One of the pitfalls of taking action as you learn is you occasionally make mistakes. This happened to me recently, after happily having bought some high-yielding CDs at Schwab and then realizing that there were better options out there now that we live in California (with its 9.3% income tax rate) and not Washington state (which has no state income tax).
Once again, ignoring tax implications proves perilous. But, at least I was able to find a better place to park my cash: T-bills.
Why? Unlike the CDs I purchased, interest earned from T-bills aren’t subject to state income taxes.
In fact, depending on your state income tax rate, T-bills might be a much better investment than a regular CD. For Californians like me, here’s a list of the equivalent annual percentage yields (APYs) based on the 8/17/06 1-month bill (via the t-bill thread on Fatwallet):
Unadjusted APY ………………. 5.29%
Itemizers (deduct state tax)…. 5.83%
Non-Itemizers @ 15%………… 5.94%
Non-Itemizers @ 25%………… 6.04%
Non-Itemizers @ 28%………… 6.08%
Non-Itemizers @ 33%………… 6.14%
Non-Itemizers @ 35%………… 6.17%
These are higher than the 5.3% and 5.4% 3-month CDs that I purchased (subject to state income tax) and moreover, they’re shorter-term. In fact, current rates for the 1-month T-bill are higher than the 3-month T-bills as well.
Here are the formulas to calculate the yields above:
If itemizing (deducting) state income taxes from federal income taxes:
Equivalent APY = T-bill APY / (1 – state income tax rate)
If taking the standard deduction:
Equivalent APY = T-bill APY * (1 – federal income tax rate)/(1 – federal income tax rate – state income tax rate)
Yesterday, I opened up a Treasury Direct account (surprisingly easy given this is a government-run site!) and I’ve put in a request to deposit $10 into a Zero-Percent Certificate of Indebtedness (or C of I), which is essentially a non-interest bearing account. I wanted to do this just to make sure there aren’t any unforeseen issues with transferring money before I attempt to buy an actual T-bill.
T-bills are auctioned on Tuesdays and issued on Thursdays, so I’m looking at purchasing my first T-bill next week. (Treasury Direct will automatically enter in the next available purchase date if you’ve missed this week’s window.)
If you don’t live in a state with income tax, T-bills may still be worth considering, but depending on rates, they may not be as compelling a choice depending what CDs and high-yield savings accounts like Emigrant Direct are offering.
Like everything else in investing, you can get more creative or active with T-bills and savings bonds, selling before they mature or buying on the secondary market, for example, but for now, I plan on keeping it simple and holding mine to maturity.
I’m still new to this, but I plan on updating what I learn through the process through my posts.
However, if you’re interested in learning more now, be sure to check out the series of posts at MyMoneyBlog on treasury bills and bonds (always great learning from a fellow PF blogger). There’s also a very long thread discussing and tracking rates on treasury billsthat’s updated every week. I learned a lot from both of these, though there’s plenty of reading there. (Thanks very much to everyone, but especially mariojm for starting the thread and answering so many of the questions!)
If I’m happy with the results of my T-bill performance and rates stay competitive, I will probably move the cash currently tied up in my 3-month CDs over to T-bills when they mature in October. I’ll just have to consider the taxes I pay on the CDs as my tuition for the lesson I learned!
I also plan on looking into municipal bonds and funds in order to determine whether those are worth considering or not. They seem a bit more complex, and at first glance, their benefits over T-bills haven’t been that apparent to me, in large part because I don’t yet fully understand their risks or how they work.