There’s a saying — “A little knowledge is a dangerous thing.” When you don’t know much about a subject, you stay with the tried-and-true because there’s safety in the mainstream. As you learn more about the subject, you start to explore off the beaten path. That’s when the danger starts. You think you know what to do but you don’t know what to avoid. If you only know enough to get into trouble, you’re better off not knowing it.

We have an example of this in using TreasuryDirect.

Many people bought I Bonds last year at TreasuryDirect. You link a bank account and put in an order to buy. TreasuryDirect debits the bank account and gives you I Bonds in the account. Many readers of this blog have done that. It works in reverse when you sell. TreasuryDirect credits the linked bank account. These are all routine transactions.

Some people discover that you can also buy regular Treasuries in the TreasuryDirect account. You can buy in $100 increments as opposed to in $1,000 increments in a brokerage account. You can place the order more days in advance versus having to wait for the official announcement. TreasuryDirect supports “auto roll” whereas not all brokers support it. TreasuryDirect debits the same linked bank account for purchases and credits it when the Treasuries mature. These are all routine too.

Then some people notice this peculiar thing called a “Zero-Percent Certificate of Indebtedness” or in short “Zero-Percent C of I” or simply “C of I.” It’s basically TreasuryDirect’s version of uninvested cash in a brokerage account. It doesn’t pay any interest, hence “Zero-Percent.” Zero-Percent C of I can be designated as the destination of the credits from matured Treasuries, to be used as the source of your debits for the next purchase.

You would think this Zero-Percent C of I is useless because drawing from and sending to the bank account works just fine and you can at least earn some interest while the money is in your bank account, but some people decide to use Zero-Percent C of I to hold cash in TreasuryDirect.

That’s when the trouble starts. I read this report on the Bogleheads investment forum (I edited it slightly for brevity):

Well, I moved all of my savings into the US Treasury, in the form of four-week T-Bills that redeeem to C of I.

Normally, that’s not an issue, works every time.

Until two days ago when I got an email saying my account was flagged as having some concerns and Risk Management had placed a hard lock on the account as a precautionary measure.

I was asked to fill out a FS Form 5444. I mailed the notarized form but the processing time for this form is “20 weeks minimum.”

I called the Treasury and got transferred to the hardlock department. They said they received my form but couldn’t act on it.

They also said, the reason for the hard lock was because I bought a $1,000 C of I with my bank account, intending to use it to buy a T-Bill, and this was a fraud risk.

So I will not be able to log into my account to recover any of my money, nor will I be able to reinvest it.

Over the next 20 weeks I’m going to lose out on perhaps about $5,000 worth of interest, yikes.

False positives in risk management and account restrictions happen sometimes. Normally it wouldn’t be a big problem because at worst you can’t place new orders and money from matured T-Bills will still come back to your bank account. In this case, the money goes to Zero-Percent C of I, which earns no interest while it takes 20 weeks to resolve the account restriction.

This investor is clearly better off not knowing that Zero-Percent C of I exists.

He or she is also better off not knowing that you can use TreasuryDirect to buy T-Bills. If he or she bought T-Bills in a commercial brokerage account, at least the settlement fund or core position earns interest and it should be much quicker to resolve the risk management issue than 20 weeks.

To be clear, I don’t blame this investor for using Zero-Percent C of I or using TreasuryDirect to buy T-Bills. It still wouldn’t be a big problem if TreasuryDirect could review the notarized form and remove the restriction in two days as opposed to 20 weeks, but the reality is that TreasuryDirect is understaffed. The computer system runs routine transactions efficiently but anything requiring human intervention takes a long time.

Lessons learned: Treat TreasuryDirect as a delicate object. Do as little as possible with it. Stay on the beaten path. Buy your I Bonds. Sell your I Bonds. Use your linked bank account to transact. Don’t use the browser’s back button. Remember your password and your answers to the security questions. Be extra careful not to get your account locked. Use your brokerage account when you buy regular Treasuries. Stay away from Zero-Percent C of I in TreasuryDirect.

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We talked about the right way to transfer money in the previous post ACH Push or Pull. I read this story online related to using Fidelity as a checking or savings account. I’m not linking to it because I don’t intend to shame anyone. Let’s see what lessons we can learn from this case study of a transfer gone awry.

I had over $6,000 in a money market fund in my Fidelity Cash Management Account one day. I transferred an additional $20,000 from another institution to that account.

Once the money arrived at Fidelity, it was available to invest as always but not to withdraw (the holding period was 7 days). Fair enough. I then invested it in the same money market fund.

Then I decided to move the money to my other Fidelity brokerage account to keep it (away) from my checking needs. So I called a rep who did that (or so I thought!). I’m now supposed to have $6,000 in my Cash Management Account as if nothing happened, but no, when the rep moved the $20k and because of the holding period, the system used first the $6,000 already cleared. Anyway, I didn’t notice that whole mess and bounced some credit card payments.

Use Push

Most problems in transferring money are caused by initiating the transfer at the wrong place. If you remember only one thing from the previous post ACH Push or Pull, it’s that you should use a push when you have a choice. There are exceptions but in general, your first choice should be a push. In other words, initiate the transfer at the origin where the money currently resides, not at the intended destination. Push the money out. Don’t pull it in.

If the first transfer in this story had been initiated at the other institution (a push to Fidelity), all the subsequent problems wouldn’t have happened. Money received from a push has no hold. It’s fine to invest it or transfer it again to another account.

Go Direct

When people travel by air, most people prefer a direct flight. It takes less time. Having fewer stops means fewer things can go wrong.

The same principle applies to transferring money. If it’s intended to be kept away from checking needs, transfer it directly to the final destination. Don’t create hops.

Even a pull directly into the brokerage account would’ve worked in the story. The Cash Management Account used as a checking account wouldn’t have been affected if the money had been pulled directly into the brokerage account. Credit card payments from the checking account wouldn’t have bounced.

The money pulled into the brokerage account would’ve still had a hold but it could be invested immediately. The hold wouldn’t have been noticed because withdrawals weren’t taken out of the brokerage account.

Let It Age

If a money transfer landed in the wrong account by mistake, don’t exacerbate the mistake by making a back-to-back transfer. Slow down. Let it age. It makes no difference which account the money is in after it’s already invested. Just wait a week and let everything settle.

Besides fund availability problems, rapid back-to-back transfers can trigger anti-money laundering flags. Some banks and credit unions restrict or close accounts when they see an account is used as a “hub” with fast in-and-out transfers. This goes hand-in-hand with “Go Direct.” If money needs to go from A to B, don’t make an interim stop at C.

***

The transfer in the story went poorly because it took the most problematic path. These would’ve been better ways to make the transfer in question in the order of preference:

1. A push directly to the brokerage account.
2. A push into the Cash Management Account followed by an internal transfer to the brokerage account.
3. A pull directly into the brokerage account.
4. A pull into the Cash Management Account. Transfer to the brokerage account only after it completely settles.

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When you earn interest in a bank account or a CD, the bank typically does not withhold taxes. The bank sends a 1099 form for the interest after the end of the year. You report the interest income from the 1099 form on your tax return.

It works similarly when you sell I Bonds at TreasuryDirect. By default, TreasuryDirect doesn’t withhold any taxes from the proceeds. You download the 1099-INT form from TreasuryDirect next year and report the interest on your tax return.

Some people prefer to pay taxes through tax withholding as opposed to paying quarterly estimated taxes. Taxes paid through withholding are assumed to have been paid throughout the year. It helps with some timing issues.

If you’d like to have TreasuryDirect withhold taxes when you sell I Bonds, here’s how to do it.

Log in and click on “ManageDirect” on the top.

Click on “Update my personal information” under the heading “Manage My Account.”

Answer a security question. Scroll to the bottom. Change the “Withholding Rate” from the default 0% to your desired rate (up to 50%). This new withholding rate will be used on all future sales. If you buy regular Treasuries at TreasuryDirect, it affects payments from those regular Treasuries as well.

The withholding rate applies only when you sell I Bonds. It doesn’t reduce the increase of the redemption value while you still hold I Bonds. You will see this on the review page when you sell I Bonds:

I set the withholding rate to 20% for this test. TreasuryDirect knows how much interest is included in the sale. The 20% only applies to the interest portion, not to the gross amount. TreasuryDirect does not withhold state taxes because I Bonds are exempt from state taxes.

If you choose to have TreasuryDirect withhold taxes, the withholding amount will be on the 1099-INT form together with the interest amount. Tax software will take that into account when you enter the 1099 form. Make sure you download the 1099 form from TreasuryDirect next year. TreasuryDirect will send an email when the form is ready but you should set a reminder on your calendar in case you miss the email.

Having TreasuryDirect withhold taxes from the sale is completely optional. I don’t choose to do that because I prefer to pay quarterly estimated taxes. Also, don’t choose tax withholding if you elected to pay taxes on I Bonds each year as opposed to deferring taxes until you sell, otherwise you’ll pay taxes twice and must get it back from a refund.

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Many people are interested in buying Treasuries but they hesitate because they don’t want to complicate their taxes. That’s a legitimate concern. How much buying Treasuries will complicate your taxes depends on which Treasuries you buy and how you buy them.

We go from the simplest to the most complicated in this post. It’s better to learn how to walk before you run when you aren’t familiar with how taxes on Treasuries work.

No Worries in Tax-Advantaged Accounts

Buying Treasuries in a tax-advantaged account doesn’t affect your taxes. These tax-advantaged accounts include workplace retirement accounts such as 401k or 403b, Traditional IRA, Roth IRA, or HSA. You don’t pay tax when you buy, hold, or sell investments inside a tax-advantaged account. Taxes on withdrawals from these accounts depend only on the account type. It doesn’t matter what investments you buy or how you buy them in tax-advantaged accounts.

It makes no difference in terms of taxes whether you buy Treasury Bills, Notes, or Bonds, whether you buy regular Treasuries or TIPS, whether you buy a new issue through an auction or you buy an existing bond on the secondary market, or whether you hold to maturity or you sell before maturity on the secondary market. Buy or sell to your heart’s content when you’re in a tax-advantaged account. See How To Buy Treasury Bills & Notes Without Fee at Online Brokers and How to Buy Treasury Bills & Notes On the Secondary Market.

Tax treatments are different only when you buy Treasuries outside tax-advantaged accounts.

Hold Treasury Bills to Maturity

Taxes outside tax-advantaged accounts are also easy if you only buy Treasury Bills and hold them to maturity.

We’re talking about strictly Treasury Bills here. A Treasury Bill has no “coupon,” which means it doesn’t pay any interest while you hold it. A Treasury note with a coupon that was issued some time ago but now has less than one year left to maturity isn’t really a Treasury Bill. The first and the third listings in the screenshot below are Treasury Bills. The middle one isn’t.

Treasury Bills are sold at a discount to the face value. The difference between the purchase price and the face value you receive at maturity is your interest. It doesn’t matter whether you buy Treasury Bills as a new issue at a Treasury auction or on the secondary market as long as you hold them to maturity. Taxes are simple because the purchase price is the only variable.

Your broker will include the difference between the purchase price and the face value as interest on a 1099-INT form. If you buy at TreasuryDirect, make sure to download the 1099-INT form from TreasuryDirect. The specific field on the 1099-INT form says it’s exempt from state and local taxes. Your tax software will calculate both federal and state taxes automatically after you enter the 1099-INT form.

Through a Mutual Fund or an ETF

Buying Treasuries through a mutual fund or an ETF in a regular taxable brokerage account also doesn’t make your taxes too complicated. The dividends from the mutual fund or ETF will be included on a 1099-DIV form. If you sell shares in a mutual fund or an ETF, the capital gain or loss will be included on a 1099-B form.

These tax forms aren’t new. You will have them when you buy or sell other mutual funds or ETFs as well. Your tax software will automatically handle the federal taxes without any additional steps.

Extra Step for State Taxes

The extra wrinkle is in state taxes. You’ll need to get a report from the fund manager on what percentage of the fund’s income came from Treasuries. That portion is exempt from state and local taxes. It takes an extra step but it’s not that difficult. Please read how to do that in State Tax-Exempt Treasury Interest from Mutual Funds and ETFs.

Maturity Choices

Buying through a mutual fund or an ETF doesn’t mean that you’re buying long-term Treasuries. You have many choices in funds that invest in different maturities. Choose a fund that only invests in short-term Treasuries if you only want short maturities. Choose a fund that only invests in TIPS if you only want TIPS. The expense ratio is very low in many funds and ETFs.

With so many choices in funds and ETFs at a very low cost, you really don’t need to get into individual Treasury notes and bonds unless you must withdraw in a short period on a preset schedule or you just prefer the psychological comfort. See Two Types of Bond Ladder: When to Replace a Bond Fund or ETF.

Hold New-Issue Treasury Notes and Bonds to Maturity

New-issue Treasury Notes and Bonds bought at a Treasury auction and held to maturity are a little more complicated but they’re still not too bad in terms of tax complexity.

Buying at a Treasury auction doesn’t mean you must use TreasuryDirect. You can buy new issues at a Treasury auction in your brokerage account through Fidelity, Charles Schwab, Vanguard, or E*Trade with no fee whatsoever. See How To Buy Treasury Notes Without Fee at Online Brokers.

Avoid Reopenings

Not all Treasury Notes and Bonds sold at an auction are true new issues though. Some Treasury auctions are reopenings. A reopening happens when the government is selling additional quantities of a bond that was already issued some time ago. The tax treatment of buying a reopening is the same as buying on the secondary market, which is more complicated than the tax treatment of buying a true new issue.

Reopenings are marked with the letter “R” in Treasury’s auction schedule. Avoid reopenings if you’d like to keep your taxes simple.

The price of a true new issue from a Treasury auction will be at a slight discount to the face value. You’ll handle this small discount when the bond matures. Treasury Notes and Bonds pay interest every six months. Your broker will report these interest payments in the right place on a 1099-INT form. Your tax software will automatically calculate both federal and state taxes.

Accrued Interest

Usually there’s zero accrued interest on a true new issue. If there is any, it’s very small. The small accrued interest doesn’t show up on the 1099 form. It’s only in the 1099 supplement. You’re allowed to add a negative entry for the accrued interest to offset the coupon payments but because it’s small, it’s not a big deal even if you don’t know how to do it or you simply forget.

Hold New-Issue TIPS to Maturity

TIPS adds a little more complexity than regular Treasury Notes and Bonds because TIPS receives both interest payments and inflation adjustments. It’s still not too bad if you stay with true new issues (avoid reopenings) and you hold them to maturity.

In addition to the 1099-INT form, the inflation adjustment will be on a 1099-OID form. It’s one extra form but your tax software knows how to handle it.

Similar to regular Treasuries, the price of a true new issue TIPS from a Treasury auction will be at a slight discount to the face value. You’ll handle this small discount when the bond matures.

A true new issue TIPS has only a small amount of accrued interest. You’ll find it in the 1099 supplement and add a negative entry on your tax return to offset the interest. It’s not a big deal if you can’t figure out how to do it or you simply forget.

Buying a TIPS reopening at a Treasury auction is the same as buying on the secondary market in terms of taxes. It’s more complicated than buying a true new issue.

