share of the value is never redeemed. The industry calls these unspent balances “breakage.” Shoppers also tend to spend more than the card’s value, paying the difference out of pocket.

Types of Gift Cards

Closed-Loop Gift Cards

A closed-loop card works only inside one merchant’s system, either a single retailer or a family of brands under one parent company. A coffee chain’s card works only at that chain, and a department store’s card works in its stores and on its website. These cards rarely carry purchase fees, and retailers sometimes add a bonus card when you buy a larger one. They make sense when you know where the recipient already shops; otherwise the balance can sit unused for years.

Open-Loop Gift Cards

Open-loop cards carry a payment network’s logo, are issued by a bank and work wherever that network is accepted, much like prepaid cash. That makes them popular for general gifts, rebates and employee rewards. They usually cost more to buy, because the issuer charges a purchase or activation fee on top of the loaded amount, and some must be registered with a name and ZIP code before they work for online or phone orders.

Physical Gift Cards

Physical cards are plastic, metal or cardboard and are sold at checkout counters, on display racks and online. They work in stores and, with the card number and PIN, on the retailer’s website. Losing one can mean losing the money: some merchants will replace a lost or stolen card if you have the receipt or registered the card, and many will not.

Digital Gift Cards

Digital gift cards, also called eGift cards, arrive by email or text message as a code, a link or a scannable barcode. They suit last-minute or long-distance gifts and can often be saved in a retailer’s app or a digital wallet. The risk shifts from losing plastic to losing the message: if the email is deleted, retrieving the code depends on the sender’s or retailer’s records.

Gift Certificates

A gift certificate is the paper predecessor of the gift card: a printed voucher for a set amount or a specific service, common at restaurants, spas and small businesses. Federal gift card rules also cover many gift certificates. The practical difference is that a certificate may need to be redeemed in full in a single visit, while a card keeps a running balance.

How to Use a Gift Card

In Stores

Hand over the physical card, or show the barcode on your phone, at checkout. If the purchase costs more than the card holds, most merchants let you pay the difference with another method, a split-tender transaction. With open-loop cards, tell the cashier the exact balance first: card readers may try to charge the full amount to the gift card and decline it if the balance falls short.

Open-loop cards can also run into problems wherever merchants place a hold larger than the final bill, such as gas pumps, hotels and car rentals. A card with a small balance may be declined at the pump even if the actual fill-up would have cost less.

Online

To pay online, choose the gift card option at checkout and enter the card number and PIN, which on physical cards is often hidden under a scratch-off strip. With a digital gift card, copy the code from the email or app into the payment field. An open-loop card is entered like a debit card; if it is registered, the billing ZIP code must match.

For Cash Value

Most retailers will not give cash for a gift card balance, but some states require it for small remainders. California, for example, requires cash redemption of balances under $10. Leftover cards can also be sold or traded through gift card exchange sites, usually for less than face value. Those same sites sell cards below face value to buyers, which is one way to stretch a budget at a store you already use.

Check the balance before shopping. Use the issuer’s website or phone number printed on the card, or the merchant’s register, rather than a third-party site that asks for the full card number and PIN.

Rules That Protect Gift Card Value

In the U.S., the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 set federal rules for gift cards that took effect in August 2010. Under these rules:

• Funds on a gift card generally cannot expire until at least five years after the card was issued or money was last loaded onto it.
• Inactivity (dormancy) fees can be charged only after 12 months with no activity, and only one such fee per month.
• Expiration dates and fees must be clearly disclosed on the card or its packaging.

The card itself can carry an earlier expiration date than its funds. If the plastic expires while money remains, the holder can generally request a replacement card at no charge. These rules cover retail gift cards and network-branded gift cards. Loyalty and promotional cards, such as a free card given as a reward, may follow shorter terms if those terms are disclosed.

States can go further. Some ban expiration dates or inactivity fees entirely, some require cash back for small balances, and unused balances may eventually be reported to the state as unclaimed property, depending on state law and the type of card. If a retailer goes bankrupt, it may honor its gift cards for a limited window or not at all, which is a reason not to sit on a balance at a struggling store.

Pros and Cons of Gift Cards

Pros

• Convenient: gift cards are sold in grocery stores, pharmacies and online, and digital cards arrive within minutes.
• Recipient choice: the recipient picks what they want, which avoids returns.
• Fixed budget: the buyer sets the amount up front.
• Occasional bonuses: some retailers add promotional value, especially around holidays.
• Some spending control: a closed-loop card can be used to budget a category such as groceries or coffee.

Cons

• Fees: open-loop cards often charge a purchase fee, and inactivity fees can erode a dormant balance after a year.
• Expiration risk: promotional cards and state rules vary beyond the five-year federal minimum.
• Limited use: a closed-loop balance is worthless to someone who never shops at that store.
• Loss and theft: a lost card or deleted code may not be replaceable, and stolen card numbers can be drained quickly.
• Issuer risk: the balance depends on the merchant staying in business.
• Less flexible than cash: a gift card cannot pay rent or a utility bill, and resale returns less than face value.

Gift Cards vs. Prepaid Cards

Gift cards and general-purpose prepaid cards look alike, and both may carry a network logo, but they are built for different jobs. A gift card is designed for one-time giving. It holds a set amount and usually cannot be reloaded once spent. A reloadable prepaid card works more like a debit card without a bank account. You can add money repeatedly, often through direct deposit, and use it for everyday spending, bill payments and ATM withdrawals.

Consumer protection is the bigger difference. A registered reloadable prepaid card generally comes with error-resolution rights and limits on liability for unauthorized charges, similar to a debit card, though it often carries monthly or reload fees. Gift card rules govern expiration and fees, not lost-card or fraud recovery, so getting money back on a lost or stolen gift card depends on the issuer’s own policy and on whether you kept the receipt or registered the card.

Gift Cards From Employers

Employers often hand out gift cards as holiday bonuses or rewards, sometimes branded as “benefit” or reward cards. The IRS treats gift cards as cash equivalents, so their value is taxable wages to the employee even when the amount is small. That differs from a small physical item such as a holiday ham, which can qualify as a tax-free de minimis fringe benefit.

Avoiding Gift Card Scams

Scammers favor gift cards because, once someone reads them the card number and PIN, the money can be spent or resold within minutes and is hard to trace or recover. Common schemes include:

• Fake prizes or sweepstakes: a caller says you have won money but must first pay “taxes” or “fees” with gift cards.
• Impostors: callers pose as a government agency, a utility, a tech support desk or a relative in trouble and demand urgent payment in gift cards.
• Online sales: a seller insists on gift card payment for an item that never ships.
• Card tampering: thieves record or alter card numbers on store racks, then drain the balance as soon as a buyer activates the card.

No legitimate business or government agency requires payment in gift cards. Buy cards from behind the counter or directly from the retailer, inspect the packaging for tampering, keep the receipt, and never share the card number or PIN with someone you do not know. If you have already paid a scammer, contact the issuer right away using the number on the back of the card, since an unspent balance can sometimes be frozen. Then report the scam to the Federal Trade Commission at ReportFraud.ftc.gov.

FAQs

The Bottom Line

Gift cards suit buyers who know where the recipient shops or want to give a fixed amount quickly. Since lost cards and fraud losses may not be recoverable, buy from behind the counter, keep the receipt, register cards when possible, and spend balances promptly, especially at a struggling store. Employees should know that gift cards from an employer count as taxable wages, even for small amounts.