Using Vanguard for CD ladder

[cbo111]

I currently have about 60% of my investments with Vanguard. I am looking to cash out some maturing CDs from various banks and institutions, then build a CD ladder in Vanguard. Have any of you with a Vanguard account used this feature? Also, the way I read the website, there is no transaction fee to open a new CD within the Vanguard site. Any thoughts would be greatly appreciated.
regards,

 

[samclem]

Just a reminder: The CDs available through Vanguard are "brokered CDs" (Vanguard isn't the original issuer). That means that, if you want out of one or more, you have to sell them at whatever they are worth to a buyer at that time. If an investor wants to sell and lock in the new higher rates, it is possible they would be better off with an "original issue" CD, particularly one with a small early withdrawal penalty. With interest rates so low, the early withdrawal penalties can be minimal in real dollar terms.

 

[meierlde]

Just a reminder: The CDs available through Vanguard are "brokered CDs" (Vanguard isn't the original issuer). That means that, if you want out of one or more, you have to sell them at whatever they are worth to a buyer at that time. If an investor wants to sell and lock in the new higher rates, it is possible they would be better off with an "original issue" CD, particularly one with a small early withdrawal penalty. With interest rates so low, the early withdrawal penalties can be minimal in real dollar terms.

Actually I just found out thatBBVa compass moved to a 3% early withdrawal penalty. Good reason to move money out of there.

 

[HadEnuff]

I recently did just what you are thinking, cbo.

First, you have to change your account from a regular VG account to what they call a "brokerage" account, which involves some forms. I was able to do mine over the phone with a rep, except two small "inherited" IRAs, which for some reason are treated differently. It wasn't too bad, and the reps were very helpful.

when you do this you will set up a "transfer" account, which is a money market, but not the Vanguard (VMMIX) money market account. When you buy your CD's you have to make sure you have enough money moved into the transfer account to cover the cost of the CDs you are purchasing.

You are correct, there is no fee for buying the brokered CDs.

 

[samclem]

S

I recently did just what you are thinking, cbo.

First, you have to change your account from a regular VG account to what they call a "brokerage" account, which involves some forms. I was able to do mine over the phone with a rep, except two small "inherited" IRAs, which for some reason are treated differently. It wasn't too bad, and the reps were very helpful.

Small note: Once Vanguard converts a user to a brokerage account, it's possible they'll get your 1099 forms about a month later than before. Under federaal rules, federal requirements of when they must provide users normally get their 1099s for MF accounts in late Jan, for brokerage accounts it will be late Feb.

I'm avoiding the "upgrade" of my Vanguard mutual funds to the brokerage structure as long as possible.

Another thread on this is here.

 

[HadEnuff]

S

Small note: Once Vanguard converts a user to a brokerage account, it's possible they'll get your 1099 forms about a month later than before. Under federaal rules, federal requirements of when they must provide users normally get their 1099s for MF accounts in late Jan, for brokerage accounts it will be late Feb.

I'm avoiding the "upgrade" of my Vanguard mutual funds to the brokerage structure as long as possible.

Another thread on this is here.

When I spoke with my rep he said VG was going to make everyone do it at some point. I don't think he mentioned when that might be.

 

[wolf]

Just an FYI. Is any of this $ in an IRA. If yes, when you start taking RMD, you will only be able to withdraw the CD interest each year. Not the principle. (unless you sell the CD).

With Bank/Credit Union CDs. Some/all allow you withdraw RMD ( principle) with no early withdrawal penalties.

 

[OldShooter]

Since it can be costly to sell a CD instead of holding it to maturity, if you think you might need to get some cash out early you might want to consider a "multiracial" ladder, with the nearest asset being t-bills instead of a CD. T-bills are almost as liquid as cash. Or even have the first two assets being govvies.

To clarify something said earlier, a typical brokered CD sold by a Vanguard, Schwab, etc. are new "original issue" CDs. I suppose one could buy a "used" CD as well but I have never had one offered to me. Probably you have to ask. It might even be a good investment strategy.

 

[cbo111]

Just an FYI. Is any of this $ in an IRA. If yes, when you start taking RMD, you will only be able to withdraw the CD interest each year. Not the principle. (unless you sell the CD).

With Bank/Credit Union CDs. Some/all allow you withdraw RMD ( principle) with no early withdrawal penalties.

No IRAs involved. All CDs will be funded from cash, and I will not need to worry about early withdrawal. I am just trying to consolidate so finances will be as simple as possible for DW and heirs in the event of my ultimate demise.