Sell Treasury Bills Before Maturity

Selling Treasury Bills before maturity adds one variable to the otherwise simple tax treatment of holding them to maturity. Now you’ll have both interest and a capital gain or loss. Please note we’re still only talking about Treasury Bills that don’t have a coupon. It’s more complicated if you sell a Treasury note, bond, or TIPS that has a coupon.

The concept goes like this. If you bought $10,000 worth of a 13-week Treasury Bill for $9,865, you were supposed to earn $135 in interest in 91 days by holding it to maturity. Suppose you sold it for $9,947 after holding it for 60 days, you do a linear extrapolation to calculate the interest earned:

( $10,000 – $9,865 ) / 91 * 60 = $89

Your capital gain or loss is the sale price minus the purchase price minus the interest:

$9,947 – $9,865 – $89 = -$7

You earned $89 in interest and you had a $7 capital loss when you sold the Treasury Bill before maturity.

You’ll have to calculate this split between interest and capital gain/loss yourself if your broker doesn’t do it for you. If your broker reports the difference between your purchase price and your sale price as 100% interest or 100% capital gain/loss on the 1099 form, you’ll have to correct it on your tax return.

You have this complexity from selling before maturity. You can avoid it if you hold your Treasury Bills to maturity. If you must sell something before maturity though, sell Treasury Bills. It’s still simpler than selling bonds with a coupon before maturity.

Buy or Sell on the Secondary Market

The more complicated tax treatment comes from buying or selling Treasury notes or bonds with a coupon on the secondary market (including buying a reopening through an auction).

The current market rate can be quite different from the coupon rate of an existing bond. This results in a large discount or premium in the price. The large discount or premium makes taxes more complicated. Buying or selling on the secondary market often involves paying or receiving a meaningful amount of accrued interest, which you must also handle on the tax return.

How to handle these complexities is beyond the scope of this already long post. If you can help it, for the sake of keeping your taxes simple in a taxable account, don’t buy Treasury notes or bonds with a coupon on the secondary market, don’t buy them in a reopening, and don’t sell them on the secondary market. Use the secondary market only for Treasury Bills. If you must do those things, do them in a tax-advantaged account.

***

Taxes on Treasuries get progressively more complicated as you move down the list. Learn to walk before you run.

That’s as far as I would go. Any more complications aren’t worth it to me.

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The post Which Treasury to Buy While Keeping Your Taxes Simple appeared first on The Finance Buff.

I have a brokerage account at Merrill Edge and a free checking account at Bank of America. I qualified for Bank of America’s Preferred Rewards program after three months. Then I added a Bank of America Travel Rewards credit card to the Preferred Rewards program.

On its own feet, this card isn’t that special. It gives 1.5% rewards on every purchase with no specific categories or caps. It has no annual fee and no foreign transaction fee. There’s a small sign-up bonus. The Preferred Rewards program makes it much nicer.

75% Bonus from Preferred Rewards

When you enroll in the Preferred Rewards program, you get a boost in the credit card rewards. $100k in assets at Merrill Edge puts you at the Platinum Honor tier, which gives you a 75% bonus on the credit card rewards. 1.5% rewards on everything then becomes 2.625% rewards on everything.

For example, $71.30 purchase earned 187 reward points worth $1.87. That’s 2.625%. You get the 75% bonus after you qualify for the Platinum Honor tier in Preferred Rewards. If your Bank of America checking account is new, it has to go through three month-ends before you qualify.

This Bank of America card with 75% bonus gives more rewards than other 2%-rewards card such as Fidelity Visa and Citi Double Cash card.

Hold ETFs at Merrill Edge

The best way to qualify for the Platinum Honor tier in Preferred Rewards is by transferring $100,000 worth of assets to Merrill Edge. The $100,000 doesn’t have to sit in cash. It can be an IRA or brokerage account holding stocks, mutual funds, or ETFs.

You don’t have to trade in the Merrill Edge account if you prefer to use a different broker. Just holding $100,000 worth of an S&P 500 ETF and setting up automatic reinvestment of dividends will do. Merrill Edge doesn’t charge any maintenance fee.

Redeem Against Travel Charges

Like some other travel cards, the reward points are worth the most when you redeem against past travel charges (100 points = $1). As long as you put travel expenses on this card once in a while, you should be able to redeem the points easily.

You get the best redemption rate when you redeem the points against travel charges. These charges all counted as travel in my account:

• Airlines (both tickets and baggage fees)
• Hotels
• Airbnb
• Car rentals
• Uber
• Public transit
• Ski passes and lunch at ski resorts

The minimum number of points for redemption is 2,500 points (earned by spending $952 at 2.625%). You have one year from the time of the travel charge to redeem points against it. You can redeem points against the same charge multiple times until the charge is fully covered by points redemption.

Premium Rewards Card

Bank of America also offers a Premium Rewards card that’s similar to the Travel Rewards card.

If you pay airline baggage fees or charge a good amount for travel, the statement credit and the higher rewards on travel charges can make it worth it to pay the annual fee on the Premium Rewards card.

Auto Pay Full Balance

It’s not obvious how you set up for automatically paying the full balance every month on Bank of America credit cards. Please follow the steps in Set Up Autopay On Bank of America Credit Card.

***

I use the Travel Rewards card from Bank of America as my primary card. It works to its full potential when you also have Merrill Edge and Bank of America accounts and you make it to the Platinum Honor tier in the Preferred Rewards program.

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Everyone knows the point of putting money into a Roth IRA is that withdrawals are tax-free. That’s true at a high level but it isn’t that simple when you go one level down into the detail. Withdrawals from a Roth IRA follow a set of complex rules to determine how much of a withdrawal is tax-free and penalty-free.

Roth IRA Withdrawal Rules

The rules require that you understand normal contributions and conversions including backdoor Roth and mega backdoor Roth, rollovers from Roth 401k to Roth IRA, a 5-year clock on each conversion, the taxable and non-taxable amount in each conversion, and earnings in the Roth account, etc., etc. Gathering and keeping records to put dollar amounts into each bucket year by year requires another level of attention. See Maintain a Roth IRA Contributions and Withdrawals Spreadsheet.

Relief After 59-1/2

The great news is that all these complexities go away when you’re 59-1/2. You only need to answer this one question when you withdraw from your Roth IRA after age 59-1/2:

Did you have a Roth IRA at least five years ago?

The answer is obviously “Yes” for most people. It’s the simplest way to make your Roth IRA withdrawal 100% tax-free. That’s the path I’m aiming for.

You’ll get a 1099-R from your Roth IRA custodian in the following year after you take a withdrawal. Let’s look at how it works on your tax return when you use tax software TurboTax and H&R Block.

H&R Block

I normally start with TurboTax when I do these tax software walkthroughs but I’m starting with H&R Block this time for reasons that will become apparent later.

The screenshots below are from H&R Block Deluxe downloaded software. The downloaded software is both less expensive and more powerful than the online version. You can buy H&R Block downloaded software from Amazon, Walmart, Newegg, Office Depot, and many other retailers.

I started the tax return with a 67-year-old single taxpayer.

Go to Federal -> Income -> IRA and Pension Income (Form 1099-R). You can import the 1099-R or enter it manually. I’m showing manual entries.

My test 1099-R is a normal 1099-R. Enter the numbers from your 1099-R as-is. It looks like this for a $10,000 withdrawal from the Roth IRA:

The amount of the withdrawal shows up in Box 1. Yours may have the same amount repeated in Box 2a and that’s OK too. It’s important to have a checkmark in Box 2b “Taxable amount not determined.” Your Roth IRA custodian isn’t determining whether your distribution is taxable. The box 7 distribution code is “T.”

I didn’t inherit it.

Here it’s asking whether I had my first Roth IRA at least five years ago. Of course I did.

That’s it. It’s tax-free after I answer just two simple questions. I didn’t have to give any detail for the past contributions, recharacterizations, conversions, rollovers, or distributions. It doesn’t matter how the money got into the Roth IRA or when.

We can see how this shows up on the tax form. Click on Forms on the top and open Form 1040 and Schedules 1-3. Click on Hide Mini WS. Scroll down to lines 4a and 4b.

It shows the withdrawal on Line 4a and zero on Line 4b. Line 4b is the taxable amount. A zero there means it’s tax-free. If you have other IRA distributions such as RMDs on Lines 4a and 4b, this tax-free withdrawal from your Roth IRA adds to your other distributions on Line 4a but it doesn’t add to the taxable amount on Line 4b.

TurboTax

Now let’s look at how it works in TurboTax. The screenshots below are from TurboTax Deluxe downloaded software. The downloaded software is way better than online software. If you haven’t paid for your TurboTax Online filing yet, you can buy TurboTax download from Amazon, Costco, Walmart, and many other places and switch from TurboTax Online to TurboTax download (see instructions for how to make the switch from TurboTax).

I started the tax return with a 67-year-old single taxpayer.

Go to Federal Taxes -> Wages & Income -> IRA, 401(k), Pension Plan Withdrawals (1099-R). Import the 1099-R if you’d like. I’m choosing to type it myself.

Just the regular 1099-R.

Box 1 shows the amount taken out of the Roth IRA. You may have the same amount copied as the taxable amount in Box 2a. That’s OK when Box 2b is checked saying “taxable amount not determined.” Pay attention to the code in Box 7. Make sure your entry matches your 1099-R exactly. I have a code “T” in my test 1099-R. The IRA/SEP/SIMPLE box is not checked because it’s from a Roth IRA.

I didn’t inherit it.

I didn’t move the money to another retirement account.

I didn’t buy a home.

It wasn’t due to a disaster. I took the money out and spent it.

We come to this 1099-R summary but we’re not done yet. TurboTax will ask more follow-up questions.

I didn’t take disaster distributions or repay them.

This is the most relevant question. Yes, I owned a Roth IRA for at least five years.

I don’t know why it matters whether I have an open Roth IRA but whatever.

Now TurboTax is trying to scare us. Why does it matter? I’m already 59-1/2!

Now TurboTax will go through the rigmarole of Roth IRA distribution ordering rules, which are irrelevant when you’re already 59-1/2 and you had your Roth IRA for at least five years. I’m going to lie to TurboTax now because I know the answers just don’t matter at this point.

If you answer truthfully which year you did a Roth conversion, TurboTax will take you through the details of your prior conversions. You will waste time doing a lot of unnecessary work. So don’t cooperate.

Again, irrelevant.

No excess contributions.

TurboTax is finally done with its irrelevant questions. Are you taxed on the withdrawal from your Roth IRA? Click on Forms on the top right.

Find Form 1040 in the left navigation panel. Scroll up or down on the right to find lines 4a and 4b.

It shows the withdrawal amount on Line 4a and zero on Line 4b. A zero on Line 4b means it’s tax-free. If you have other IRA distributions such as RMDs on Lines 4a and 4b, this Roth IRA withdrawal adds to your other distributions on Line 4a but it doesn’t add to the taxable amount on Line 4b.

TurboTax arrives at the same results as H&R Block but it takes such a long and unnecessary journey. It uses a one-size-fits-all approach that doesn’t distinguish by whether you’re 59-1/2 or not.

Nothing matters when you’re already 59-1/2 and you had your first Roth IRA at least five years ago. All your withdrawals from the Roth IRA are tax-free, end of story. You get a big relief when you’re 59-1/2. You don’t have to provide any other data or records. So don’t think you must meticulously keep everything. Just save one statement from a Roth IRA to show that you had it open at least five years ago.

Not Yet 59-1/2?

It’s a whole different story if you’re planning to withdraw from your Roth IRA before age 59-1/2. You do need detailed records to answer those questions from TurboTax. You can use something like the spreadsheet I included in Maintain a Roth IRA Contributions and Withdrawals Spreadsheet.

To be honest, I gave up on keeping track of Roth IRA contributions, recharacterizations, conversions, rollovers, and distributions. I’ll take the easy path and wait until the year I’m 59-1/2.

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You can request a debit card when you use Fidelity as a checking or savings account. Fidelity says this in their debit card FAQs:

For each foreign transaction, there is a foreign transaction fee (currently, 1% of the transaction for non-US dollar transactions), which may be included in the amount charged to your account. This charge may apply whether or not there is a currency conversion.

Fidelity customer service also repeated this as an official response in this Reddit post Does the Fidelity Debit Card Charge Foreign Transaction Fees? Because I don’t use a debit card for purchases whether in the U.S. or in foreign countries (no rewards), the only way this foreign transaction fee could be relevant to me is on ATM withdrawals when we travel internationally.

The FAQ says that a foreign transaction fee “may be included.” It implies that the fee isn’t always included. When exactly is it included and not included?

A Real-World Test

I had a chance to see in real life whether a foreign transaction fee applied to ATM withdrawals using a Fidelity debit card.

My wife took a trip to Canada. She withdrew $200 Canadian from an ATM at a gas station. Fidelity sent me this debit card activity alert in real-time:

A bank teller withdrawal on card ending in XXXX for $153.06 from CANCO #XXX XXXXXXXXX was posted to your account on 08/03.

$200 Canadian for $153.06 U.S. gave an exchange rate of 1 US dollar = 1.307 Canadian dollars. Google showed that the exchange rate on that day was 1 US dollar = 1.33 Canadian dollars. Using that exchange rate, we should be charged $200 Canadian / 1.33 = $150.38. Fidelity charged us $2.68 more than that. Did Fidelity include a foreign transaction fee in the amount charged to us?

Fidelity posted another entry to our account a day later:

ADJUST FEE CHARGED ATM FEE REBATE (Cash) +$2.26

Ah, the original $153.06 included an ATM fee charged by the machine. Fidelity reimbursed us that fee. The net charge after the ATM fee reimbursement was $153.06 – $2.26 = $150.80. This makes the exchange rate $200 Canadian / $150.80 U.S. = 1.326. That’s close to the 1.33 number from Google but it still doesn’t quite match it. Was the difference a foreign transaction fee that Fidelity included?

Card Network Exchange Rate

Fidelity’s debit card is a Visa debit card. Visa has an online Exchange Rate Calculator to show how the Visa network converted currencies each day. The calculator showed this when I put in the transaction date and a 0% bank fee:

$150.795295 USD rounds to $150.80. That’s exactly the net amount Fidelity charged us after the ATM fee reimbursement. There was NO foreign transaction fee from Fidelity on the ATM withdrawal.

Visa has a small markup in the exchange rate used on its network. Fidelity is only passing along the exchange rate from Visa. It’s the best exchange rate you can get as long you’re using a Visa card. A Schwab Visa debit card can’t do any better.

***

Some side notes on spending money in a foreign country:

Getting Local Currency

The best way to get local currency is to use a local ATM machine. You pay no ATM fee and you get the best exchange rate when you have the right card. Don’t buy foreign currency in the U.S. before you leave. Don’t use the currency exchange booths at the airport. You don’t need to bring US dollar bills and plan to exchange them except as a backup just in case. Just take your debit card and use an ATM machine when you’re there.

It doesn’t matter which ATM you use. An ATM at the airport works. One at a gas station also works, as you see in my wife’s ATM withdrawal. So does an ATM outside a bank branch.

If your bank charges an out-of-network ATM fee plus a foreign transaction fee and it doesn’t reimburse you the ATM fee charged by the machine, you’re with the wrong bank. Consider one of the 3 Ways to Use Fidelity as a Checking or Savings Account.

