Treasury bills at auction

In short

If you are holding cash that you will need in a few weeks or months, you have probably wondered what else it could do. A Treasury bill is a loan you make to the United States government for a short stretch of time. You buy it at a discount to its face value and get the full face value back on the maturity date. The difference between the two is your interest. You can bid on bills at TreasuryDirect.gov, the Treasury's own site, or you can buy them through a broker. Treasury sets the bill terms and the auction calendar, so check the official schedule before you plan around a date. Interest on bills is taxed by the federal government but is not taxed by state or local governments, according to TreasuryDirect.

The whole of it

What it is

A friend of mine kept a pile of savings in a checking account because he was afraid of tying it up. When I told him the government borrows money for as little as four weeks, he laughed. He thought lending to Washington was a thing only banks and big funds could do. It is not. Anyone with a TreasuryDirect account or a brokerage account can do it.

A Treasury bill, often called a T bill, is a short term debt of the United States government. The Treasury issues bills with terms of 4, 6, 8, 13, 17, 26, and 52 weeks, and it offers them at regular auctions. The Treasury calls it a discount security, which means it pays no coupon. You pay less than the face value today, and the government pays the full face value when the bill matures. That gap is what you earn.

How it works

You have probably watched a price drop on something you wanted and waited for the right moment. An auction works a little like that, only the Treasury is the seller and thousands of buyers bid at once. The Treasury announces how much it plans to sell, the term, and the date. Then bidders submit offers before the deadline. The Treasury accepts bids starting with the lowest yield and works upward until it has sold what it planned to sell.

There are two ways to bid. A competitive bid names the yield you are willing to take. If your yield is too high compared with others, you may get nothing. A noncompetitive bid says you will accept whatever yield the auction sets. Noncompetitive bidders get their bills as long as they stay within the limit the Treasury sets, and that limit is stated on TreasuryDirect. Most small buyers choose this route because it is simple and certain. Everyone who wins pays the same price, which is set by the highest yield the Treasury accepted. The Treasury calls this a single price auction.

Once the auction closes, the bills are issued a few days later. On the maturity date, the Treasury pays the face value. At TreasuryDirect, the money goes to the bank account you linked. At a broker, it lands in your brokerage account. You can also hold a bill in your account and let it be reinvested into a new one when it matures, and TreasuryDirect has a setting for that.

The numbers, and where to find yours

I once watched a neighbor try to compare two offers by squinting at fine print. It would have gone easier if he had known which numbers mattered. Here they are.

The minimum purchase at TreasuryDirect is set by the Treasury, and the current figure is the current figure, which the official source publishes each year. The most you can buy in a single noncompetitive auction is the current figure, which the official source publishes each year. Both are stated on TreasuryDirect.gov, so look there for the verified figure and its date.

The auction results page on TreasuryDirect lists the discount rate, the investment rate, the price per $100 of face value, and the total accepted. The discount rate is the number news stories often quote, but it is figured on the face value over a 360 day year. The investment rate, which the Treasury also calls the coupon equivalent, is figured on what you actually paid over a 365 day year, so it is the better one to compare against a savings account. Your own numbers are the price you paid, the face value, and the number of days to maturity. The confirmation from TreasuryDirect or your broker shows all three.

A worked example

Let me tell you about a woman named Dolores. She sold a used truck and had $9,800 she would need for a roof repair in about six months. She did not want to watch it sit idle, so she placed a noncompetitive bid for a 26 week bill with a face value of $10,000.

Suppose the auction set the price at $97.60 per $100 of face value. Her cost is $10,000 times 0.976, which is $9,760 (that is, $10,000 times 0.976 comes to $9,760.00, since $97.60 per $100 of face value is the same as 0.976 of the face value). At maturity the Treasury pays her $10,000. Her interest is $10,000 minus $9,760, which is $240.

To see the return, divide the $240 gain by the $9,760 she paid. That comes to about 0.0246, or 2.46 percent over 26 weeks. A year has 52 weeks, so she can double that for a rough yearly figure of about 4.92 percent. That is a simple comparison number and not a promise of what she would earn by rolling over.

Notice what Dolores did and did not do. She paid $9,760, not $10,000, and she did not have to guess the price, because the noncompetitive bid took whatever the auction set. She got $9,800 from the truck sale, so $40 stayed behind in her checking account. When the bill matures, the $10,000 returns, and the roof money is there with $240 on top.

At tax time, the $240 is interest income for federal purposes. TreasuryDirect issues a Form 1099 INT for it. It is not taxed by her state, according to TreasuryDirect.

Where it goes wrong

I have a soft spot for people who learn the hard way, because I have been one of them. A few traps are worth knowing about.

The first is timing. Bids must arrive before the auction deadline, and the money must be in the linked bank account when the bill is issued. A bid that misses either one does not go through. Check the Treasury's announced auction schedule rather than trusting a date from memory.

The second is selling early. A bill is a promise to pay on one date. The seller of a bill before maturity gets the market price, which can differ from what was paid. Holders who need the money sooner than planned should know this before they buy. A bill is easy to hold to the end. It is less tidy to sell in the middle.

The third is mixing up the two rates. A friend of mine once saw two different rates beside one bill and thought the paper had a mistake. The discount rate and the investment rate are figured on different bases, so they can describe the very same bill and still differ. The TreasuryDirect auction results page lists both for each bill. A buyer who compares one to a bank's yield without checking which is which may draw the wrong conclusion.

The fourth is taxes. State tax relief on the interest does not mean the federal government skips it. The federal government taxes the interest, and the filer has to report it.

The fifth is reinvesting by habit. A bill that rolls over automatically will keep rolling at whatever the next auction sets. That rate may be lower or higher than the last one. Check it.

Last, a bill carries the credit of the United States government, but it does not pay a promised steady rate. The return depends on the auction where it was bought. Read the confirmation.

Questions to answer before you leave this page

When will you need this money, and does a bill that matures on that date fit, or would an early sale be forced on you? Have you opened a TreasuryDirect account or a brokerage account, and is your bank account linked and verified so the payment can arrive? Did you check the announced auction date, the deadline for bids, and the issue date against your own calendar? Will you bid noncompetitively for a sure fill, or do you accept the risk of a competitive bid that might win nothing? Did you compare the investment rate, not the discount rate, against what your bank pays? Do you know how much federal tax you may owe on the interest, and have you set that money aside? And will you let the bill roll over when it matures, or send the money back to your bank?