 

[pb4uski]

I may do something like that as well when my PenFed 5 year 3% CDs mature in December.

 

[jebmke]

No IRAs involved. All CDs will be funded from cash, and I will not need to worry about early withdrawal. I am just trying to consolidate so finances will be as simple as possible for DW and heirs in the event of my ultimate demise.

I am not familiar with the tax treatment of CDs/bonds purchased at discount or premium. It may not be simple. I'd make sure I understood this before venturing into individual bonds or CDs held in taxable account.

 

[meierlde]

I am not familiar with the tax treatment of CDs/bonds purchased at discount or premium. It may not be simple. I'd make sure I understood this before venturing into individual bonds or CDs held in taxable account.

Just like any other investment: if you get more selling the bond early you have a gain if you get less you have a loss. Your basis is the amount you paid, just like any other bond. If you sell for more than you paid its a gain, if you sell for less its a loss.

 

[pb4uski]

^^^^ I think there is more to it than that.

In addition, I think that they require that the purchase premium or discount be amortized over the remaining term of the CD/bond as an adjustment of interest income... so if you buy at a discount then your interest income will be higher than interest received/credited and the inverse. Having never done these, what I don't know is whether Vanguard does the calculation of the amount of accrual of discount or amortization of premium for you or not.

https://www.thetaxadviser.com/issues/2007/oct/taxtreatmentofmarketdiscountbonds.html

Example 1: A debt instrument with stated principal amount of $200,000, payable at maturity, is issued on January 1, 2003; it provides for interest at the rate of 10%, payable annually. The debt instrument matures on January 1, 2006. It is purchased from the original holder by taxpayer B on October 1, 2004. The debt instrument was issued at par and was sold to B for $184,000. B holds the debt instrument until March 12, 2005, on which date B sells the debt instrument at a gain. The market discount is $16,000, the excess of the debt instrument’s $200,000 stated redemption price at maturity over B’s basis immediately after acquisition. When B acquired the debt instrument, there remained 456 days to maturity. B held the debt instrument 162 days before selling it. Market discount accrued on a ratable basis to the date of sale is $5,684.21 ($16,000 x 162 ÷ 456). A gain realized not in excess of $5,684.21 will be recognized as interest income.

 

[Peter]

I have a CD ladder at Fidelity. I imagine the Vanguard offering is similar. The CDs are all new issue, and unless I do something they will be held to maturity. As each CD matures, Fidelity reinvests in a new CD. I can turn off the ongoing renewal at any time, although in practice I would only do that as one of the CDs matures. In that way I always 'get my money back'. (Yes, I understand that this is an illusion that does not take account of inflation.)

I view this as an alternative to a short/medium term bond fund. Returns are going to be very similar.

 

[meierlde]

^^^^ I think there is more to it than that.

In addition, I think that they require that the purchase premium or discount be amortized over the remaining term of the CD/bond as an adjustment of interest income... so if you buy at a discount then your interest income will be higher than interest received/credited and the inverse. Having never done these, what I don't know is whether Vanguard does the calculation of the amount of accrual of discount or amortization of premium for you or not.

https://www.thetaxadviser.com/issues/2007/oct/taxtreatmentofmarketdiscountbonds.html

Here is a quote from vanguards Disclosure on CDs that is on their web site re fixed rate cds on the secondary market "Interest paid on a fixed rate interest-bearing CD is
generally taxable each year as ordinary income to the owner in accordance with the owner’s method of accounting. An owner will realize gain or loss on the sale, early withdrawal, maturity, or other disposition of a CD equal to the difference between (i) the amount received by the owner on the disposition of the CD and (ii) the amount the owner paid to acquire the CD. For this purpose, the amount received does not include any amount attributable to accrued and unpaid interest on the CD, which amount is treated as interest income. Gain or loss generally will be long-term capital gain or loss if the CD were held for more than one year."

You can get this disclosure on the vanguard web site.
This is consistent with the definition of original issue discount which requires a discount to the face value of the instrument when issued, which is not the case with a brokered fixed rate CD , it would apply to a zero coupon CD if such existed.

Or a quote from the H&R Block web site "Original issue discount (OID) is a form of interest. It usually occurs when companies issue bonds at a price less than their redemption value at maturity. The difference between these two amounts is the OID."
The fixed rate cd yields the same amount at maturity as when originally issued. Which is consistent with the term original issue discount. (Note in your example the original instrument was sold at a discount to its redemption value

 

[Al18]

Interest on a brokered CD does not compound like a typical bank CD. For comparison, a 60 month bank CD paying 2.79% APY will mature at the same amount as a 60 month brokered CD paying 2.95% when it matures.