Act as a Local

Act as a local when you’re in a foreign country. If you see any mention of the U.S. dollar on any ATM machine or credit card terminal, back out and press a different button to transact in the local currency. They certainly don’t offer to charge locals in U.S. dollars and you shouldn’t pay any differently.

If you’d like to verify whether your bank included a foreign transaction fee on your international charges, use the Exchange Rate Calculator from Visa (or the Currency Converter Calculator from MasterCard if your card is a MasterCard). MasterCard may give better exchange rates on its network than Visa. If you do a lot of foreign transactions, get a MasterCard when all else is equal.

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Fidelity Investments is best known as an administrator for workplace retirement plans and an online broker for retail investors. In addition to 401k/403b accounts, Traditional and Roth IRAs, HSAs, and taxable brokerage accounts, Fidelity also offers accounts that can be used for the same purpose as a checking account and a savings account.

Because Fidelity is interested in having a full relationship with its customers for both banking and investing and its primary focus is on the investing part, it’s in a good position to offer better rates and features than other banks in the banking part.

Here are three ways to use a Fidelity account to manage day-to-day spending and savings.

CMA as Checking

Fidelity Cash Management Account (CMA) is a separate account type from Fidelity’s regular taxable brokerage account officially called “The Fidelity Account.” You have to choose the account type when you open the account. A Cash Management Account can’t be changed to a regular taxable brokerage account after you open the account. Nor can an existing regular taxable brokerage account be changed to a CMA.

Included Features

The Cash Management Account is specifically designed to meet banking needs. It has pretty much everything people need for a checking account and nearly everything is free.

– FDIC-insured balance

– Pays interest (2.6% APY as of July 31, 2023)

– No minimum balance

– No monthly maintenance fee

– Does not require direct deposit

– Provides a routing number and an account number for direct deposits and direct debits

– Accepts check deposits by mobile app or dropoff at a Fidelity branch

– Free checkbook

– Free Visa debit card for purchase, ATM withdrawal, and teller cash advance

– Reimburses ATM fee charged by any ATM worldwide

– Free Bill Pay service with eBill

– Free same-day ACH

– Free wire transfers

The 2.6% interest rate is lower than the rate on many high yield savings accounts but it’s a lot higher than the rate on most online checking accounts. For example, although Ally Bank pays 4% on its savings account as I’m writing this, its checking account pays only 0.25%. Most high yield savings accounts don’t have all the checking features such as check writing, debit card, and Bill Pay.

Routing Number and Account Number

You see the routing number and account number for direct deposits and direct debits when you click on the three dots next to the account name.

Limitations

Fidelity Cash Management Account has some limitations that aren’t a deal-breaker to me.

– Does not accept deposits of physical cash.

– Does not support Zelle (but it works with PayPal, Venmo, Cash App, Apple Pay, and Google Pay).

– Does not link instantly through Plaid.

– Does not offer cashier’s checks.

– Recurring outgoing transfers only support monthly and annual frequencies.

– 1% transaction fee on debit card purchases in foreign countries. This fee doesn’t apply to international ATM withdrawals.

– ACH pulls and check deposits are held for up to four business days. The money still earns interest. It’s just not available for withdrawal while on hold.

I’ve used Fidelity CMA for at least 15 years. It’s my primary checking account. I use my otherwise dormant Bank of America checking account on those rare occasions when I need to deposit physical cash, use Zelle, link instantly through Plaid, get a cashier’s check, or set up recurring transfers on an odd schedule. I don’t use a debit card for purchases.

The hold time on ACH pulls and check deposits will shrink over time for established accounts on smaller amounts. My ACH pulls and check deposits are usually available for withdrawal on the second business day. I do an ACH push from the other side when I need it to be available immediately. See ACH Push or Pull: The Right Way to Transfer Money.

When you use the Fidelity CMA as your checking account, you can link it to an existing high yield savings account as you normally do with a checking account. You earn much higher interest in the Fidelity CMA than in a typical checking account.

CMA as Checking/Savings Combo

Instead of linking to an external savings account, you can buy a money market fund in the Cash Management Account and keep both checking and savings in the same account.

Although the CMA is designed for banking needs, it’s still a brokerage account. With some exceptions (no margin or options), you can buy in the CMA pretty much everything that’s available in a regular brokerage account. That includes stocks, bonds, brokered CDs, mutual funds, and ETFs. A Fidelity money market fund pays about 4.8% annualized yield as of July 31, 2023, which is higher than the rate paid by many high yield savings accounts.

A money market fund isn’t FDIC-insured but when you buy a government or Treasury money market fund, the underlying investments in the money market fund are backed by the government. See No FDIC Insurance – Why a Brokerage Account Is Safe.

The CMA becomes a checking/savings combo when you buy a money market fund in it. The core balance in the CMA serves as the checking part and the money market fund serves as the savings part. You have to buy the money market fund manually but Fidelity will automatically sell from the money market fund when your core balance in the CMA is insufficient to cover a debit. This is like having free automatic overdraft transfers from savings to checking.

Because Fidelity will automatically sell from the money market fund to cover debits, if you’re so inclined, you can be aggressive in keeping the core balance in the CMA close to zero while keeping the bulk of your account in the money market fund earning a higher yield. Or you can set a maximum target balance alert with the Cash Manager to buy more shares of the money market fund when you have excess cash in the “checking” part.

Add Treasury Bills or Brokered CDs

If you’d like to take it one step further, you can also buy Treasury Bills or brokered CDs in the CMA when you have money that you know you won’t need for some time. The CMA then becomes a checking/savings/CD combo. The money automatically goes into the “checking” part when the Treasury Bill or brokered CD matures. For example, the amount set aside for the next property tax bill can go into a Treasury Bill or a brokered CD. See How To Buy Treasury Bills & Notes Without Fee at Online Brokers and How to Buy CDs in a Fidelity Brokerage Account.

Please note if you enable the “auto roll” feature when you buy new-issue Treasury Bills or brokered CDs in the CMA, the amount for the next roll reduces your “available to withdraw” number for a few days during the roll. A debit may fail if you don’t have enough available to withdraw. It’s not a problem if you don’t use auto roll or if you keep a substantially higher amount in cash and money market fund than the amount on auto roll.

I use a Fidelity Cash Management Account as a checking/savings/CD combo this way. I buy into the Fidelity Government Money Market Fund (FZCXX) when I have a large core balance. I also buy Treasury Bills with money I know I won’t need for some time. Fidelity automatically sells from the money market fund as needed to cover direct debits and outgoing transfers.

My setup works well but if I were to start from scratch, I would use a different setup below.

Separate Regular Brokerage Account

A regular Fidelity taxable brokerage account (“The Fidelity Account”) also provides a routing number and an account number for direct deposits and direct debits, free checks, debit cards, and Bill Pay. It includes basically everything in the CMA except ATM fee reimbursement. It uses a money market fund that pays a higher yield as the core position instead of the FDIC-insured balance as in the CMA.

The ATM fee reimbursement is also included when you have Premium Services or Private Client Group status, which generally requires having $250k or more with Fidelity in all accounts. It doesn’t matter whether you have an assigned advisor.

You see your service level at the top right when you log in to Fidelity’s website. Contact customer service if you have more than $250k with Fidelity but you’re not given a premium service level.

Even if you don’t get ATM fee reimbursement, the higher yield on the core balance may very well cover the ATM fees several times over. Suppose your core position has an average balance of $3,000 during the year (the “checking” part in the CMA), a 2% higher yield pays $60 more in interest. That’s plenty to pay for ATM fees unless you frequently take ATM withdrawals. My account records show that I used an ATM only once in seven months so far this year.

The same missing features and limitations of the CMA also apply to the regular taxable brokerage account — no physical cash deposits, no Zelle, no cashier’s check, no instant Plaid, 1% foreign transaction fee on debit card purchases, and hold on ACH pulls and check deposits for up to four business days.

Using a regular brokerage account for spending and savings becomes truly set-and-forget. You don’t have to manually buy a money market fund. All deposits automatically go into a money market fund that pays about a 4.8% yield as of July 31, 2023. All debits come out of this money market fund. It’s like using a savings account as a checking account.

You can still buy Treasury Bills or brokered CDs to set aside money for specific bills in the future. The same caveat on “auto roll” and “available to withdraw” as mentioned above also applies.

Name Your Accounts

Although you can keep the money for spending and short-term reserves in the same regular taxable brokerage account that also holds your long-term investments, most people probably prefer to keep them separate. You can have two (or more) regular taxable brokerage accounts for different purposes. You just give them different names to know which is which.

To change the display name of your accounts, click on the setup icon near the top left and then click on “Account display preferences.”

Check the box next to the account you’d like to name and then click on the “Rename” link on the top. Change the name to “Spending Account” or something to that effect.

You can also move an account to a different group to help you organize. There’s a built-in “Spend & Save Accounts” group but I leave my account in the “Investment Accounts” group so that it shows up on the top.

***

The biggest draw of using a Fidelity brokerage account for spending and shor-term reserves is the checking features. You effectively use a savings account as a checking account and earn a good yield from the first dollar. Everything is seamlessly together.

A Vanguard money market fund and some less well known high yield savings accounts pay more but when you pair it with a checking account that pays close to zero, the blended yield on all your cash goes down. You also have to manage the balance of your checking account and transfer back and forth.

Transitioning a checking account takes some time and effort. Banks know it. That’s why they pay you close to zero on checking accounts. They bet that you think it’s too much trouble to switch. Don’t fall for it. It’s easier than you think when you take your time to make the move.

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What does it take to reset the password to your email account? What happens next if someone hacks into your email?

Log out of your email and try the “forgot password” link. If it takes a security code sent by SMS text message to your cell phone, consider upgrading your security setting.

I read this report on the Bogleheads investment forum: $250k lost in unauthorized wire fraud – experience/advice? An elderly couple lost $250,000 because their email account was set to send a security code by SMS text message to their cell phone number for resetting the password. It can happen to you too.

Password Reset Attacks

Fraudsters fooled the couple’s cell phone company to transfer their cell phone number to another company. It then started cascading from there. They used the security code sent to that number (now under their control) to reset the password to the couple’s email account. They logged in and looked in old emails for where the couple had bank accounts. Access to the email account and security codes sent to the cell phone number gave these criminals access to the bank accounts. They requested wire transfers from three banks.

Two banks stopped a pending wire when the couple reported unauthorized access. A third bank promised to freeze the account but they sent out a wire on a fraudulent request anyway. It took more than a month for the bank to finally return the money to the elderly couple. The couple almost had to sue the bank to get their money back.

Secure Your Email Account

It isn’t clear whether the bank paid lost interest. If not, the lost interest on $250k is well over $1,000, and think about the aggravation for over a month! You don’t want this to happen to you. Secure your email account with something stronger than text message codes sent to a cell phone number.

I wrote about using security hardware to protect investment accounts in this blog post: Security Hardware for Vanguard, Fidelity, and Schwab Accounts. The Yubikey security hardware mentioned in that post can be used to secure email accounts by GMail, Microsoft (Hotmail, Outlook), and Yahoo. It costs $50-60 to buy two Yubikeys but it’s worth the peace of mind.

Use a Better Bank

Which bank failed to freeze the couple’s account after getting a report of fraudulent access and then dragged their feet over a month to return the money? This is totally unacceptable. The poster only said it was an online bank headquartered in Utah. Does the name start with the letter A?

If you have an account with an online bank headquartered in Utah, maybe consider using a different bank. You can search for a bank’s headquarters by its name or web address on this FDIC web page.

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The post How to Secure Your Email Account and Prevent Wire Fraud appeared first on The Finance Buff.

Most electronic payments and transfers to and from a bank account in the U.S. go through ACH, which stands for Automated Clearing House. To make money go from A to B, you can initiate the transfer from the sending account or you can initiate it from the receiving account. When I see complaints about ACH, it’s usually caused by not doing it the right way.

ACH Push vs Pull

If an ACH transaction is initiated from the sending account, it’s an ACH credit or figuratively an ACH push — you are pushing the money out from the sending account. When you receive a payroll direct deposit, the payroll provider is doing an ACH push into your account.

If an ACH transaction is initiated from the receiving account, it’s an ACH debit or figuratively an ACH pull — you are pulling the money into the receiving account. When you link your checking account to a mortgage or a credit card for autopay, the bank is doing an ACH pull against your checking account. When you write a paper check, the recipient’s bank uses the routing number and the account number on the check to do an ACH pull.

An ACH transfer isn’t a wire transfer. A wire transfer is faster but it usually costs more. Most banks charge $10-15 for sending a wire. Some banks also charge $10 for receiving a wire. An ACH transfer is usually free on both sides.

ODFI and RDFI

As members of the ACH network, financial institutions go by the operating rules set by an association (NACHA).

Whether it’s an ACH push or an ACH pull, the bank that initiates the ACH transaction is called the Originating Depository Financial Institution (ODFI). The bank that receives the ACH request is called the Receiving Depository Financial Institution (RDFI).

Originating and receiving refer to the ACH request, not which direction the money flows. The money flows in the same direction as the ACH request in an ACH push— from the ODFI to the RDFI. In an ACH pull, the money flows in the opposite direction of the ACH request. The ACH request goes from the ODFI to the RDFI but the money flows from the RDFI to the ODFI.

The fundamental rule in ACH is that the bank that initiates the ACH (the ODFI) is liable for the transaction. The RDFI can reject the ACH if the account isn’t in good standing but otherwise they must honor the transaction. The RDFI can’t place any hold on the incoming ACH credit or delay the outgoing ACH debit. After posting the ACH transaction, if the account holder says the transaction isn’t authorized, the RDFI can reverse it.

ACH Limits

Because the ODFI is liable, some banks and credit unions set limits on the frequency and/or the amount of ACH transactions they initiate. For example, a credit union has a policy of not initiating any ACH pull into its checking account. It also limits any ACH push to $5,000 per business day and $15,000 over any five business days.

These limits only apply when the credit union initiates the ACH. If the ACH is initiated by another bank, the credit union must faithfully accept it.

When you see limits on the frequency or the amount of ACH transfers, the limits only apply to ACH transactions initiated by that institution. It doesn’t mean you can’t transfer more frequently or in larger amounts. It just means you have to initiate the ACH on the other side.

ACH Fees

The ACH operator charges banks less than one penny for each ACH transaction. Because this cost is so low, most banks don’t charge consumers for ACH transfers but some large banks still do. For example, Bank of America doesn’t charge for ACH pulls but it charges $3 for each ACH push to be delivered in three business days and $10 for next-day delivery.

Similar to the ACH limits, these fees only apply when this bank initiates the ACH. The fees don’t apply when the ACH transaction is initiated outside this bank. If your bank charges a fee for ACH, initiate your ACH on the other side. If I need to transfer money from Bank of America to Fidelity, I initiate a pull from Fidelity.

ACH Hold

ACH goes by the principle of “No news is good news.” The ODFI will hear back if anything goes wrong but they won’t have any positive confirmation that the ACH transaction “cleared.” The ODFI only knows that it hasn’t been reversed yet. The RDFI has 60 days to reverse an ACH transaction.

