Treasury Bond vs. CD Interest Tax
Treasury bonds and certificates of deposit, commonly referred to as CDs, issued by U.S.-based financial institutions are debt instruments. When you buy a treasury bond, you are loaning money to the federal government. When you buy a bank certificate of deposit, you are loaning money to the bank. Treasury bonds and CDs are both low-risk, interest-bearing investments that have some similarities, but also some significant differences, particularly when it comes to how they are taxed.
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Interest
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The primary way you earn money on your investment in treasury bonds or certificates of deposit is through interest payments. The issuing organization agrees to pay a specified rate of interest, which may be fixed or variable, on your investment and to return the face amount of your bond or CD upon maturity. This interest typically becomes taxable income once you receive it, according to the Internal Revenue Service. The IRS considers interest received once it is credited to your account if it is accessible to you and can be withdrawn without penalty.
Taxing Authority
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Bank certificates of deposit may pay a higher rate of interest than treasury bonds. If you live in a state that has a state income tax, however, you may get a better after-tax return by investing in treasury bonds. While the interest on both bank CDs and treasury bonds is subject to federal income taxes, treasury bonds are exempt from income taxation at the state and local level.
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Capital Gains
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Treasury bonds and some bank certificates of deposit may be bought and sold through the secondary market. The market value of these investments tend to fluctuate inversely to prevailing interest rates. When prevailing interest rates rise, the price of outstanding bonds and CDs typically drop. When prevailing interest rates fall, bond and CD prices typically rise. If you sell your treasury bonds or CDs at higher price than you paid for them, you will have a capital gain. Capital gains on both treasury bonds and CDs are taxable at the federal, state and local level.
Considerations
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Certificates of deposit that are offered by most banks are insured by the Federal Deposit Insurance Corporation up to the maximum allowable by law, which was $250,000 as of July 2010, according to the FDIC. Treasury bonds are not insured by the FDIC or any other private or governmental agency, but they are considered among the safest of all investments because they are backed by the full faith and credit of the United States government.
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References
- Department of the Treasury: Treasury Bonds: Tax Considerations
- Securities and Exchange Commission: High-Yield CDs – Protect Your Money by Checking the Fine Print
- Internal Revenue Service: Topic 403 -- Interest Received
- Fidelity: U.S. Treasury Bonds
- Federal Deposit Insurance Corporation: Certificates of Deposit: Tips for Savers
