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By Herb Weisbaum ConsumerMan
msnbc.com
updated 11/28/2008 10:20:28 AM ET 2008-11-28T15:20:28

For the first time since they became so popular, gift cards sales are expected to drop this year – anywhere from 6 to 9 percent. The tough economy is partly to blame; consumers need to trim their holiday spending.

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But some shoppers plan to avoid gift cards so they don’t get stuck with worthless plastic, which can happen when a store goes out of business.

Despite that, the National Retail Federation says gift cards are the most requested gift again this year. Holiday shoppers are expected to spend almost $25 billion on them.

Ellen Davis, NRF vice president, insists consumers have nothing to worry about. “Most of the retailers who are here today will be here next year at this time and their gift cards will be perfectly valid.”

The risk is real
Retail gift cards are extremely convenient: You never give the wrong size or color because the recipient buys whatever he or she wants. But clearly, there is some risk involved. These colorful pieces of plastic are not the same as a credit or debit card. A gift card can lose its value overnight if the retailer goes out of business.

Here’s a reality check. According to research by the TowerGroup, gift card holders lost more than $100 million dollars this year. The bulk of these worthless cards came from a few big stores that filed for bankruptcy: The Sharper Image, Linens ‘N Things and Bombay Company. But this figure also includes many smaller stores across the country that went bust.

When Circuit City filed for Chapter 11 a few weeks ago, it asked and received court permission to honor its gift cards. Circuit City continues to sell them. Consumer Reports advises against buying gift cards from a distressed retailer. “Just because they honor gift cards today, doesn’t mean they will honor them tomorrow,” cautions assistant finance editor Anthony Giorgianni.

Remember: there’s no guarantee a company in Chapter 11 bankruptcy will survive. And as part of its reorganization it may close stores near you. What if there’s no brick-and-mortar store to go to and the company doesn’t accept gift cards online? What will you do then?  In bankruptcy court, gift card holders are unsecured creditors. They can file a claim, but they go to the back of the line.

Gift cards from credit card companies
With all the news coverage about retail gift cards, some people may decide to play it safe and switch to gift cards from Visa, MasterCard, Discover and American Express. The TowerGroup expects sales of gift cards from financial institutions to grow by 5.6 percent this holiday season, even though there’s always a charge – usually $3.95 to $4.95 above face value – to buy them.

Consumer groups never liked these cards. Yes, they do give the recipient much more flexibility because they can be used anywhere the credit card is accepted. “But they often have gotcha fees and other anti-consumer traps,” says Linda Sherry, director of national priorities at Consumer Action. For example, they have expiration dates (most store gift cards don’t) and they can be difficult to use.

Scott Sistek of Mukilteo, Wash., saw the value of his Visa gift card melt away when he put it in a dresser drawer and forgot about it for about  a year. He was “shocked” to learn the $50 card was only worth $26.50. After a grace period, the bank charged him a monthly maintenance fee of $3.50. Plus, Sistek was dinged $2.50 when he called to check on the balance.

“I think it’s a really bad deal, “Sistek says. “It sucks for you because you don’t have that much money and it sucks for the person who gave it to you because they paid the full value for it.”

FYI: Many states now have laws regulating gift cards, but these laws do not cover gift cards issued by banks or credit card companies. Many shopping mall gift cards, which are issued by credit card companies, also escape state regulation.

Federal action may be needed
Retailers could put the money they earn from the sale of gift cards into a trust account that would cover the value of the cards and protect the funds from bankruptcy proceedings. But they are not required to do this – so they don’t.

“We believe the federal government should force gift card companies to segregate gift card money and protect it rather than just use it as operating cash,” says Ed Mierzwinski, consumer programs director at U.S. Public Interest Research Group. “That money belongs to the people who have the card in their pocket. It doesn’t really belong to the store.”

A coalition of consumer groups has asked the Federal Trade Commission to require these gift card escrow accounts. A spokesman for the commission tells me the matter is being reviewed.

The bottom line
All gift cards have some sort of downside. Bank cards have fees. Store cards can be risky. “There’s nothing embarrassing about giving someone cash if you don’t know what to buy them,” says Consumer Federation of America’s Jean Ann Fox. I agree. Cash doesn’t expire, it doesn’t have dormancy fees, and you can use it anywhere.

If you already have gift cards, use them as soon as possible. If you get any for holiday presents, do the same thing. Why take a chance the store could close? This also reduces the chance you’ll lose the card or forget about it. Consumer Reports estimates 25 percent of the people who received a gift card last year still haven’t used it.  What are you waiting for? Get out there and buy something already!

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