The RDFI is given 60 days to reverse an ACH transaction because customers can’t be expected to watch their accounts daily. In the old days, banks issue paper statements monthly and that was the only opportunity for customers to review their accounts. Customers are given time to receive the statement in the mail, review the statement, and object to any errors. With online and mobile banking and paperless statements today, consumer protection laws still go by the monthly statements as the official account records.

This creates a problem especially for ACH pull transactions and check deposits. You see that your other account is already debited but the ODFI can’t trust that it won’t be reversed. That’s why the credit union I mentioned has a policy of not initiating any ACH pulls into its checking account. That’s why Fidelity holds any ACH pull and check deposit for up to four business days before making it available for withdrawals (it’s available immediately for trading, just not for withdrawals). That’s also why if you made a deposit to Vanguard recently, your withdrawal can only go back to the same bank where it came from originally. These policies limit their liability when they initiate the ACH pull.

On the other hand, when you do an ACH push, the sending bank processes it only if you have enough money in your account. The receiving bank treats the incoming ACH credit as good funds because the sending bank is liable. The receiving bank can’t put a hold on the money pushed in.

Therefore, when you have a choice, push the money from the source to avoid a hold. Don’t do it as an ACH pull.

ACH Speed

ACH traditionally processes overnight. The ODFI sends a batch of ACH transactions to the ACH operator in the evening. The RDFI posts the transactions to the accounts the next morning.

There is no 3-day ACH versus next-day ACH on the ACH platform. If the ACH transaction takes longer than one business day, it’s only caused by the ODFI delaying it on purpose. It takes 3 business days when the ODFI intentionally delays sending it on a push or when it intentionally delays crediting your account on a pull.

If you want faster ACH, use a better bank to initiate it.

Same-Day ACH

The current gold standard in ACH is same-day ACH. When you request the ACH in the morning, you see it arrive on the other side in the afternoon.

This is again controlled by the bank that initiates the ACH. If the ODFI sends ACH requests to the ACH operator multiple times a day, your ACH transaction will arrive at your destination on the same day. If the ODFI only sends once in the evening, your ACH will arrive on the next business day.

For example, Fidelity does same-day ACH. When I ask Fidelity to transfer money to Bank of America before a cutoff time, I see the money in my Bank of America account in a few hours.

Not all financial institutions process same-day ACH but you should use one that does it at least overnight. Any slower than that is just lame. Because Fidelity’s same-day ACH is fast enough, I don’t bother using wire transfers even though Fidelity also offers free wire transfers.

FedNow Instant Payments

The Federal Reserve will launch a new real-time payment system soon. It’s called FedNow. It’ll work even faster than same-day ACH. Chase, Wells Fargo, and a number of other banks are already certified to work with FedNow.

We’ll have to see which banks will offer FedNow to consumer accounts and how it works in the real world. For the time being, let’s make sure all your transfers arrive at least the next business day.

When to Use ACH Pull

To minimize hold on your ACH, in general you should do your ACH as a push. Request the ACH at the institution where your money is at. Ask them to send the money to the receiving account.

However, you should do an ACH pull in the following situations (writing a check also counts as an ACH pull):

Bill Payments

When you pay a bill, it’s important to associate the payment with your bill. You can use your bank’s Bill Pay service and include a reference for your bill but involving a third party creates the potential for finger-pointing when there’s a problem. Did the Bill Pay service fail to make the payment on time? Did the Bill Pay service pay but the biller didn’t apply it correctly?

It’s much cleaner to let the biller pull from your bank account. Their billing system will apply the pull to your bill. You can always dispute the pull with your bank if the amount is wrong.

When It May Not Go Through

If there’s a chance that the ACH won’t go through, you should do it as a pull.

If you do a push but it doesn’t show up in the receiving account, the money already left your sending account. If you do a pull and it doesn’t come through, at least the money is still in your original account. If the money left your account and the receiving bank doesn’t credit you, you can ask your bank to reverse it.

Overcoming Limits and Fees

As I mentioned previously, if the sending bank has low limits or charges a fee for a push, you can initiate a pull from the receiving side. The pull may be subject to a hold though.

Contributing to an IRA

When you contribute to an IRA between January 1 and April 15, it can be for the previous year or it can be for the current year. If you do an ACH push into your IRA, the custodian doesn’t know which year it’s for. They can assume but their assumption can be wrong. If you ask the IRA custodian to pull, you’ll have an opportunity to say whether it’s for the previous year or the current year.

Buying a CD

A CD at a bank or a credit union doesn’t have an account number that accepts ACH. You can push to a checking account or a savings account at that bank and then use the money to buy a CD but it’s easier to just let the bank pull from your current account.

Depositing to Vanguard

Vanguard accounts don’t have a routing number for ACH except for its new Cash Plus Account currently in pilot. To transfer funds into your Vanguard account, you link your bank account at Vanguard and ask Vanguard to pull.

Internal Transfers

The fastest transfers happen within the same institution or between two institutions owned by the same parent company. Both sides trust each other and they know that you have sufficient funds for the transfer.

Some large financial institutions offer both banking and investment services. Bank of America owns Merrill Edge. Chase has J.P. Morgan Self-Directed Investing. Fidelity offers a Cash Management Account. Charles Schwab owns Schwab Bank. Vanguard will have the Cash Plus Account when it’s made available to everyone. An internal transfer between the banking side and the brokerage side happens instantly and there won’t be any hold.

In a way, internal transfers are the best way to transfer money — no limit, no time delay, no hold. Using the same company as a one-stop shop for both banking and investing doesn’t give you everything in the best of breed but it’s a lot easier when you make fewer things matter.

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When I started my first full-time job years ago, the first thing my manager asked me to do was to order a Franklin Covey Day Planner. It was the standard issue for all employees of that company.

Technology evolved over the years. The standard tool was Microsoft Outlook at my last full-time job. We used the calendar features in Outlook to book conference rooms and manage meeting invites.

I use Google Calendar now to track personal events such as dentist appointments and recurring household chores.

A computer-based calendar makes it easy to create recurring events, whether it’s monthly, quarterly, or annually. You set it only once and you’ll have it on your calendar every month, every quarter, or every year. For really important tasks, you can set up the calendar to send you not just one reminder but several reminders — for example, seven days before, three days before, and one day before — to make sure you don’t forget.

I have repeating events on my calendar to change the furnace filter, add salt to the water softener, run a cleaning cycle on the dishwasher, check the engine oil, and replace the air filters in my car. If I think of something else that needs to be done on a set schedule, I add it to the calendar.

Bills and Taxes

I also started using Google Calendar to manage financial chores.

I set all my bills on autopay to let them charge a credit card or debit a bank account but I understand not everyone is comfortable with autopay. Some bills, especially those from government entities, can’t be set on autopay.

For example, your state DMV may not have autopay for annual vehicle registration renewals. You have to renew and pay manually each time. Rather than using the renewal notice you get in the mail as the prompt, you can set a calendar reminder to look for the renewal on the DMV website yourself a month before your sticker expires. That way you won’t forget to renew even if you don’t receive the renewal notice. You’ll have this reminder on your calendar every year after you set it up only once.

If you pay estimated tax because you’re self-employed or retired, the IRS and the state revenue agency don’t send you invoices. You have to pay them proactively four times a year. I use EFTPS to schedule payments to the IRS. If you set up the four quarterly due dates as annually repeating events, your calendar will remind you every time without fail.

The same goes for the property tax if you’re not paying it through mortgage escrow. If the property tax bill is lost in the mail or if their email notification gets filtered into spam, you still owe the property tax. Property tax is due on a set date every year. You can set an annually repeating calendar reminder to make sure you pay it on time.

Investing Tasks

If you’re not automatically reinvesting dividends, you can set a recurring calendar event to go into your account and reinvest manually.

If you invest in Treasuries or brokered CDs, the interest payments can’t be automatically rolled into the same Treasury or brokered CD but you know when the interest will be paid out as cash. If the amount is substantial, you can set a recurring calendar reminder to reinvest.

You also know when your Treasury or CD will mature. If your broker doesn’t have the “auto roll” feature or if you choose not to use it, as soon as you buy the Treasury or CD, you can set a calendar reminder to reinvest the principal repayment at maturity.

If you’re required to take the Required Minimum Distribution from your retirement accounts, you can set up an annually repeating calendar event to help you remember to take it. The IRA custodian may also remind you but the ultimate responsibility falls on you.

If you’re planning to cash out I Bonds to buy new ones at a higher fixed rate, set a calendar reminder for the best time to sell. After you sell, set another calendar reminder to download the 1099 form from TreasuryDirect next January because they don’t send it by mail.

Automation is usually my first choice. If I can’t make it happen automatically, I put it on my calendar to make sure I don’t forget. I use Google Calendar but any other calendar system works too.

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The previous post Buying CD in a Brokerage Account vs Bank CD or Treasury talked about the advantages and disadvantages of buying brokered CDs versus buying CDs directly from a bank or a credit union or buying Treasuries. It ended with these steps when you’re considering buying brokered CDs:

1. Decide what term you want because selling brokered CDs before maturity will be costly.

2. Check DepositAccounts.com for the best rate on a direct CD for your term. Weigh the convenience of brokered CDs against giving up yield and the early withdrawal option.

3. Check the yield on Treasuries for your term. Adjust it for the state and local tax exemption if you’re buying in a regular taxable account.

4. Only compare non-callable brokered CDs with direct CDs and Treasuries. Demand a large yield difference if you don’t mind callable CDs.

Now we go into the logistics of how to buy a CD in a Fidelity or Vanguard brokerage account with a real-life example.

Suppose we want a 3-year CD because we’re comfortable committing to holding it for three years.

Research Direct CDs

We go to DepositAccounts.com to see the current best rates offered directly by a bank or a credit union. We want the yield on a brokered CD to be not too far off.

We select the 3-year term in the term dropdown. The highest rate offered is 5.65%. Going into the details of the CDs that offer the highest rates shows that they’re variable-rate CDs, which means the rate can drop during the term. We don’t want that.

We go down the list to find a CD with a fixed rate. We see that the best 3-year fixed-rate CD pays 5.13%. It requires opening a new account at a credit union though. We like the convenience of using our existing brokerage account without having to open another account but we don’t want to give up too much on the yield.

Research Treasuries

We also check Treasuries. This bond yields page from Fidelity doesn’t require a login.

We see the 3-year Treasury yield is 4.36% right now. Because Treasuries are exempt from state and local taxes and we’re buying in a regular taxable account, we calculate the Treasury’s tax-equivalent yield using this formula:

treasury yield * ( 1 – federal tax rate ) / ( 1 – federal tax rate – state tax rate )

It comes out to 4.36% * ( 1 – .22 ) / ( 1 – .22 – .06 ) = 4.72% when our federal tax rate is 22% and our state tax rate is 6%. A CD that’s fully taxable for both federal and state must have a yield this high to beat the Treasury. We don’t have to make this adjustment if we’re buying in an IRA or if we live in a no-tax state.

Now we want to see if we can beat the 3-year Treasury if we buy a brokered CD and how close we can get to the best rate from a direct CD.

There are two ways to buy a brokered CD: new issue and secondary market. Whether you’re looking for new issues or the secondary market, it’s best to look when the market is open. You’ll see more choices during those hours.

New Issue

Buying a new-issue brokered CD means buying a brand-new CD offered by a bank through the broker. You see the rate and the terms of the CD set by the bank. You pay the face value to get the CD if you like the rate and the terms. The broker doesn’t charge you a fee because they’re getting paid by the bank to sell it.

Secondary CDs

Buying on the secondary market means buying from a dealer who bought the CD from a previous owner. The price the dealer asks for may be above or below the face value of the CD depending on the existing rate of the CD relative to the current market rate. The interest payments and the principal repayment from the bank are still based on the face value and the original rate because the bank doesn’t care whether you’re the first owner or the second or the third owner. The CD still has FDIC insurance.

The broker charges you a commission to buy CDs on the secondary market. The commission is typically $1 per $1,000 in face value. Paying a commission reduces the yield you get from the CD.

You also must pay accrued interest to the dealer. If the CD pays interest every six months and it’s been two months since the last interest payment date, you owe two months’ worth of interest to the dealer. You’ll still receive six months’ worth of interest from the bank when the CD pays interest next time, which reimburses you for the accrued interest you paid to the dealer.

If the price of the CD is above 100 because the coupon rate of the CD is higher than the quoted yield, you’re paying more than the face value of the CD. The difference above the face value isn’t insured by the FDIC. Avoid this type of CD or, if you must, only choose one from a bank that’s too big to fail.

If you’re buying in a regular taxable brokerage account, paying a price above or below the face value with the trading commission and accrued interest complicates your taxes. If you prefer to avoid this complication, stick with new-issue brokered CDs when you’re buying in a regular taxable brokerage account. The tax complication doesn’t apply when you’re buying in an IRA.

Fidelity

If you use Fidelity, click on “News & Research” and then “Fixed Income, Bonds & CDs” after you log in to your Fidelity account. If you use Vanguard, jump ahead to the next section.

You get to the same bond yields page.

New Issues

Clicking on the link under the term we want gives us this list of new issue CDs being offered:

A “No” in the “Call Protected” column means the CD is callable (not protected from a call). In general, we want to avoid callable CDs because although the advertised rate is higher, we’re not locked in to earn it for the full term. We see in this list that the highest yield on a non-callable 3-year CD is 4.7%.

“Coupon Frequency” shows how often the CD pays interest. Some CDs pay monthly, some pay quarterly, and some pay semi-annually. Which way is better is only personal preference. We prefer less frequent payments so that we don’t have to deal with the received cash. Some others may prefer to receive cash more frequently to meet cash flow needs.

“Maturity Date” is when we’ll get our principal back. “Settlement Date” is when our cash will leave our account to buy the CD. Our cash earns interest in the money market fund until the settlement date.

Suppose we want to buy the CD from Capital One. We see this page after we click on “Buy.”

We must buy in $1,000 increments. We enter 50 if we want to buy $50,000 in face value. Fidelity offers an optional “Auto Roll” feature. If we choose to use it, Fidelity will automatically buy another brokered CD of the same term and interest payment frequency when this CD matures. We choose not to use the “Auto Roll” feature because Fidelity can pick a callable CD for the auto roll and we don’t like callable CDs. We can set a reminder in Google Calendar to reinvest when our CD matures.

If we’re buying in an IRA or if we live in a no-tax state, the 4.7% rate on a non-callable CD is still higher than the 4.3% rate on a 3-year Treasury. We can decide whether the 0.4% extra yield is worth the poor liquidity in a brokered CD. However, when we’re buying in a regular taxable account, the 4.7% rate on a non-callable CD isn’t any better than the tax-equivalent yield on a 3-year Treasury after we adjust for the state and local tax exemption from the Treasury. We might as well just buy the Treasury.

Secondary CDs

Before we abandon the idea of buying a brokered CD in favor of buying the Treasury, we’re curious whether we can do better by buying a brokered CD on the secondary market.

We go back to the bond yields page by clicking on “News & Research” and then “Fixed Income, Bonds & CDs.”

Click on the “Bonds” tab and then the “CDs” sub-tab. We’re now searching for CDs on the secondary market. Enter a date range for the maturity date and then click on “See xx CUSIPs.”

First, click on “Yield to Worst” in the “Ask” columns to sort the list by the offered yield.

