Picking up Nickels

Wednesday, August 23, 2006

T-Bills: An Alternative to CDs

I am always trying to find new ways to maximize the return on my cash holdings. Early this year, I jumped on board when the high yield savings accounts started offering 5% rates as the FOMC continued raising the discount rate.

In April, I started following the FatWallet discussion on Treasury Bills. Treasury Bills (T-Bills) are a short-term investment vehicle offered by the U.S. Treasury. Individuals can purchase T-Bills at auction directly from the Treasury via their TreasuryDirect web site or through a broker (like Fidelity or Vanguard).

TreasuryDirect allows individuals to purchase 4, 13, and 26 week T-Bills at noncompetitive auction on a weekly basis. The 13 and 26 week bills are auctioned every Monday, while the 4 week bills are auctioned every Tuesday. All bills are issued on the Thursday after the auction. They can be held to maturity or sold on the secondary market (an additional $45 fee at TreasuryDirect).

T-Bills are similar to 1, 3, and 6 month CDs with one major difference: T-Bill interest is exempt from state and local income taxes . This tax exemption is particularly beneficial if you live in a state with a high income tax rate (like 9.3% max in CA).

Unfortunately, comparing the tax-adjusted return of a 3 month T-Bill at 5.04% and a 3 month CD @ 5.50% isn't necessarily as simple as finding the difference between the two numbers. Since state income tax rates vary, one of the helpful contributors to the FatWallet thread has developed a handy T-bill tax equivalent yield spreadsheet.

Using the default data included with this spreadsheet, let's compare yields for states with various income tax rates: high (CA 9.3%), medium (MA 5.3%), and none (TX 0%):

APY Type CA (9.3%) MA (5.3%) TX (0%)
Unadjusted 5.132% 5.132% 5.132%
Non-Itemizers@15% 5.762% 5.473% 5.132%
Non-Itemizers@25% 5.858% 5.522% 5.132%
Non-Itemizers@28% 5.893% 5.540% 5.132%
Non-Itemizers@33% 5.959% 5.573% 5.132%
Non-Itemizers@35% 5.989% 5.588% 5.132%
Itemizers 5.658% 5.419% 5.132%

From this data, we can see that the CD @ 5.5% is always a better deal for Texas residents. Conversely, the T-Bill is always a better deal for California residents. For Massachusetts residents, the best deal varies depending on the individual tax situation.

Looking at the Recent Bill Auction Results at TreasuryDirect, you can see that T-Bill investment rates rise and fall along with market sentiment. Since the FOMC decided to pause discount rate increases "for now" on August 8th, it's not clear to me if now is the time to lock in current rates for the longer term due to future rate cuts.

I will personally be sticking with 4 week bills at least until the FOMC meets again on September 20th. Due to potential inflationary pressures from the volatility of global energy prices, I believe that we're not done with interest rate hikes yet. I wonder if I will feel the same way in six months?


  • I am in the process of rolling over a small (uninsured) IRA to either T-Bills or CDs. I still don't understand if one better than the other, or more safe.

    By Anonymous Anonymous, at 10/8/08, 8:08 PM  

  • As long as the U.S. government continues to function, both are just about as safe as you can get.

    T-Bills are backed by the "full faith and credit" of the U.S. Treasury and would only become worthless if the U.S. Treasury went bankrupt (link).

    A CD federally insured within FDIC (banks) or NCUA (credit unions) limits are probably a close second to T-Bills in terms of safety.

    By Blogger Frugal Frugalson, at 10/8/08, 8:50 PM  

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