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When I tell people that I try to keep a good chunk of savings in United States Treasury Bills, they usually look at me cross-eyed. Then they hit me with tough questions like “What the heck is a Treasury Bill?” or “You got something against savings accounts?”

Well, in fact, I do have a beef against savings accounts: they’re not as a good a deal for me as U.S. Treasury Bills. Since Treasury Bills get special tax treatment with state and local governments, Treasury Bills earn a higher rate of return than savings accounts for residents of states, counties, and/or cities that levy income taxes.

Okay, Blake, you answered the first question. How about the other question.

What is a Treasury Bill?

A Treasury Bill (or T-Bill) is an IOU written to you by the United States Treasury. In other words, when you buy a Treasury Bill, you’re loaning money to the federal government. As an owner of U.S. Treasury Bills, you can take satisfaction knowing that 0.00000001% of the U.S. national debt will be paid to you.

Since Treasury Bills are IOUs written by the federal government, and not some random Joe Bank, they are even safer than savings accounts. Although banks are FDIC insured, recovering your money from the FDIC if your bank goes out of business is a slow process. Treasury Bills literally are considered the safest investments in the entire world.

Treasury Bill Terms

The Bureau of the Public Debt sells Treasury Bills every Thursday in various terms: 28 days (4 weeks), 91 days (13 weeks), and 182 days (26 weeks). The term is the length of time you loan your money to the government. So if you buy a 28-day T-Bill, it means that the federal government will return the amount you invested, plus interest, in exactly 28 days (4 weeks).

The interest rate paid by the government is determined at auctions held on Monday (91- and 182-day bills) and Tuesday (28-day bills) each week. Small investors like you and me don’t normally participate directly in the Treasury Bill auction. Instead, we buy Treasury Bills at the highest interest rate that the government accepted that week.
Rather than cutting you a check for interest, the government sells Treasury Bills at a discount to their face value.

Example
Here’s a real world example. Let’s say you bought a $1,000 28-day Treasury Bill last week. The interest rate for the 28 day T-bills issued last week was 4.885%. This means that on January 11, you paid $996.27 for a Treasury Bill worth $1,000. Exactly 4 weeks later, on February 8, the bill will “mature” and the government will pay you $1,000. The difference between the face value of the bill and what you paid, $3.73, is interest. Assuming the interest rate stays the same all year and you purchase a new Treasury Bill each time the previous one matures, you’ll earn $48.62 in a year from your $1,000 investment.

Compound Interest
Treasury Bills are sold in increments of $1,000, making it impossible to reinvest your interest each month (unless your interest exceeds $1,000). This is not conducive to earning compound interest! Fear not. You can earn compound interest by depositing the Treasury Bill interest in a high-yield savings account, like ING Direct or EmigrantDirect. This is easily accomplished by electronically linking your Treasury Bill account to your high-yield savings account.

Tax Benefits
Unlike savings account interest, the interest earned from debts of the federal government is exempt from state and local income tax. If you live in a high tax state, like the People’s Republic of California, the tax savings adds up quickly. If you are in the 8% tax bracket in California, then you would need to earn more than 5.31% interest to beat the Treasury Bill after you consider taxes.

Special Considerations
There are two downsides to parking your money in Treasury Bills instead of a savings account. The first is that your money is not as easily accessible. If you can use your credit card’s grace period to “float” the money for a couple weeks while you wait for your Treasury Bills to mature, then this shouldn’t pose a problem. The second downside is that Treasury Bills are only sold in increments of about $1,000. (I say about, because the exact sale price depends on the interest rate set at auction that week.) If you have a small amount of money to invest, you’ll have to put it somewhere else.

Pros

• Higher interest rates
• Favorable tax treatment
• Safest investment on earth

Cons

• No immediate access
• Sold only in increments of ~$1,000

How do I start buying Treasury Bills?

Almost every investment broker sells Treasury Bills. But there’s no reason to go through a broker that charges fees when you can buy Treasury Bills directly from the government at TreasuryDirect without paying commission.

The exception to this rule is that Fidelity Investments. Fidelity charges nothing to purchase new Treasury Bills and only 50¢ to sell before maturity. In comparison, the government charges nothing to purchase but $45 to sell early! The need to sell early is really only an issue if you purchase the 91- or 182-day Bills.