When we see a date in the “Next Call Date” column, that CD is callable. As we still want to avoid callable CDs, we see the highest yield for a non-callable CD is 4.751%.

The “Price Qty(Min)” column gives us three numbers. The first number is the price. It’s expressed as a percentage of the face value. 99.585 means $995.85 per $1,000 face value. We’ll have full FDIC insurance when the price is below 100. The second number shows how much in face value is available to buy. 8 means $8,000 in face value is available in that one. The third number in parenthesis shows the minimum purchase. 1 means a minimum of $1,000 in face value. The CD in the next row at a yield of 4.750% has $95,000 in face value available but we must buy at least $20,000 in face value.

Because we must pay a commission when we buy a secondary CD, our net yield will be lower than the gross yield we see in the table. This makes it not worth the hassle to buy a secondary CD when the 4.75% rate isn’t much higher than the 4.7% rate on a new issue CD to begin with.

In summary, our round of research shows:

Given these rates, if we prefer the convenience of keeping everything in the brokerage account, we’ll buy a 3-year Treasury (see How To Buy Treasury Bills & Notes Without Fee at Online Brokers and How to Buy Treasury Bills & Notes On the Secondary Market). We’ll buy a CD directly from a credit union for a slightly higher yield if we don’t mind opening a new account there. If we’re buying in an IRA, we’ll consider a new issue brokered CD but we have to weigh it against the poor liquidity. Buying a brokered CD on the secondary market doesn’t give us much at this moment.

The tradeoffs will change as rates change. Sometimes brokered CDs are more competitive and sometimes they’re less competitive. Sometimes you find a bargain in a secondary CD and sometimes you don’t. The research process I’m showing in this example will stay the same.

Vanguard

It works similarly in a Vanguard account. Click on “Products & plans” and then “CDs” after you log in to your Vanguard account.

New Issues

Scroll down a little and click on the big “View detailed CD rates” button.

The next page displays an old-style page in a frame. If you’re using the Safari browser on a Mac and you don’t see anything, turn off “Prevent cross-site tracking” in your Safari settings.

Find the term you’re interested in and click on the rate. The displayed rate may be from a callable CD.

We keep scrolling down to find the first non-callable CD. It pays 4.7%. This is the same rate we see in Fidelity but it’s from a different bank. Suppose we want to buy $50,000 in this CD. We click on that row and then the “Continue” button. We see this order page:

It doesn’t matter that the CD is from a bank we haven’t heard of because it has FDIC insurance. We also must buy in $1,000 increments. We enter 50,000 in the quantity box. Vanguard doesn’t offer an “Auto Roll” feature. We can set a reminder in Google Calendar to reinvest when our CD matures.

Secondary CDs

We’re also curious whether we can find a better bargain on the secondary market. Click on “Cancel” to go back to the previous page.

Click on the “CDs” tab. Uncheck the box for “New issue” and check the box for “Secondary” because we’re looking for secondary CDs. Enter a date range for the maturity date and click on “Search.”

We look carefully to skip the callable CDs. The second row in the “Yield to worst” column shows the yield. The search results show that the highest yield available in a non-callable CD on the secondary market is 4.772%. The second row in the “Qty” and “Min. qty” columns shows how much is available and the minimum purchase amount. 48 under “Qty” means $48,000 in face value is available and 25 under “Min. qty” means we must buy at least $25,000 in face value. The second row in the “Price” column shows the price we must pay. We want to see a number below 100 to get full FDIC insurance.

If we want to buy $50,000 worth of CDs, that one from Cross River Bank only has $48,000 available. We’ll have to mix and match or go down to the next one from Discover Bank for a slightly lower yield at 4.754%. Either 4.772% or 4.754% still has to be reduced by the trading commission we must pay for buying secondary CDs.

We come to the same conclusion using Vanguard as we did using Fidelity:

Given these rates, if we prefer the convenience of keeping everything in the brokerage account, we’ll buy a 3-year Treasury (see How To Buy Treasury Bills & Notes Without Fee at Online Brokers and How to Buy Treasury Bills & Notes On the Secondary Market). We’ll buy a CD directly from a credit union for a slightly higher yield if we don’t mind opening a new account there. If we’re buying in an IRA, we’ll consider a new issue brokered CD but we have to weigh it against the poor liquidity. Buying a brokered CD on the secondary market doesn’t give us much at this moment.

The tradeoffs will change as rates change. Sometimes brokered CDs are more competitive and sometimes they’re less competitive. Sometimes you find a bargain in a secondary CD and sometimes you don’t. The research process I’m showing in this example will stay the same.

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Retirees on Social Security receive an increase of their Social Security benefits each year known as the Cost of Living Adjustment or COLA. The COLA was 8.7% in 2023, which was the largest in 40 years. Retirees on Social Security will once again receive a COLA in 2024 but it won’t be as big as the one in 2023.

Automatic Link to Inflation

Some retirees think the COLA is given at the discretion of the President or Congress and they want their elected officials to take care of seniors by declaring a higher COLA. They blame the President or Congress when they think the increase is too low.

It was done that way before 1975 but the COLA has been automatically linked to inflation for nearly 50 years. How much the COLA will be is determined strictly by the inflation numbers. The COLA is high when inflation is high. It’s low when inflation is low. There’s no COLA when inflation is zero or negative, which happened in 2010, 2011, and 2016.

CPI-W

Specifically, the Social Security COLA is determined by the increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). CPI-W is a separate index from the Consumer Price Index for All Urban Consumers (CPI-U), which is more often referenced by the media when they talk about inflation.

CPI-W tracks inflation experienced by workers. CPI-U tracks inflation experienced by consumers. There are some minor differences in how much weight different goods and services have in each index but CPI-W and CPI-U look practically identical when you put them in a chart.

The red line is CPI-W and the blue line is CPI-U. They differed by only smidges in 30 years.

There’s also a research CPI index called the Consumer Price Index for Americans 62 years of age and older, or R-CPI-E. This index weighs more by the spending patterns of older Americans. Some researchers argue that the Social Security COLA should use R-CPI-E, which has increased more than CPI-W in the last 30 years.

The green line is R-CPI-E. The red line is CPI-W. R-CPI-E outpaced CPI-W in 30 years between 1993 and 2023 but not by much. Had the Social Security COLA used R-CPI-E instead of CPI-W, Social Security benefits would’ve been higher by 0.1% per year, or a little over 3% after 30 years. That’s still not much difference.

Regardless of which exact CPI index is used to calculate the Social Security COLA, it’s subject to the same overall price environment. Congress chose CPI-W 50 years ago. That’s the one we’re going with.

Q3 Average

More specifically, Social Security COLA for next year is calculated by the increase in the average of CPI-W from the third quarter of last year to the third quarter of this year. You get the CPI-W numbers in July, August, and September. Add them up and divide by three. You do the same for July, August, and September last year. Compare the two numbers and round the change to the nearest 0.1%. That’ll be the Social Security COLA for next year.

The government releases the CPI-W for September in mid-October each year. The Social Security Administration makes the calculation and announces the Social Security COLA for the following year at that time.

2024 Social Security COLA

Although we won’t know for sure what the Social Security COLA will be in 2024 until we have the CPI-W for September, we can make educated guesses based on the inflation numbers in recent months and different scenarios for inflation in the coming months.

I project the CPI-W under three scenarios – low, mid, and high. If inflation in the coming months through September is 0%, meaning that prices freeze at the latest level, that’s our low inflation scenario. If inflation in the coming months is 3% per year, which means that prices will increase by approximately 0.25% per month through September, that’s our mid-line scenario. Finally, if inflation in the coming months is 5% per year, which means that prices will increase by approximately 0.4% per month through September, that’s our high scenario.

Here’s what the Social Security COLA will be in each scenario:

In the low inflation scenario, even though prices will freeze at the latest level, Social Security recipients will still receive a 2.2% COLA in 2024 because current prices are already higher than prices in the third quarter of last year. As we progress toward September and we see positive inflation, this 2.2% number will go up.

The mid-line is probably the most likely scenario. Inflation in recent months is down but not zero. If inflation continues at a moderate pace, Social Security recipients will see approximately a 3% COLA in 2024.

The high scenario requires a 0.4%/month increase in the CPI-W through September. This isn’t out of the question. If inflation stays high, Social Security will have a 3.5% COLA in 2024.

The differences in these three scenarios aren’t huge. Between a 2.2% COLA in the low inflation scenario and a 3.5% COLA in the high inflation scenario, it comes down to a difference of about $25/month on a $2,000/month Social Security benefit or a difference of about $40/month on a $3,000/month benefit.

Medicare Premiums

If you’re on Medicare, the Social Security Administration automatically deducts the Medicare premium from your Social Security benefits. The Social Security COLA is given on the “gross” Social Security benefits before deducting the Medicare premium and any tax withholding.

Medicare announces the premium for next year around the same time Social Security announces the COLA but not necessarily on the same date. The increase in healthcare costs is part of the cost of living that the COLA is intended to cover. You’re still getting the full COLA even though a part of the COLA will be used toward the increase in Medicare premiums.

Retirees with a higher income pay more than the standard Medicare premiums. This is called Income-Related Monthly Adjustment Amount (IRMAA). I cover IRMAA in 2023 2024 2025 Medicare IRMAA Premium MAGI Brackets.

Root for a Lower COLA

People intuitively want a higher COLA but a higher COLA can only be caused by higher inflation. Higher inflation is bad for retirees.

Whether inflation is high or low, your Social Security benefits will have the same purchasing power. It’s the purchasing power of your savings and investments outside Social Security that you should worry about. When inflation is high, even though your Social Security benefits get a bump, your other money loses more value to inflation. Your savings and investments outside Social Security will last longer when inflation is low.

You want a lower Social Security COLA, which means lower inflation and lower expenses.

Some people say that the government deliberately under-reports inflation. Even if that’s the case, you still want a lower COLA.

Suppose the true inflation for seniors is 3% higher than the reported inflation. If you get a 1% COLA when the true inflation is 4% and you get a 5% COLA when the true inflation is 8%, you are much better off with a lower 1% COLA together with 4% inflation than getting a 5% COLA together with 8% inflation. Your Social Security benefits lag inflation by the same amount either way, but you’d rather your other money outside Social Security loses to 4% inflation than to 8% inflation.

Root for lower inflation and lower Social Security COLA when you are retired.

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The debt ceiling has been resolved. While it was hanging in the air and you were hesitant to buy Treasuries, you may have come across brokered CDs, which you can buy in a brokerage account without having to open a separate account with a bank. Are they worth it?

What Is a Brokered CD

A brokered CD is a CD issued by a bank and sold through brokers. When you see a CD offered in your Fidelity, Vanguard, or Charles Schwab account, that’s a brokered CD.

The CD is issued by a bank. It has FDIC insurance. If you have other money at the same bank that issues the CD, your FDIC insurance limit is aggregated across your direct holdings and your brokered CDs from that bank.

A brokered CD is safe as long as you stay under the FDIC insurance limit. I bought a brokered CD from a bank in Puerto Rico during the 2008 financial crisis. FDIC paid me in full with interest when that bank failed.

How a Brokered CD Works

Except for having FDIC insurance, a brokered CD works more like a bond.

1 CD is $1,000 of principal. You buy them in $1,000 increments. Fidelity offers “fractional CD” on some CDs. You will see fluctuating prices for the CD after you buy it in your brokerage account.

Periodic interest payments from the CD are paid into your brokerage accounts as cash. They aren’t automatically reinvested into the same CD. You get the principal back as cash when the CD matures. If you want to get out of the CD before it matures, you must sell it on the secondary market to another buyer.

Brokered CD vs Direct CD

Brokerage CDs have some advantages over CDs you buy directly at a bank or a credit union. They also have two large disadvantages.

Everything In One Account

It’s more convenient to buy brokered CDs from several different banks in one brokerage account than to open a separate account at each bank. This is helpful especially when you buy short-term CDs, but if you’re considering a 5-year CD, you only open an account once when you buy directly from a bank or a credit union and you’re good for five years.

Competitive Rates

Because banks know that brokers present brokered CDs in a table sorted by the yield, they have to offer a competitive yield to show up on top. They can’t prey on customers not being up to speed on the going rates. Many banks still offer very low rates on their websites but they have competitive rates on brokered CDs.

Not all banks offer brokered CDs though. Some banks, and especially credit unions, offer CD specials only to their direct customers. You should check the best rates on DepositAccounts.com to see whether a bank or a credit union offers a better rate than the rate you see from a brokered CD.

No Renewal Trap

By default, a brokered CD is automatically cashed out when it matures. Some brokers offer an “auto roll” feature to buy another brokered CD of the same term when one CD matures but you specifically sign up for that feature only if you want it.

Most banks and credit unions automatically renew a matured CD. The new CD they renew you into often has uncompetitive rates. You’ll have to tell them to stop the renewal within a short window. If you aren’t on top of it, you’ll either be stuck with a low rate or you’ll have to pay a big early withdrawal penalty that can eat into your principal. See Beware: Banks Auto-Renew CDs with a Short Window to Back Out.

Call Risk

Many brokered CDs are callable, which means the bank has the right to terminate (“call”) the CD before the stated maturity date.

Having your CD terminated prematurely is the opposite of you refinancing your mortgage when the market rate goes down. The bank has the choice to terminate the CD or not. You have no right to refuse.

Some callable CDs have preset dates when the bank may exercise its right to terminate. Some are continuously callable, which means the bank has the right to terminate at any time after a certain date.

Naturally, the bank will only terminate the CD when the going rate goes down. You were counting on earning the guaranteed interest for the full term. All of a sudden the bank decides to pay you out early. You get your money back but you can only earn less now because the going rate is lower. On the other hand, if the going rate goes up, the bank chooses not to terminate the CD, and you’re stuck with a below-market rate until maturity.

A callable CD gives you the worst of both worlds. Most direct CDs aren’t callable. You’re guaranteed to enjoy the rate you locked in for the full term when you buy a CD directly from a bank or a credit union. You should compare only non-callable brokered CDs with direct CDs or demand a substantially higher yield from a callable brokered CD.

For example, as I’m writing this, Vanguard shows the best 5-year brokered CD pays 5.2% and DepositAccounts.com shows the best 5-year direct CD from a credit union pays 4.68%. That makes brokerage CDs look attractive until you find out that the brokered CDs with higher rates are all callable.

The best rate on a 5-year non-callable brokered CD is only 4.5%. This is lower than the 4.68% yield on a 5-year CD you can get from a credit union. You will have to weigh the convenience of buying a brokered CD against getting a lower yield or taking the call risk.

Can’t Withdraw Early

A CD bought directly from a bank or a credit union has a big advantage over a brokered CD because you can break it by paying a preset early withdrawal penalty. Some direct CDs have no early withdrawal penalty (“no-penalty CDs”).

A brokered CD doesn’t offer an option to withdraw early. You must sell the brokered CD on the secondary market to another buyer if you want to get out early.

There may not be a buyer for your CD when you want to sell. If there’s a buyer, the price you receive from selling the CD is determined by the current market rate at that time minus a large haircut. It may be much lower than paying the preset early withdrawal penalty on a direct CD.