 

[Ready]

Now that several credit unions are offering a 3% 5 year CD with a 6 month early termination penalty, brokered CDs are going to have to be more competitive than they've been in the past couple of years. I have yet to find any on Fidelity or Vanguard's websites that are more attractive than the 3% deals at the credit unions. Has anyone else found any?

 

[KB]

S

Small note: Once Vanguard converts a user to a brokerage account, it's possible they'll get your 1099 forms about a month later than before. Under federaal rules, federal requirements of when they must provide users normally get their 1099s for MF accounts in late Jan, for brokerage accounts it will be late Feb.

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I got my Vanguard brokerage 1099s by February 14th this year, so even if they say late Feb, it was earlier.

 

[meierlde]

Now that several credit unions are offering a 3% 5 year CD with a 6 month early termination penalty, brokered CDs are going to have to be more competitive than they've been in the past couple of years. I have yet to find any on Fidelity or Vanguard's websites that are more attractive than the 3% deals at the credit unions. Has anyone else found any?

Vanguard just offered 3% on a 5 year cd. Note that the shape of the yield curve is such that going for a shorter term unless building a ladder might make sense i.e 2 year is 2.65 and 1 year is 2.10. If you think interest rates are going to keep going up postponement might make sense. I.E. pick a shorter term now. go for the long terms when the yield curve maxes out.

 

[Ready]

Vanguard just offered 3% on a 5 year cd. Note that the shape of the yield curve is such that going for a shorter term unless building a ladder might make sense i.e 2 year is 2.65 and 1 year is 2.10. If you think interest rates are going to keep going up postponement might make sense.

Exactly why I hate brokered CDs. They offer no protection if you need to sell early in a rising interest rate environment yet they offer no premium over the credit unions CDs that fix your early term penalty at 6 months.

 

[meierlde]

Exactly why I hate brokered CDs. They offer no protection if you need to sell early in a rising interest rate environment yet they offer no premium over the credit unions CDs that fix your early term penalty at 6 months.

Note that banks have wised up and penalties are now often 3% of the amount withdrawn. I suspect more banks will do this soon. (to keep the cheap money they have)

 

[Another Reader]

Interest on a brokered CD does not compound like a typical bank CD. For comparison, a 60 month bank CD paying 2.79% APY will mature at the same amount as a 60 month brokered CD paying 2.95% when it matures.

Which is why you should always compare APY. I do think the brokers should be required to show APY, as the banks are.

I use these in an inherited IRA along with treasury bills to get a better return on cash set aside for distributions. Fidelity is getting a high ER on their money market accounts which I don't want to pay. I have to work to avoid that loss.

 

[Ready]

Note that banks have wised up and penalties are now often 3% of the amount withdrawn. I suspect more banks will do this soon. (to keep the cheap money they have)

So if the APY is 3% this would represent 12 months penalty instead of 6 months. That would begin to make the brokered CDs look a little better but I still think I would take the guarantee of a one year fixed interest penalty versus selling a CD prior to maturity in the open market.

 

[meierlde]

So if the APY is 3% this would represent 12 months penalty instead of 6 months. That would begin to make the brokered CDs look a little better but I still think I would take the guarantee of a one year fixed interest penalty versus selling a CD prior to maturity in the open market.

Currently that bank is offering less than 1% so it would take a major move. Other banks are moving to charging a penalty based upon the then current interest rate, i.e. 1 year at the difference between the current and the CD interest rate. Further some are also saying promo rates do not apply to renewed CDs either. The other nice thing about brokered cds is at maturity the funds automatically appear in your settlement account. (Of course the down side is no compounding).
Of course with the fairy flat yield curve on brokered CDs it does not make sense to go out beyond 2 to 3 years. (2.65 at 2 years 3.0 at 5 years and 10y at 3.2%) Since I expect rates to continue rising and the flat yield curve stay short.

 

[jazz4cash]

So when you say the funds automatically appear in your settlement account at maturity, are you referring to the principle or interest and principle? I see some brokered CDs pay monthly and others pay annually and I assumed the interest payment goes into another account which could be a high yield savings to offset some of the loss incurred by not compounding.

I hate the way Ally compounds monthly but the interest doesn't get credited until year end. At least I thing that's what they do.