treasury bills

In short

A friend of mine once kept his spare cash in a drawer, and he sleepily thought of it as safe. If you have extra money you will need within a year or so, a Treasury bill is one tool worth understanding. It is a short loan you make to the United States government. You buy it at a discount and get the full face value back on the maturity date. The gap between the two prices is your interest. TreasuryDirect, the government's own website, lets a person buy bills with no broker. Interest on bills is taxed by the federal government but not by states or cities, according to TreasuryDirect. Know your date, know your price, and know your tax bill.

The whole of it

What it is

I once watched my neighbor lend a tool to a man down the road, and he got it back on the day they agreed. A Treasury bill works much the same way, only the borrower is the federal government. Bills come due in a year or less. The Treasury Department sells them in terms such as 4 weeks, 8 weeks, 13 weeks, 17 weeks, 26 weeks, and 52 weeks, as listed on TreasuryDirect.

A bill pays no regular interest check. That surprises folks. Instead the government sells it for less than its face value, then pays the full face value at the end. Face value is the amount printed on the bill, and the minimum purchase is listed on TreasuryDirect.

If you are holding a pile of cash and wondering where it can sit, this is one of the plainer answers. It is not a fancy product. It is a promise from the government, with a date and a price.

How it works

A friend of mine bought his first bill at an auction, and he thought he needed a suit. He did not. The Treasury holds regular auctions, and a buyer on TreasuryDirect places an order and waits for the result. There are two ways to bid. A noncompetitive bid means the buyer accepts whatever rate the auction sets. A competitive bid names a rate, and it is mostly used by large buyers and dealers. Most small savers use the noncompetitive route, which TreasuryDirect describes on its site.

When the bill matures, the Treasury pays the face value into your linked bank account. You may also tell the system to roll the money into a new bill. That is called reinvesting, and TreasuryDirect lets a buyer set it up in advance.

You can also sell a bill before it matures. A bill held at a brokerage can usually be sold on the open market, though the price you get may be higher or lower than what you paid. A bill held at TreasuryDirect has to be moved to a broker first before it can be sold early.

The numbers, and where to find yours

You have probably seen a rate quoted on the news and wondered what it meant for your own money. Two numbers matter most. The first is the discount rate, which is how the auction results are posted. The second is the investment rate, sometimes called the coupon equivalent, which lets you compare a bill to other savings. Both appear on the Treasury Department's auction results page at TreasuryDirect.

The minimum purchase is the current figure, which the official source publishes each year. The most one person may buy in a single auction is the current figure, which the official source publishes each year by noncompetitive bid. Check the TreasuryDirect page for the figures in force today.

Tax rules matter here too. The interest is taxed at the federal level at your ordinary rate. It is exempt from state and local income tax. Your tax form for it is the 1099 INT, which TreasuryDirect issues each January for the prior year, according to its own help pages.

A worked example

Let me tell you about a woman named Maria. She is a schoolteacher who saved $5,000 for a roof repair she expects to need in six months. She wants it safe and she wants it to earn something.

Maria buys a 26 week bill with a face value of $5,000. Suppose the auction sells it at a price of $4,850. These are plain figures chosen for the story, not a quote of any real auction.

Her interest is the face value minus the price. That is $5,000 minus $4,850, which equals $150.

Now she wants to know her return over the half year. She divides the interest by what she paid. That is $150 divided by $4,850, which is about 0.0309, or 3.09 percent for the half year.

To compare that to a yearly rate, she doubles it. That is 3.09 percent times 2, or about 6.18 percent a year. This is a rough comparison, since it ignores compounding.

Now the tax. Say her federal rate on this income is 22 percent. The tax is 22 percent of $150, which is 0.22 times $150, or $33. She owes nothing to her state on that interest. Her interest after tax is $150 minus $33, or $117.

So Maria puts in $4,850 and gets back $5,000 on the date. After federal tax she keeps $117 of the gain. The roof money is there when the roofer calls.

Where it goes wrong

I once knew a fellow who bought a bill and forgot the date. Money sat idle for weeks. That is one trap. Auto reinvest can help, but it can also roll your money into a term you never meant to choose. Read the setting before you save it.

Another trap is the rate. A bill locks in its rate only until it matures. When it comes due, new bills may pay less. Savers who count on a certain income have to plan for that.

If you sell early, the price can be lower than what you paid. The market sets that price on the day of sale, and the seller must accept it. Hold to the date, and the face value is paid.

Tax surprises catch people too. The interest is taxable at the federal level even if you reinvest it and never touch it. The Internal Revenue Service treats the gain as income for the year the bill matures, as its guidance on interest income explains.

Be wary of lookalikes. A Treasury bill is not a savings bond, a note, or a bond fund. Each has its own terms. A fund holding bills can rise or fall in price, while a bill held to maturity pays its face value. Check what you are really buying.

Last, remember inflation. If prices rise faster than your interest, your money buys a little less at the end. That is not a flaw in the bill. It is simply a cost to keep in view.

Questions to answer before you leave this page

When will you need this money, and does a bill that matures on that date fit? What does the current auction rate look like on the TreasuryDirect page, and what would your interest be in plain dollars? Which tax rate applies to you, and what would you keep after tax? Will you buy through TreasuryDirect or a brokerage, and do you know what each one requires if you want to sell early? Have you chosen whether the money pays out or rolls into a new bill? And what will you do if rates are lower on the day your bill comes due?