Breaking a CD isn’t only for an unexpected need for cash. When interest rates go up sharply, it makes sense to pay an early withdrawal penalty and reinvest at a higher yield. I broke all my direct CDs last year by paying the early withdrawal penalty because the CD Early Withdrawal Penalty Calculator shows that I will end up with a higher value than holding the CDs to maturity. I wouldn’t have had this option had I bought brokered CDs.

No Reinvestment of Interest

When you have a CD directly from a bank or a credit union, you have the option to have the interest paid out to you to reinvest the interest into the same CD at the same stated yield of the CD. If the going rate goes up, you choose to have the interest paid out and earn a higher yield elsewhere. If the going rate falls, you choose to reinvest the interest at the original higher yield.

You don’t have this option with a brokered CD. All interest is paid out in cash. If the going rate goes down, you can only earn a lower yield on the interest.

Brokered CD vs Treasury

Suppose you like the convenience of brokered CDs and you don’t mind giving up a small difference in yield and the option to withdraw early. Still don’t pull the trigger just yet. You always have the option to buy Treasuries instead.

Brokers sell brokered CDs because they’re paid by the banks to sell the CDs. You see more advertising from the broker for brokered CDs than for Treasuries but you may be better off buying Treasuries anyway.

Because Treasuries have a direct guarantee from the government versus through a separate government agency (the FDIC), brokered CDs must overcome several hurdles before you consider them. Otherwise you just buy Treasuries.

Yield May Be Lower

Brokered CDs don’t always pay more than Treasuries of a comparable term. For example, as I’m writing this, the best six-month brokered CD pays 5.3% APY whereas a six-month Treasury pays 5.4%.

Don’t buy a brokered CD only because the rate sounds attractive on the surface. Always find out first what a Treasury is paying for the same term. See How To Buy Treasury Bills & Notes Without Fee at Online Brokers and How to Buy Treasury Bills & Notes On the Secondary Market. Don’t bother with a brokered CD when a Treasury pays more.

No State Tax Exemption

If you buy in a regular taxable brokerage account, interest from Treasuries is exempt from state and local taxes. Interest from brokered CDs is fully taxable by the state and local governments. Brokered CDs must pay more than Treasuries after adjusting for this state and local tax exemption.

If your federal marginal tax rate is f and your state and local marginal tax rate is s, the tax-equivalent yield of a Treasury with a quoted yield of t is:

t * ( 1 – f ) / ( 1 – f – s )

For example, as I’m writing this, the best 1-year brokered CD has a yield of 5.4% and a one-year Treasury has a yield of 5.24%. When your federal marginal tax rate is 22% and your state and local marginal tax rate is 6%, the tax-equivalent yield of the Treasury is:

5.25% * ( 1 – .22 ) / ( 1 – .22 – .06 ) = 5.68%

That means a CD must have a yield of 5.68% to earn the same amount after all taxes as a Treasury with a yield of 5.24%. Although the brokered CD with a yield of 5.4% appears to pay more than the Treasury with a yield of 5.24% at first glance, it actually pays less than the Treasury after you take all taxes into account.

You don’t have to make this adjustment if you’re buying in an IRA or if you don’t have state and local taxes.

Treasuries Aren’t Callable

Many brokered CDs are callable whereas all Treasuries aren’t callable. You should compare only non-callable brokered CDs with Treasuries or demand a substantially higher yield from a callable brokered CD.

For example, as I’m writing this, Fidelity shows the best 5-year brokered CD pays 5.2% when the yield on a 5-year Treasury is 3.89% but the best yield on a 5-year non-callable brokered CD is only 4.5%.

The yield advantage shrinks further when you adjust the Treasury yield for the state and local tax exemption. If we use the same federal marginal tax rate of 22% and state and local marginal tax rate of 6% in the example above, the tax-equivalent yield of the 3.9% Treasury is 4.21%. The 4.5% brokered CD only has a marginally higher yield than the Treasury. It’s more competitive in an IRA and in no-tax states.

Large Haircut When You Sell

If you want to get out of a brokered CD before it matures, you must sell it to a willing buyer. That’s the same for Treasuries but there are far fewer buyers for brokered CDs than for Treasuries. The buyer for your brokered CD will demand a substantial price concession to take over the CD from you.

Treasuries are highly liquid and competitive. If you must sell your Treasuries before maturity, you may get a lower price than your original purchase price but it’s going to be a fair price based on the market condition at that time.

Any slight yield advantage you have from a brokered CD over a comparable Treasury vanishes quickly if you must sell before maturity. Don’t even consider brokered CDs if there’s any chance you won’t hold them to maturity.

***

Before you explore whether it makes sense to buy a brokered CD, you should:

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The tax season is over for most people but if you used TurboTax downloaded software, don’t uninstall it just yet.

I showed in previous posts some unwelcoming features in TurboTax that you may want to opt out of — underpayment penalty and estimated tax payment vouchers. Ironically, TurboTax downloaded software also has a very useful feature hidden deep inside. You have to know to dig it out.

Project for Current Year

It’s called the What-If Worksheet. After you’re done with your previous year’s taxes, you use the What-If Worksheet to project your taxes for the current year. It also makes it easy to compare different scenarios.

The idea of the What-If Worksheet is that you can create alternative scenarios and see how your taxes will change.

What if you earn more income?

What if your income drops?

What if you take on a mortgage?

What if you sell some investments and realize capital gains?

What if you convert some IRA money to Roth AND you sell some investments with a capital loss?

The What-If Worksheet is only available in TurboTax downloaded software, not in its online software. It’s another reason to use TurboTax downloaded software, not the online software. As far as I know, only TurboTax has it. H&R Block doesn’t have it. Neither does FreeTaxUSA.

Plan for Roth Conversion

I’ll use the same example I used in the previous post Roth Conversion with Social Security and Medicare IRMAA to show how you can plan for Roth conversion with this Work-If Worksheet in TurboTax.

A retired couple, both age 66, Florida residents, married filing jointly with no dependents. They live on $60,000 of Social Security benefits, $20,000 of Traditional IRA withdrawals, $5,000 of interest income, and $10,000 of qualified dividends. They have no other income or deductions. Both of them enrolled in Medicare Part B and Part D.

TurboTax shows that this couple with $95,000 of income paid $2,018 in federal income tax. That’s only 2% of their income. They are interested in doing a Roth conversion next year to take advantage of their low tax rate.

Find What-If Worksheet

You’ll have to know that the What-If Worksheet exists and really look for it.

Click on Forms on the top right in TurboTax downloaded software and then click on the Open Form button.

This opens a pop-up window. Type “what” or “what-if” in the search box. Double-click on the “What-If Worksheet” in the search results to open it.

Create a Baseline

The What-If Worksheet has four columns. Column 1 is auto-populated with data from your tax return. Columns 2 to 4 are used for tax planning.

First, you create a baseline for the current year. Checking the box “Copy column 1 to column 2” under “Copy columns” copies your tax return for last year to Column 2. Checking the box “Check box to use XXXX tax rates” under Column 2 applies the current year’s tax brackets. You can give it a short name such as “Baseline.”

Change the numbers under Column 2 with what you already know will be different this year. For example, you know you will earn more interest because interest rates have gone up, you know you will have less in dividends because you sold some investments last year, your Social Security benefits will go up because of COLA, etc.

Column 2 is your best guess of your current year’s taxes before you take any deliberate actions.

Test Alternatives

After you create a good baseline for the current year, suppose you want to see how converting $20,000 from your Traditional IRA to Roth will affect your taxes.

Copy Column 2 to Column 3 by checking the box under “Copy columns.” Check the box to use the current year’s tax brackets again. Give it a short description such as “Convert $20k.”

Scroll down to the line for taxable IRA distribution and raise the number by $20,000 from the baseline in Column 2 to your alternative scenario in Column 3.

The What-If Worksheet shows this additional income will increase the taxable amount of the Social Security benefits for this couple in the example by $17,000. Together with the $20,000 Roth conversion, the AGI will increase by $37,000.

Scroll down further. The What-If Worksheet shows that converting $20,000 to Roth will increase the total tax from $2,138 in the baseline to $6,565. That’s a difference of $4,427, which translates into $4,427 / $20,000 = 22% average marginal tax rate on converting $20k.

Now you can decide whether paying a 22% tax to convert $20,000 is worth it. Do it if you think your future tax rate will be higher than 22%. Don’t do it if you think your future tax rate will be lower than 22%.

If you’d like to test another alternative, such as converting $50k, repeat the above to copy the baseline in Column 2 to Column 4 and increase the IRA withdrawal by $50k in Column 4. Calculate the difference in total tax and the average marginal tax rate when you convert $50k.

Case Study Spreadsheet

The Case Study Spreadsheet in the previous post shows the same effect for converting $20k in this same example.

The chart from the Case Study Spreadsheet shows that increasing the IRA withdrawal from $20k to $40k produces a 22% marginal tax rate. It also shows that this same marginal tax rate continues before hitting a spike when the IRA withdrawal reaches $45k (converting $25k to Roth on top of a $20k withdrawal).

The What-If Worksheet in TurboTax doesn’t show the marginal tax rate directly. You have to calculate it yourself by dividing the difference in total tax by the conversion amount. Nor does it show the marginal tax rate for different conversion amounts in a chart. You don’t know where it may hit a spike. You’d have to do trial-and-error with different inputs: $20k is OK, what about $30k; $50k is too high, what about $40k, …

It also only shows the difference in federal income tax. It doesn’t include the effect on state income tax or Medicare IRMAA. The Case Study Worksheet includes both the state income tax and Medicare IRMAA.

The What-If Worksheet in TurboTax is easier to use though. TurboTax already has your tax data. You don’t have to find the right places to enter them in a spreadsheet. You don’t need to learn how to use a spreadsheet if that sounds intimidating.

Professional Software

I heard great praises for a professional tax planning software called Holistiplan. Many financial advisors use it to do tax planning for their clients. I watched a demo of Holistiplan on YouTube:

Holistiplan uses the same technique as the What-If Worksheet in TurboTax.

• Copy data from the tax return for the previous year to the current year.
• Make known changes to create a baseline.
• Copy the baseline to an alternative scenario.
• Make changes to the alternative scenario and compare it with the baseline.

It also produces a chart of the marginal tax rate similar to the Case Study Spreadsheet.

If you go to a financial advisor this type of planning, it may cost you $1,000 or more. After you use TurboTax downloaded software to file your taxes, you already have the What-If Worksheet in TurboTax for tax planning estimates. It doesn’t show a chart or include the effect on state tax or Medicare IRMAA but it gets you 80% there. Use the Case Study Spreadsheet if you want 100%.

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Despite a long list of things that Fidelity’s retirement planning tool doesn’t do, I still use it as a high-level model. The planning exercise I did at the end of last year revealed two fundamental drivers of financial success in retirement.

Baseline Spending

First, I created a baseline annual spending. The planning tool showed a table of the projected values of our investments at different ages when the investment returns are “significantly below average.” Significantly below average means “a scenario in which your outcome was successful 90% of the time” using historical data. I created this chart by sampling a few age milestones from the table:

All values are in today’s dollars. I’m not showing numbers on the vertical axis for obvious reasons.

Our investment portfolio is projected to increase while we take withdrawals to support the planned annual spending. That’s both good and bad. It’s good because it shows we have enough for our retirement. It’s bad because we don’t need or want 60% more money at age 95 than at age 65.

Higher Spending

Next, I increased the annual spending by 20%. The planning tool showed a different set of projected values:

Now the projected values go down with age. It gets dangerously close to zero at age 95. This means that our sustainable spending is somewhere between these two levels. If the future market returns are below 90% of returns in the past, we can still spend a little more than the baseline plan but not 20% more.

Better Market Conditions

The planning tool also produced a table of projected values for returns merely below average but not significantly below average. Below average means “a scenario in which your outcome was successful 75% of the time” as opposed to 90%. The projected asset values under these better market conditions while supporting the higher spending looks like the blue line in this chart:

It shows that if the returns are only below average — not significantly below average — our assets would be higher than the baseline scenario through age 90 while supporting 20% higher spending every year.

Fundamental Drivers

When I presented these three scenarios to my wife, she pointed out that it was only too obvious.

“You didn’t have to run a fancy tool to tell me that higher spending will drain our investments faster and better returns will help.”

She told me the same thing when I said I discovered the secrets to a fat 401k 11 years ago.

It’s obvious because it’s true. Spending and investment returns are indeed the two fundamental drivers of financial success in retirement because they compound. We can handle low returns (the green line) or higher spending (the blue line) but not both year after year if we live long (the red line).

When we think of the usual consternations in retirement planning — when to claim Social Security, which accounts to withdraw from first, when and how much to convert to Roth, buckets strategy or proportional withdrawals, buy an annuity or not, … — everything added together can’t alter our retirement trajectory as much as our annual spending and investment returns.

If we’re on the red line because our annual spending is too high relative to the investment returns, the most optimal tactics in Social Security claiming, Roth conversion, and withdrawal sequencing won’t yank us back to the green line. We’ll need to reduce spending. If we’re on the blue line because we aren’t so unlucky with investment returns, we’ll do just fine even if we aren’t so clever in retirement planning tactics.

You don’t have to use Fidelity’s retirement planning tool to see this effect. Any other tool will show the same two fundamental drivers.

Make It Robust

Retirement planning tactics are useful but we should make our plan NOT rely on them. If optimal executions of Social Security claiming, Roth conversion, and withdrawal sequencing make or break our retirement, it means our plan is too fragile. It isn’t robust enough when a slip in execution, a miscalculation, or a change of laws will knock us off track.

The goal should be to make our retirement successful regardless. When we get our spending right for the market conditions, any optimization tactics will only be icing on the cake, and suboptimal executions won’t jeopardize our retirement. If we get our spending wrong for the market conditions, no amount of optimization will rescue our retirement.

***

We’ll be watching the trajectory of our investments. If we see we’re at risk of going on the red line when we have a combination of high spending and low returns, we’ll reduce spending and try to move toward the green line. If we see that the market returns aren’t too bad, we’ll know we have more leeway in our spending. That’s how we’ll keep our eyes on the two fundamental drivers of financial success in retirement.

I told my wife that’s all she needs to do if something happens to me. Everything else is optional. How does SECURE Act 2.0 alter the financial success of our retirement? It does not, because it doesn’t change the two fundamental drivers.

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TreasuryDirect announced that I Bonds bought between May and October 2023 will have a 0.9% fixed rate plus a variable rate that changes every six months. This new fixed rate is the highest we’ve ever seen in 15 years.

Low Fixed Rate on Older I Bonds

If you bought I Bonds between May 2020 and October 2022, the fixed rate on those older I Bonds is 0%. This 0% fixed rate stays with the bonds for their entire life up to 30 years. If you cash out the older I Bonds to buy new ones, you will benefit from the higher fixed rate over the long run.

I Bonds bought between November 2022 and April 2023 are still in the 12-month mandatory holding period by October 2023. They can’t be switched to new bonds until their mandatory holding period is over.

You see a list of your existing I Bonds by clicking on Current Holdings after you log in to your TreasuryDirect account. Then you choose Series I Savings Bond and click on Submit.

Here’s a reminder of the fixed rate on existing I Bonds issued since November 2010:

Look up the fixed rate for your existing I Bonds from the table above. If the fixed rate is 0%, 0.1%, 0.2%, or 0.3%, they’re all good candidates for switching to new ones.

