Treasury notes work like this: you lend money to the federal government for a set term between 2 and 10 years, the government pays you a fixed interest rate every six months, and at the end of the term you get your original investment back. The rate is locked in at the auction where the note is sold, the minimum purchase is $100, and the interest is exempt from state and local income tax. That is the whole product in one paragraph. The details below cover how the pricing, buying, selling, and taxes actually play out.1TreasuryDirect. About Treasury Marketable Securities
What You Get: Coupon Payments and Principal Back
The auction sets a fixed coupon rate, and that rate never changes over the life of the note. Twice a year you receive an interest payment equal to that rate applied to the note’s face value.2TreasuryDirect. Understanding Pricing and Interest Rates On a $1,000 note with a 4% coupon, that’s $20 every six months, $40 a year, for as long as you hold it.
On the maturity date, the government pays back the full face value and the obligation ends. Because the payments are backed by the full faith and credit of the United States, credit risk is effectively zero, and the total cash flow is known the moment the auction closes. That predictability is the whole point of the instrument.
The Five Terms You Can Choose
Treasury notes come in five maturities: 2, 3, 5, 7, and 10 years. The 2-, 3-, 5-, and 7-year terms are auctioned monthly. The 10-year is auctioned quarterly in February, May, August, and November, with eight reopenings scattered through the rest of the year.3TreasuryDirect. Treasury Notes The Treasury publishes an auction calendar with announcement, auction, and settlement dates, and it’s worth glancing at before you buy so you know when funds will actually be pulled.
Shorter terms usually pay less but return your money sooner. Longer terms lock in today’s rate for a decade, which is either an advantage or a drawback depending on where rates go from here.
Why the Price Isn’t Always $100
A Treasury note has a face value, but the price you actually pay at auction is often slightly different. The reason is that the note’s coupon rate is fixed in advance, while the yield investors demand shifts with market conditions right up to the moment of the sale.
If the coupon rate is higher than the market yield, the note sells at a premium (above face value). If the market yield is higher, the note sells at a discount (below face value). If they line up, the note prices at par.2TreasuryDirect. Understanding Pricing and Interest Rates The mechanism keeps the effective yield in step with the market even though the coupon itself can’t move. A recent 10-year auction, for example, carried a 4.125% coupon and priced at roughly $99.25 per $100 of face value, slightly below par.3TreasuryDirect. Treasury Notes
Buying at a discount means your effective yield beats the stated coupon, because you paid less than the face value you’ll eventually collect. Buying at a premium works the other way.
How to Buy One
You have two channels. You can open a TreasuryDirect account with the government directly, or you can buy through a bank, broker, or dealer.4TreasuryDirect. Buying a Treasury Marketable Security The minimum is $100, and you can buy in $100 increments up to $10 million on a non-competitive bid.5eCFR. 31 CFR 356.12 – Types of Bids and Bidding Limitations
To open a TreasuryDirect account as an individual, you’ll need a Social Security number, a U.S. address, and a linked domestic bank account that accepts electronic transfers.3TreasuryDirect. Treasury Notes Trusts, corporations, and other entities can open accounts too, using an Employer Identification Number and an IRS Name Control.6TreasuryDirect. TreasuryDirect FAQ
Non-Competitive vs. Competitive Bids
Auctions accept two kinds of bids, and the difference matters.
A non-competitive bid means you accept whatever yield the auction produces, and in exchange you’re guaranteed to receive the full amount you asked for, up to the $10 million cap. If you buy through TreasuryDirect, this is the only option available.7TreasuryDirect. How Auctions Work
A competitive bid means you specify the yield you’ll accept. If the auction settles at a lower yield than you asked for, you get nothing. Competitive bids run through a bank, broker, or dealer, and any single bid at one yield is capped at 35% of the offering amount.5eCFR. 31 CFR 356.12 – Types of Bids and Bidding Limitations
For an individual investor, non-competitive is almost always the right call. Competitive bidding is where institutional desks manage exposure at scale.
