My wife and I buy promotional CDs with our tax-refund check. Is now a bad time to switch to Treasurys?
Short answer: Not necessarily. Whether it’s a good moment to swap your annual “promo CD” routine for Treasurys depends less on timing the market and more on your tax bracket, state of residence, time horizon, and how much flexibility you want. Here’s a clear way to decide.
How CDs and Treasurys differ
– Safety
– Bank CDs: FDIC/NCUA insurance up to $250,000 per depositor, per bank, per ownership category. Above those limits you’re exposed to the bank’s credit risk.
– Treasurys: Backed by the full faith and credit of the U.S. government, with no dollar cap.
– Taxes
– CDs: Interest is generally taxed at both federal and state/local levels.
– Treasurys (T-bills, notes, bonds): Interest is taxed federally but is exempt from state and local income taxes.
– Practical takeaway: The higher your state tax rate, the more Treasurys “gain ground” versus same-APY CDs.
– Liquidity and penalties
– Bank CDs: Early withdrawal is usually allowed but costs an interest penalty (e.g., 3–12 months of interest). Your principal is stable—you don’t face market price swings—but breaking early forfeits interest.
– Brokered CDs (bought in a brokerage): No early withdrawal allowed; you must sell in the market at a gain or loss, and many are callable.
– Treasurys: You can sell anytime at market prices (no penalty), but prices move with interest rates. Hold to maturity and you get par value.
– Rates and optionality
– Promotional CDs can offer eye-catching APYs, often for specific short terms.
– Treasurys let you build precise ladders (4–52 week T‑bills; 2–30 year notes/bonds) and are state-tax-free.
– If rates rise, the small fixed penalty on a bank CD can be cheaper than a mark-to-market loss on a longer Treasury you’d need to sell early. If rates fall, Treasurys can appreciate in price; CDs won’t, though you keep your locked APY.
A quick, practical way to compare yields after tax
To compare a CD to a Treasury on equal footing, look at after-tax yield:
– After-tax CD yield ≈ CD rate × (1 − federal tax rate − state tax rate)
– After-tax Treasury yield ≈ Treasury rate × (1 − federal tax rate)
Breakeven Treasury rate ≈ CD rate × (1 − fed − state) ÷ (1 − fed)
Example:
– CD = 5.00%
– Federal bracket = 24%
– State tax = 5%
After-tax CD ≈ 5.00% × (1 − 0.24 − 0.05) = 5.00% × 0.71 = 3.55%
Treasury rate needed to match that after-tax return ≈ 3.55% ÷ (1 − 0.24) ≈ 4.67%
So in this bracket, a 4.67% Treasury roughly equals a 5.00% bank CD, thanks to the state-tax break.
Is now a bad time to switch?
It depends on your use case more than “now”:
– If you need the money within 12 months
– Choose the higher after-tax yield between a 6–12 month promo CD and matching T-bills (13, 26, or 52 weeks).
– If you might need to tap funds early and your bank CD’s penalty is only a few months of interest, that penalty can be predictable and sometimes cheaper than selling a longer Treasury at a loss if rates rise.
– In high-tax states, T-bills often win on an after-tax basis at similar headline yields.
– If your balance is near or above FDIC limits
– Treasurys eliminate the insurance-cap headache. Alternatively, spread CDs across multiple banks or use brokered CDs and keep each under FDIC caps.
– If you think rates will fall
– Locking in longer terms can be sensible. Treasurys offer potential price gains if you exit early after yields drop; CDs don’t.
– But if you plan to hold to maturity anyway, compare after-tax yields and simplicity.
– If you think rates will rise
– Favor shorter maturities. Bank CDs with small penalties can be attractive because you can break and reinvest. Short T-bill ladders are also a good fit.
– If you value simplicity and guaranteed outcomes
– Bank CDs are easy to understand: fixed APY, known penalty schedule, no price volatility.
– Treasurys require a bit more comfort with auctions/secondary pricing and price movement if sold before maturity.
A practical game plan
1) Decide your time horizon and flexibility needs
– 0–12 months: Compare 6–12 month promo CDs to 13–52 week T-bills after tax.
– 1–3 years: Consider a ladder of 1–3 year bank CDs (with modest penalties) or 1–3 year Treasurys. If early sale is possible and you dislike price risk, CDs may be preferable. If you might benefit from price gains on falling rates, Treasurys have upside.
2) Run the after-tax math before each purchase
– Use the breakeven formula above or a calculator that incorporates your federal and state brackets.
– Remember: APY for CDs vs yield for Treasurys—make sure you’re comparing like with like.
3) Place and manage your Treasury purchases
– Where: TreasuryDirect (direct auctions, simple for T-bills) or your brokerage (easier to sell, see secondary inventory).
– How: Build a ladder—e.g., buy 13, 26, and 52 week T-bills so one matures near when next year’s tax bill or refund arrives.
– Taxes: You’ll receive 1099-INT (bank CDs) and 1099-INT/1099-OID for Treasurys; Treasury interest is state-tax-exempt—keep records.
4) Mind product nuances
– Bank CDs: Confirm early withdrawal penalty in months of interest; confirm they’re not callable; verify FDIC coverage.
– Brokered CDs: Can trade at a gain or loss; often callable; no early withdrawal privilege.
– Treasurys: No early withdrawal penalty, but prices move; hold to maturity to avoid principal volatility.
An adjacent option: I Bonds with your refund
– You can direct up to $5,000 of a federal tax refund into paper Series I Savings Bonds each year. They combine a fixed rate plus an inflation rate, are state-tax-exempt, and defer federal tax until redemption. They’re illiquid for 12 months and carry a three-month interest penalty if redeemed in the first five years. Not a substitute for T-bills if you need cash within a year, but a useful complement for long-term, inflation-conscious savings.
Bottom line
It’s not inherently a bad time to switch from promotional CDs to Treasurys, but it’s also not a decision you need to “time.” Let your bracket, state taxes, balance size, and flexibility needs drive the choice:
– High state taxes or balances near FDIC caps: Treasurys often make more sense.
– Need guaranteed, penalty-defined early access: Bank CDs with modest penalties are compelling.
– Expecting rate cuts and open to selling early: Treasurys offer price upside; CDs do not.
– For short-term needs: Compare after-tax yields on like maturities and ladder either product.
Make the comparison each year when the refund lands, pick the higher after-tax yield that matches your timetable, and keep maturities short enough that you’re never forced to sell at a bad moment. That approach matters far more than trying to guess if “now” is the perfect time.