Early Withdrawal Penalty

You’ll pay an early withdrawal penalty when you cash out I Bonds within five years but you can minimize the penalty if you time it correctly.

The early withdrawal penalty is the interest earned in the last three months before you cash out the bond. The variable rate will drop to a relatively low 3.38% annual rate in the coming months. If you wait three months after the bonds start earning 3.38%, you only give up three months’ worth of interest at 3.38% per year, which comes out to about 0.85%. You’ll make up for it in about a year from a higher fixed rate when you hold the new I Bonds for the long term.

I Bonds issued in the following months can be cashed out on these dates to keep the penalty low:

It’s a little tricky for I Bonds issued in these other months:

The 3-month period at the 3.38% annual rate doesn’t end until after November 1, 2023, but we don’t know whether the fixed rate will drop by that time. If the fixed rate doesn’t drop, you can cash out on the dates in the table above and get new I Bonds. If you worry that the fixed rate might drop after November 1, 2023, cashing out in October 2023 to get new I Bonds will give up a part of the interest at the 6.48% annual rate as opposed to 3.38%.

If you have spare cash, you can buy new I Bonds first in October and wait a few months to cash out your older I Bonds on the dates in the table above. This way you keep the early withdrawal penalty low while locking in the 0.9% fixed rate in case the fixed rate drops after November 1, 2023.

Take a look at the issue month of your older I Bonds. Set a calendar reminder to cash them out on the corresponding dates.

New 12-Month Holding Period

The new I Bonds you buy will have a new 12-month holding period. It’s not a problem when you hold them for the long term.

If there’s a chance that you’ll need the money from I Bonds in 12 months, don’t switch. You won’t make up for the early withdrawal penalty anyway if you hold the new bonds only for another year.

Pay Tax on Accrued Interest

You will pay federal income tax on the interest earned when you cash out I Bonds unless you chose to pay tax annually. See I Bonds Tax Treatment During Your Lifetime and After You Die.

The interest is exempt from state and local taxes. The 3-month early withdrawal penalty doesn’t count as interest earned because you never received it. You won’t pay tax on the early withdrawal penalty.

TreasuryDirect won’t withhold taxes when you cash out I Bonds. You will add the interest to your tax return using the 1099 form from TreasuryDirect.

Remember to download or print the 1099 form from TreasuryDirect in January. It’s under ManageDirect -> Manage My Taxes.

TreasuryDirect sends an email notification when the 1099 form is available but they won’t send the form by mail. Set a calendar reminder for yourself to download the 1099 form on January 31 in case you miss the email notification or the email notification is mistakenly directed to the spam folder.

Annual Purchase Limit

Buying new I Bonds after cashing out older I Bonds still counts toward your annual purchase limit. If you already bought I Bonds in 2023 or if you have more than $10,000 worth of I Bonds at 0%, you can’t switch all of them to new ones by buying new bonds directly but you can still buy them as gifts and hold them for delivery in the future.

Buying I Bonds doesn’t count toward the annual limit of the purchaser. It counts toward the annual limit of the recipient in the year when the gift is delivered to the recipient.

This works especially well for married couples. You can cash out all your old 0% fixed rate I Bonds, buy new ones as gifts to your spouse, and hold the gifts for delivery in the future. The new bonds start earning the 0.9% fixed rate right away while they’re held. Then you deliver the gifts in $10,000 chunks to your spouse in the coming years. Your spouse can do the same in the opposite direction.

See Buy I Bonds as a Gift: What Works and What Doesn’t and Deliver I Bonds Bought as a Gift in TreasuryDirect for more details on how this works.

***

The 15-year high fixed rate represents a great opportunity to lock into a higher fixed rate for many years to come. If you plan to hold I Bonds for the long term, see which bonds you should switch over, when is the best time to cash out, and whether you should buy new bonds directly or via gifts.

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After reading my previous posts Which Vanguard Money Market Fund Is the Best at Your Tax Rates and Which Fidelity Money Market Fund Is the Best at Your Tax Rates, a reader asked me to do the same for Charles Schwab. Many people have a brokerage account with Schwab. It’s more convenient to keep cash and other investments in one place. Although Vanguard charges the lowest expense ratio on its money market funds, if you don’t need absolutely the highest yield, a Schwab money market fund is still quite good enough.

As I wrote in No FDIC Insurance – Why a Brokerage Account Is Safe, when you keep your cash in a money market fund at a broker, the safety of your money doesn’t depend on the financial health of the broker. The safety comes directly from the safety of the holdings in the money market fund. Your money market fund is safe when the fund’s underlying holdings are safe.

Why Money Market Fund

The reason to keep your cash in a money market fund, as opposed to a high yield savings account, is that you’re not depending on any bank to set their rate competitively. You automatically get the market yield minus the fund manager’s cut, no more, no less, sort of like when you invest in an index fund. You’re not moving to another bank because it’s offering a promotional rate. You’re not moving again when that bank decides to lag behind. See my Guide to Money Market Funds & High Yield Savings Accounts.

Schwab offers eight money market funds of different types. Each fund has an Investor Shares class and an Ultra Shares class. Ultra Shares pay more but they require a $1,000,000 minimum. Investor Shares require no minimum. I will only talk about Investor Shares in this post.

These eight money market funds differ in their underlying holdings and tax treatment at both the federal and the state levels. Which one is slightly better for you than another depends on your preference for convenience and your federal and state tax brackets.

Taxable Money Market Funds

Four of the eight Schwab money market funds are taxable money market funds. You pay federal income tax on the income earned from these funds. A portion of the income earned in some funds is exempt from state income tax in most states.

The quoted yield on any money market fund is always a net yield after the expense ratio is already deducted. You don’t need to deduct it again.

Unlike Vanguard and Fidelity, Charles Schwab doesn’t sweep uninvested cash to a money market fund (except in some legacy accounts). The default “cash sweep” pays much less than a money market fund. You have to buy a money market fund yourself if you want to earn more on your cash. Charles Schwab doesn’t automatically liquidate from a money market fund to cover trades or transfers either. You have to sell a money market fund manually.

Prime Money Market Funds

Schwab Value Advantage Money Fund (SWVXX) is a prime money market fund. It invests in repurchase agreements, CDs, time deposits, and commercial paper. Prime money market funds pay more but they have a slightly higher risk.

The income earned from a prime money fund is fully taxable at the federal level. A small percentage of the income may be exempt from state income tax. That percentage varies from year to year. It was 0% in 2022.

Government Money Market Funds

Schwab Government Money Fund (SNVXX), Schwab Treasury Obligations Money Fund (SNOXX), and Schwab U.S. Treasury Money Fund (SNSXX) are government money market funds. They only invest in government securities and repurchase agreements that are collateralized by cash or government securities.

Think of repurchase agreements (“repo”) as a deal with a pawn shop. Entities give collaterals to the money market fund for short-term cash. They’ll come back later to buy back (“repurchase”) their collaterals at a higher price. If they don’t fulfill the repurchase agreement, the money market fund will sell those collaterals. Repurchase agreements aren’t guaranteed by the government. Their safety comes from the collaterals.

A government money market fund is safer than a prime money market fund. Schwab U.S. Treasury Money Fund (SNSXX) is the safest of the three because it invests only in Treasuries. It pays a little less though.

The income earned from these three funds is fully taxable at the federal level. A percentage of the income is exempt from state income tax. That percentage varies from year to year.

The expense ratio is the same across all four taxable money market funds. If you want a higher yield and you’re not concerned about the slightly higher risk, you can go with the prime money market fund (SWVXX). If you want the most solid peace of mind at the cost of a slightly lower yield, you can choose the U.S. Treasury fund (SNSXX) for extra safety and additional state income tax savings.

The other two funds — Schwab Government Money Fund (SNVXX) and Schwab Treasury Obligations Money Fund (SNOXX) — are good middle ground with safer holdings than the prime fund and you’re not giving up too much yield. Schwab Treasury Obligations Money Fund (SNOXX) limits the repurchase agreements to being backed by Treasuries only. Schwab Government Money Fund (SNVXX) includes repurchase agreements backed by both Treasuries and government agency debts.

Remember to claim the state tax exemption when you do your taxes. See how to do it in State Tax-Exempt Treasury Interest from Mutual Funds and ETFs.

Single State Tax-Exempt Money Market Funds

Schwab offers tax-exempt money market funds specifically for investors in higher tax brackets in California and New York. Schwab California Municipal Money Fund (SWKXX) and Schwab New York Municipal Money Fund (SWYXX) invest in high-quality, short-term municipal securities issued by entities within the state. Income from these funds is tax-exempt from both the federal income tax and the state income tax. They’re sometimes called “double tax-free” funds.

The yield on these single state tax-exempt money market funds is lower than the yield on the four taxable money market funds but the federal and state tax exemption makes up for it when you’re in a high tax bracket.

Remember to claim the state tax exemption when you do your taxes. See how to do it in State Tax-Exempt Muni Bond Interest from Mutual Funds and ETFs.

National Tax-Exempt Money Market Fund

Schwab offers two tax-exempt money market funds for investors in higher tax brackets outside of California and New York. Schwab Municipal Money Fund (SWTXX) and Schwab AMT Tax-Free Money Fund (SWWXX) are more diversified than the two single-state funds because they invest in short-term, high-quality municipal securities from many states. The two funds are similar. AMT tax-free or not makes a difference when you’re subject to the Alternative Minimum Tax but a lot fewer people are affected by it now than before.

Income from these two national tax-exempt money market funds is tax-exempt from the federal income tax but only a small percentage is exempt from state income tax. The yield is lower than the yield on the four taxable money market funds but the federal income tax exemption makes up for it when you’re in a high tax bracket. If you live in California or New York, you can still invest in these national funds if you don’t mind paying more in state income tax.

Remember to claim the small state tax exemption when you do your taxes. See how to do it in State Tax-Exempt Muni Bond Interest from Mutual Funds and ETFs.

Taxable or Tax-Exempt?

A tax-exempt money market fund offers tax savings but it pays less. Choose a tax-exempt fund if you’re in a high tax bracket. Choose a taxable fund if you’re in a low tax bracket. If you’re not sure whether your federal and state tax brackets are considered high or low, you can use a calculator to see which fund offers a better yield after taxes.

Yield Swings

A wrinkle in comparing taxable and tax-exempt money market funds is that the yield on tax-exempt money market funds swings wildly throughout the year. This chart shows the yield on a taxable money market fund and the yield on a tax-exempt money market fund over a 12-month period:

While the yield on the taxable fund (green line) rose steadily over time as the Fed raised interest rates, the yield on the tax-exempt fund (orange line) swung wildly up and down. If you happen to compare the after-tax yields when the yield on the tax-exempt fund is near a top, it would show that the tax-exempt fund is better even in a low tax bracket. If you happen to compare them when the yield on the tax-exempt fund is near a bottom, it would show that the taxable fund is better even in a high tax bracket.

MM Optimizer

So you can’t just adjust for taxes only based on the yields at this moment. You need to look over a longer period to take into account the wild swings in the yield on tax-exempt funds.

User retiringwhen on the Bogleheads forum created a Google Sheet that does this. It’s called MM Optimizer. Although this tool only backtests Vanguard money market funds, it’s also informative when you use a Schwab money market fund. If the tool shows that a Vanguard taxable money market fund is better than a Vanguard tax-exempt fund at your tax rates, it’s highly likely that a Schwab taxable money market fund is also better than a Schwab tax-exempt fund for you at the same tax rates.

Your Tax Rates

MM Optimizer is a shared as View Only. After you make a copy of it to your Google account, you change the tax rates on the My Parameters tab to your tax rates.

Compare After-Tax Yield

The My Charts tab shows the after-tax yield of different funds over the last 12 months. You can watch the yields and switch back and forth between a taxable fund and a tax-exempt fund but I wouldn’t bother. The chart shows how many times you would’ve had to switch to catch the temporary swings and how short-lived each switch was.

I would take a look at this chart and see which line is on top most of the time. Choose a Schwab taxable money market fund and stay with it if the chart shows that the smoother line is on top most of the time. Choose a Schwab tax-exempt money market fund if the chart shows that the bouncy line is on top most of the time.

When I played with MM Optimizer, it showed that a taxable money market fund was still better for someone in a 35.8% federal income tax bracket (32% plus 3.8% Net Investment Income Tax) and a 9% state income tax bracket. The tax brackets must be higher than those levels for a tax-exempt money market fund to win.

MM Optimizer has a lot more features but you don’t have to get into those. It’s simple to use if you only look at the places I’m showing here. The author is still adding new features. You’ll find the link to the latest version in this post on the Bogleheads forum.

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The previous post Which Vanguard Money Market Fund Is the Best at Your Tax Rates covered Vanguard money market funds. Vanguard has the best money market funds because they charge the lowest fees in their funds. However, many people — myself included — have a brokerage account at Fidelity Investments. It’s more convenient to keep cash and other investments in one place. If you don’t need absolutely the highest yield, a Fidelity money market fund is still quite good enough.

As I wrote in No FDIC Insurance – Why a Brokerage Account Is Safe, when you keep your cash in a money market fund at a broker, the safety of your money doesn’t depend on the financial health of the broker. The safety comes directly from the safety of the holdings in the money market fund. Your money market fund is safe when the fund’s underlying holdings are safe.

Why Money Market Fund

The reason to keep your cash in a money market fund, as opposed to a high yield savings account, is that you’re not depending on any bank to set their rate competitively. You automatically get the market yield minus the fund manager’s cut, no more, no less, sort of like when you invest in an index fund. You’re not moving to another bank because it’s offering a promotional rate. You’re not moving again when that bank decides to lag behind. See my Guide to Money Market Funds & High Yield Savings Accounts.

Fidelity offers at least 18 money market funds of different types. That’s not counting Institutional funds and funds that are only available in certain account types. These 18 money market funds differ in their underlying holdings and tax treatment at both the federal and the state levels. Which one is slightly better for you than another depends on your preference for convenience and your federal and state tax brackets.

Taxable Money Market Funds

Seven of the 18 Fidelity money market funds are taxable money market funds. You pay federal income tax on the income earned from these funds. A portion of the income earned in some funds is exempt from state income tax in most states.

The quoted yield on any money market fund is always a net yield after the expense ratio is already deducted. You don’t need to deduct it again.

Core-Eligible Money Market Funds

Every Fidelity brokerage account has a core position. You don’t have to do anything extra to buy or sell the core position. Any cash you transfer into your Fidelity brokerage account will automatically land in the core position. Any cash you transfer out of your Fidelity brokerage account will come out of the core position.

Your choices in the core position may include these money market funds depending on the account type:

The income earned in these funds is fully taxable at the federal level. A percentage of the income is exempt from state income tax. That percentage varies from year to year.

There isn’t much difference among these three core-eligible funds. If Fidelity Government Cash Reserves (FDRXX) is an option, I would choose that one as the core position because it has a lower expense ratio.

If you’d like to see what options you have as your core position, click on your core position marked with two asterisks on the Positions page and then click on the Change Core Position button. If you see FCASH as an option in your account, don’t choose that one because FCASH isn’t a money market fund.

All money market funds except the core position require a buy order to get money into them but you don’t have to sell manually. If your core position isn’t sufficient for a debit, Fidelity will automatically sell from your money market fund to cover the difference.

