Treasury Bills (T-Bills) and brokered Certificates of Deposit (CDs) are two popular options for investors looking for relatively safe places to park their cash. However, both are quite different from one another. While both are considered extremely safe investments, one is issued by the U.S. government, the other by banks. This article will compare T-Bills and brokered CDs and is meant to serve as a comprehensive guide to making an informed decision between the two.
Understanding Treasury Bills vs. Brokered CDs
Treasury bills, or T-Bills, are short-term securities issued by the U.S. government. They are considered one of the safest investments available, as T-Bills are backed by the full faith and credit of the U.S. government. T-Bills are sold in denominations starting from $1,000 and are exempt from state and local taxes, making them an attractive investment option, especially for those in high-tax states.
Brokered CDs are certificates of deposits purchased from brokerage firms like Fidelity, Schwab, Vanguard, and others. Unlike traditional CDs, brokered CDs are bought in large quantities by brokerage companies from issuing banks. Due to these high volumes, brokerage companies often secure higher CD interest rates, which they then pass on to investors as brokered CDs.
What to Consider When Choosing Between Treasury Bills vs. Brokered CDs
When deciding between brokered CDs and T-Bills, there are three key questions you should ask yourself:
- Does the brokered CD pay a higher interest rate after taxes than the T-Bill? If you live in a state where state and local income taxes are meaning, compare the after-tax interest rate between the two. With brokered CDs, you pay federal, state, and local income taxes on interest earned. In contrast, with Treasury bills, you only pay federal income taxes on interest earned, not state and local income taxes.
- Are you planning on holding to maturity? Brokered CDs have a secondary market, meaning you can sell your CD before it matures. However, the T-Bill market is considerably more liquid than the brokered CD market. Due to a more illiquid CD market, you may not get the price you want for selling your brokered CD. If you’re not planning on holding to maturity, you may be better off buying the similar maturity T-Bill at a slightly lower rate.
- Is buying the brokered CD worth the time and effort? If the CD rates are higher and you’re considering investing significant amounts, it might be worth the time and effort to set up a ladder. A CD ladder comprises holding multiple CDs with different maturities. Brokered CDs are FDIC-insured up to $250,000 per depositor per FDIC-insured bank per ownership category. However, you need to be aware that banks can fail, and while FDIC insurance can protect your investment, the process can be stressful and time-consuming.
The Benefits of Brokered CDs
While T-Bills have their advantages, there are also several reasons why brokered CDs might be a better cash option for some investors:
- Higher Interest Rates: Brokered CDs often offer higher interest rates than T-Bills, especially for longer-term investments. Banks are willing to pay a premium to secure longer-term deposits.
- FDIC Insurance: Brokered CDs are FDIC-insured up to $250,000 per depositor per FDIC-insured bank per ownership category. This means your investment is protected even in the unlikely event of a bank failure.
- Flexibility in Interest Payment: Brokered CDs can pay interest at different intervals. Some pay interest monthly, others semi-annually, and others only at maturity. This flexibility can be beneficial for investors who rely on their investment income for living expenses.
- Callable CDs with Higher Rates: Some brokered CDs are “callable,” meaning the issuing bank can take the CDs back before they mature. While this introduces an element of risk (as the bank is likely to call the CD if interest rates fall), callable CDs generally offer higher interest rates to compensate for this risk.
- Certainty of Rate and Price: With new issue brokered CDs, you know the price you’re paying and the rate you’re getting when you place your purchase order. With T-Bills, you only know the price and yield on auction day after the competitive bidding process amongst the big banks and other institutional investors is over.
Diving Into the Tax Benefit of Treasury Bills
One of the critical differences between T-Bills and brokered CDs is taxation. T-Bills are exempt from state and local income taxes, while brokered CDs are not. This can make a significant difference in the after-tax return of these investments, especially for investors in high-tax states.
To illustrate this, let’s consider an example. Suppose you have a T-Bill and a brokered CD, both offering a 2% annual return. Let’s say you live in California, in the 24% federal tax bracket and your state and local taxes add up to 7.25%. Here’s how the after-tax return of these investments would compare:
| Investment | Interest Rate | Federal Tax | State & Local Tax | After-Tax Return |
|---|---|---|---|---|
| T-Bill | 4% | 0.96% | 0% | 3.04% |
| Brokered CD | 4.3% | 1.03% | 0.26% | 3.01% |
As you can see, even though the T-Bill and the brokered CD offer the same pre-tax return, the T-Bill has a higher after-tax return due to its exemption from state and local taxes.
Are Treasury Bills Safer than CDs?
Treasury bills are considered solid cash investments for investors looking for low-risk and fixed-rate returns. Treasury bills and CDs are considered extremely safe investments, with CDs insured by the FDIC and Treasury bills directly backed by the U.S. government.
However, Treasury bills are not limited to the $250,000 FDIC insurance limit applied to CDs. No matter how many Treasury bills you own, they’ll always be backed by the U.S. government.
Why T-Bills Might Be a Better Option
T-Bills are often preferred due to their liquidity and exemption from state and local income taxes. The tax benefit is meaningful in states with high taxes. Additionally, T-Bills are never callable by the U.S. government, providing stability. The U.S. government cannot decide to redeem your T-Bills before their maturity date.
While brokered CDs are FDIC-insured, there’s always a slight risk of bank failure. This risk, although minimal, can cause unnecessary stress. During the financial crisis of 2008-2009, more than 507 banks failed, wiping out $698 billion in deposits. While FDIC insurance ensured that insured depositors got their money back, the process could have been stressful for those involved.
Another factor to consider is the liquidity of the secondary market for brokered CDs. While it’s true that brokered CDs can be sold on the secondary market, this market is not as liquid as the treasury market. This means that if you need to sell your brokered CD before maturity, you may not be able to sell it at all, or you may have to sell it at a significantly discounted price.
In conclusion, while brokered CDs may offer slightly higher rates in some instances, T-Bills can often provide a safer and more tax-efficient investment option. However, the best choice between Treasury Bills vs. brokered CDs depends on your circumstances and financial goals.