Fidelity Cash Management Account only uses bank sweep as the core position. You can’t change it but you can still buy a money market fund manually in a Cash Management Account.

Prime Money Market Funds

Fidelity Money Market Fund (SPRXX) and Fidelity Money Market Fund Premium Class (FZDXX) are prime money market funds. They invest in repurchase agreements, CDs, and commercial paper. Prime money market funds pay more but they have a slightly higher risk.

The Premium Class fund (FZDXX) requires a $100,000 minimum investment in a taxable account and a $10,000 minimum investment in an IRA. The minimum is only required to get started. You can drop below the minimum after you have the fund. The regular class fund (SPRXX) doesn’t require a minimum investment but it pays less than the Premium Class fund because it has a higher expense ratio (0.42% versus 0.30%).

The income earned from these prime money funds is fully taxable at the federal level. A small percentage of the income is exempt from state income tax. That percentage varies from year to year. It was 0% in 2022 and 4% in 2021 (0% in CA, CT, and NY).

Government Money Market Funds

Fidelity Government Money Market Fund Premium Class (FZCXX) and Fidelity Treasury Only Money Market Fund (FDLXX) are government money market funds. They only invest in government securities and repurchase agreements that are collateralized by cash or government securities.

Think of repurchase agreements (“repo”) as a deal with a pawn shop. Entities give collaterals to the money market fund for short-term cash. They’ll come back later to buy back (“repurchase”) their collaterals at a higher price. If they don’t fulfill the repurchase agreement, the money market fund will sell those collaterals. Repurchase agreements aren’t guaranteed by the government. Their safety comes from the collaterals.

A government money market fund is safer than a prime money market fund. Fidelity Treasury Only Money Market Fund (FDLXX) is the safest because it invests more in Treasuries. It pays a little less though.

The income earned from these two funds is fully taxable at the federal level. A percentage of the income is exempt from state income tax. That percentage varies from year to year.

Among the seven taxable money market funds, if you value the convenience of no extra step to buy, you can leave the money in one of the core-eligible funds. If you want a higher yield and you’re not concerned about the slightly higher risk, you can go with one of the prime money market funds (FZDXX or SPRXX). If you want the most solid peace of mind at the cost of a slightly lower yield, you can choose the Treasury Only fund (FDLXX) for extra safety and the additional state income tax savings. Finally, the Government Money Market Fund Premium Class (FZCXX) is a good middle ground with safer holdings than the prime funds and you’re not giving up too much yield. I have my cash in FZCXX.

Remember to claim the state tax exemption when you do your taxes. See State Tax-Exempt Treasury Interest from Mutual Funds and ETFs.

Single State Tax-Exempt Money Market Funds

Fidelity offers tax-exempt money market funds specifically for investors in higher tax brackets in California, Massachusetts, New Jersey, and New York. These funds invest in high-quality, short-term municipal securities issued by entities within the state. Income from these funds is tax-exempt from both the federal income tax and the state income tax. They’re sometimes called “double tax-free” funds.

The fund for each state has two share classes — a regular share class and a Premium Class. The Premium Class fund requires a $25,000 minimum investment. The regular class fund has no minimum but it pays a little less because it has a higher expense ratio (0.42% versus 0.29% or 0.3%).

The yield on these single state tax-exempt money market funds is lower than the yield on the seven taxable money market funds but the federal and state tax exemption makes up for it when you’re in a high tax bracket.

Remember to claim the state tax exemption when you do your taxes. See State Tax-Exempt Muni Bond Interest from Mutual Funds and ETFs.

National Tax-Exempt Money Market Fund

Fidelity offers three tax-exempt money market funds for investors in higher tax brackets outside of California, Massachusetts, New Jersey, and New York. These funds are more diversified than the eight single-state funds because they invest in short-term, high-quality municipal securities from many states.

Income from these funds is tax-exempt from the federal income tax but only a small percentage is exempt from state income tax. The yield is lower than the yield on the seven taxable money market funds but the federal income tax exemption makes up for it when you’re in a high tax bracket. If you live in California, Massachusetts, New Jersey, or New York, you can still invest in these national funds if you don’t mind paying more in state income tax.

Remember to claim the small state tax exemption when you do your taxes. See State Tax-Exempt Muni Bond Interest from Mutual Funds and ETFs.

Taxable or Tax-Exempt?

A tax-exempt money market fund offers tax savings but it pays less. Choose a tax-exempt fund if you’re in a high tax bracket. Choose a taxable fund if you’re in a low tax bracket. If you’re not sure whether your federal and state tax brackets are considered high or low, you can use a calculator to see which fund offers a better yield after taxes.

I created such a calculator back in 2007. I was going to update it but I came across a much more elaborate one created by the user retiringwhen on the Bogleheads forum. It’s a Google Sheet called MM Optimizer.

Although the current version of this tool focuses on Vanguard money market funds, it’s also informative when you use a Fidelity money market fund. If the tool shows that a Vanguard taxable money market fund is better than a Vanguard tax-exempt fund at your tax rates, it’s highly likely that a Fidelity taxable money market fund is also better than a Fidelity tax-exempt fund for you at the same tax rates.

The author of MM Optimizer is considering adding support for Fidelity money market funds. It’s possible that a future version of MM Optimizer will include Fidelity money market funds as well.

Your Tax Rates

MM Optimizer is a shared as View Only. After you make a copy of it to your Google account, you change the tax rates on the My Parameters tab to your tax rates.

Yield Swings

A wrinkle in comparing taxable and tax-exempt money market funds is that the yield on tax-exempt money market funds swings wildly throughout the year. This chart shows the yield on a taxable money market fund and the yield on a tax-exempt money market fund over the last 12 months:

While the yield on the taxable fund (green line) rose steadily over time as the Fed raised interest rates, the yield on the tax-exempt fund (orange line) swung wildly up and down. If you happen to compare the after-tax yields when the yield on the tax-exempt fund is near a top, it would show that the tax-exempt fund is better even in a low tax bracket. If you happen to compare them when the yield on the tax-exempt fund is near a bottom, it would show that the taxable fund is better even in a high tax bracket.

Switching Back and Forth

You can watch the yields and switch back and forth between a taxable fund and a tax-exempt fund but I wouldn’t bother. The My Charts tab shows how many times you would’ve had to switch to catch the temporary swings and how short-lived each switch was.

I would take a look at this chart and see which line is on top most of the time. Choose a Fidelity taxable money market fund and stay with it if the chart shows that the smoother line is on top most of the time. Choose a Fidelity tax-exempt money market fund if the chart shows that the bouncy line is on top most of the time.

MM Optimizer has a lot more features but you don’t have to get into those. It’s simple to use if you only look at the places I’m showing here. The author is still adding new features. I hope it will include Fidelity money market funds soon. You’ll find the link to the latest version in this post on the Bogleheads forum.

Learn the Nuts and Bolts

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The post Which Fidelity Money Market Fund Is the Best at Your Tax Rates appeared first on The Finance Buff.

As I wrote in No FDIC Insurance – Why a Brokerage Account Is Safe, when you invest in a money market fund at a broker, the safety of your money doesn’t depend on the financial health of the broker. The safety comes directly from the safety of the holdings in the money market fund. Your money market fund is safe when the underlying holdings are safe.

Why Money Market Fund

The reason to keep your cash in a money market fund, as opposed to a high yield savings account, is that you’re not depending on any bank to set their rate competitively. You automatically get the market yield minus the fund manager’s cut, no more, no less, sort of like when you invest in an index fund. You’re not moving to another bank because it’s offering a promotional rate. You’re not moving again when that bank decides to lag behind. See my Guide to Money Market Funds & High Yield Savings Accounts.

Why Vanguard

Because all money market funds of the same type fish in the same pond, how much the fund manager charges to run the fund (the “expense ratio”) directly affects how much yield you’ll receive. Among the major brokers, Vanguard charges the lowest expense ratio on its money market funds. Even if you do your investing elsewhere, you can still open a Vanguard account just to use its money market fund in the same way you use a high yield savings account — transfer money into it when you have excess cash, transfer money out when you need cash.

Vanguard offers six money market funds of three different types. They differ in their underlying holdings and tax treatment at both the federal and the state levels. Which one will be slightly better for you than another depends on your preference for convenience and your federal and state tax brackets.

Taxable Money Market Funds

Three of the six Vanguard money market funds are taxable money market funds. You pay federal income tax on the income earned from these funds. A portion of the income earned is exempt from state income tax.

The yield from any of these three funds is very close to each other. The quoted yield on any money market fund is always a net yield after the expense ratio is already deducted. You don’t need to deduct it again.

Vanguard Federal Money Market Fund

Vanguard Federal Money Market Fund (VMFXX) is the settlement fund in a Vanguard brokerage account. You don’t have to do anything extra to buy or sell this fund. It requires no minimum investment. Any cash you transfer into your Vanguard brokerage account will automatically land in this fund. Any cash you transfer out of your Vanguard brokerage account will come out of this fund by default.

The income earned is fully taxable at the federal level. A percentage of the income is exempt from state income tax. That percentage varies from year to year. It was 38% in 2022 (0% for CA, NY, and CT residents).

This fund invests in government securities and repurchase agreements that are collateralized by government securities. Think of repurchase agreements (“repo”) as a deal with a pawn shop. Entities give government securities to the money market fund as collateral for short-term cash. They’ll come back later to buy back (“repurchase”) their government securities at a higher price. If they don’t fulfill the repurchase agreement, the money market fund will sell those government securities. Repurchase agreements themselves aren’t guaranteed by the government but their safety comes from the safe collateral.

Vanguard Treasury Money Market Fund

Vanguard Treasury Money Market Fund (VUSXX) invests primarily in Treasuries. It’s the safest money market fund at Vanguard. You have to enter a buy or sell order to get money into or out of this fund. It has a $3,000 minimum investment. The $3,000 minimum is only required to get started. You can transfer in and out less than $3,000 after you have the fund.

The income earned from the Treasury Money Market Fund is fully taxable at the federal level. A percentage of the income is exempt from state income tax. That percentage varies from year to year. It was 100% in 2022 but it will likely be in the 70% range in 2023.

Vanguard Cash Reserves Federal Money Market Fund

Vanguard Cash Reserves Federal Money Market Fund (VMRXX) is somewhere in between the Federal Money Market Fund and the Treasury Money Market Fund. As in the Treasury Money Market Fund, you have to enter a buy or sell order to get money into or out of this fund. It also has a $3,000 minimum investment.

This fund invests more in Treasuries than the Federal Money Market Fund but less than the Treasury Money Market Fund. The income earned is fully taxable at the federal level. A percentage of the income is exempt from state income tax. That percentage varies from year to year. It was 53% in 2022 (0% for CA, NY, and CT residents).

Among these three taxable money market funds, If I value the convenience of no extra step to buy or sell or if I live in a no-tax state, I would choose the Federal Money Market Fund (VMFXX). If I don’t mind the extra step to buy or sell and I live in a high-tax state, I would choose the Treasury Money Market Fund (VUSXX) for extra safety and the additional state income tax savings.

Remember to claim the state tax exemption when you do your taxes. See State Tax-Exempt Treasury Interest from Mutual Funds and ETFs.

Single State Tax-Exempt Money Market Funds

Vanguard offers a tax-exempt money market fund specifically for California and New York residents in higher tax brackets. These two funds invest exclusively in high-quality, short-term municipal securities issued by entities within the state. Income from these funds is tax-exempt from both the federal income tax and the California and New York state income tax respectively. They’re sometimes called “double tax-free” funds.

Both Vanguard California Municipal Money Market Fund (VCTXX) and Vanguard New York Municipal Money Market Fund (VYFXX) require a buy or sell order to get money into and out of the fund. Both require a $3,000 minimum investment.

The yield on these funds is lower than the yield on the three taxable money market funds but the federal and state tax exemption makes up for it when you’re in a high tax bracket.

Remember to claim the state tax exemption when you do your taxes. See State Tax-Exempt Muni Bond Interest from Mutual Funds and ETFs.

National Tax-Exempt Money Market Fund

Vanguard Municipal Money Market Fund (VMSXX) is for investors in higher tax brackets outside of California and New York. This fund is more diversified than the California and New York funds because it invests in short-term, high-quality municipal securities from many states. Income from this fund is tax-exempt from the federal income tax but only a small percentage is exempt from state income tax.

It also requires a $3,000 minimum investment and a buy or sell order to get money into and out of the fund. The yield on this fund is lower than the yield on the three taxable money market funds but the federal income tax exemption makes up for it when you’re in a high tax bracket.

Remember to claim the small state tax exemption when you do your taxes. See State Tax-Exempt Muni Bond Interest from Mutual Funds and ETFs.

Taxable or Tax-Exempt?

A tax-exempt money market fund offers tax savings but it pays less. Choose a tax-exempt fund if you’re in a high tax bracket. Choose a taxable fund if you’re in a low tax bracket. If you’re not sure whether your federal and state tax brackets are consider high or low, you can use a calculator to see which fund offers a better yield after taxes.

I created such a calculator back in 2007. I was going to update it but I saw someone else created a much more elaborate one. It’s a Google Sheet called MM Optimizer created by user retiringwhen on the Bogleheads forum.

Your Tax Rates

MM Optimizer is a shared as View Only. After you make a copy of it to your Google account, you change the tax rates on the My Parameters tab to your tax rates.

Best Right Now

The My Best Now tab then shows you which fund has the highest after-tax yield right now for the tax rates you entered.

In this example, it shows that the national tax-exempt fund has the highest after-tax yield, although not by much over the Treasury money market fund (3.57% versus 3.49%, or 5.25% versus 5.13% in pre-tax terms).

Best Last Year

A wrinkle in comparing taxable and tax-exempt money market funds is that the yield on tax-exempt money market funds swings wildly throughout the year. This chart shows the yield on a taxable money market fund and the yield on a tax-exempt money market fund over the last 12 months:

While the yield on the taxable fund (green line) rose steadily over time as the Fed raised interest rates, the yield on the tax-exempt fund (orange line) swung wildly up and down. If you happen to compare the after-tax yields when the yield on the tax-exempt fund is near a top, it would show that the tax-exempt fund is better even in a low tax bracket. If you happen to compare them when the yield on the tax-exempt fund is near a bottom, it would show that the taxable fund is better even in a high tax bracket.

MM Optimizer shows which fund was better at your tax rates if you stuck to it over a full year.

In this case, the Treasury money market fund was better for the full year even though the tax-exempt fund is slightly better at this moment only because the yield on the tax-exempt fund is near a top.

Switching Back and Forth

You can watch the yields and switch back and forth between a taxable fund and a tax-exempt fund but I wouldn’t bother. The My Rate Chart tab shows how many times you would’ve had to switch to catch the temporary swings and how short-lived each switch was.

I would take a look at this chart and see which line is on top most of the time. Choose that fund and stay with it. In this example, it’s the Treasury money market fund (green line).

MM Optimizer has a lot more features but you don’t have to get into those. It’s simple to use if you only look at the places I’m showing here.

Learn the Nuts and Bolts

I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action. Read Reviews

The post Which Vanguard Money Market Fund Is the Best at Your Tax Rates appeared first on The Finance Buff.