Selling Before Maturity
You aren’t stuck holding to term. Notes are held electronically, either in your TreasuryDirect account or your brokerage account, and both can be sold on the secondary market.7TreasuryDirect. How Auctions Work A note in a brokerage account trades like any other security. A note in TreasuryDirect first has to be transferred out to a bank or brokerage using FS Form 5511, which involves a Medallion-stamped signature and mail to Treasury Retail Securities Services in Minneapolis.8TreasuryDirect. TreasuryDirect Transfer Request – FS Form 5511 That transfer can take days to weeks, so if there’s any chance you’ll want to sell, holding at a brokerage from the start is simpler.
What you get on the sale depends on where rates have moved. If rates have risen since your purchase, the note will likely sell below what you paid. If rates have fallen, you may sell at a gain. Interest payments continue to deposit into your linked bank account automatically as long as you own the note.
What Happens at Maturity
By default, when a note matures the face value lands in your linked bank account and you’re done. If you’d rather roll the proceeds into a new note of the same type and term, TreasuryDirect offers an automatic reinvestment option, which you can set up at purchase or later, up until the closed book period near maturity.9eCFR. 31 CFR 363.205 – How Do I Reinvest the Proceeds of a Maturing Security Held in TreasuryDirect
For notes, that reinvestment is limited to one rollover. If no matching new issue has an issue date that matches your maturity date, the reinvestment is canceled and the cash comes back to your bank account instead.9eCFR. 31 CFR 363.205 – How Do I Reinvest the Proceeds of a Maturing Security Held in TreasuryDirect To keep rolling indefinitely, you’d schedule a new reinvestment each cycle.
How the Interest Is Taxed
Federal income tax applies. Treasury note interest is taxable as ordinary income for the year it’s paid.10Internal Revenue Service. Publication 550 – Investment Income and Expenses If you earn $10 or more in a year, you’ll receive a Form 1099-INT reporting the total in Box 3, which is reserved for interest on U.S. Treasury obligations.11Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Below the $10 threshold you still owe the tax, you just don’t get the form.
State and local income taxes do not apply. Federal law exempts obligations of the United States Government from taxation by any state or political subdivision, with narrow carve-outs for certain corporate franchise taxes and estate or inheritance taxes.12Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation In a high-tax state, that exemption can move the after-tax comparison against a similar-yielding corporate bond meaningfully in the Treasury’s favor.
If you sell before maturity, the tax picture gets busier. Any accrued interest since the last coupon payment is still taxed as ordinary interest income. Beyond that, if you bought the note at a market discount on the secondary market and didn’t elect to accrue that discount into income each year, any gain on the sale up to the accrued market discount is treated as ordinary income rather than capital gain. Only the portion of the gain beyond that amount qualifies for capital gains treatment.10Internal Revenue Service. Publication 550 – Investment Income and Expenses Investors who assume the whole profit is a capital gain often get this wrong.
Risks Even Though There’s No Credit Risk
Treasury notes carry virtually no default risk. That doesn’t make them risk-free.
- Interest rate risk. When market rates rise, the resale value of your note falls. This only bites if you sell before maturity, but it can hurt if you need to exit in a rising-rate stretch.
- Inflation risk. The coupon is fixed in dollar terms, so inflation erodes what those dollars buy. A 4% coupon feels different at 2% inflation than at 5%. Standard notes offer no built-in protection.
- Opportunity cost. Locking money into a 10-year note means you miss the upside if better yields appear later. Shorter maturities reduce this, at the cost of a lower starting yield.
Laddering notes across different maturities is one common way to balance the tension between yield and flexibility, so some money frees up each year while the rest keeps earning.
One Boundary Worth Noting: TIPS Are a Different Product
Standard Treasury notes have a principal that never changes and a coupon that never changes. Treasury Inflation-Protected Securities, or TIPS, are a separate instrument in which the principal itself adjusts up or down with inflation, and the interest is calculated on that adjusted principal.13TreasuryDirect. Comparison of TIPS and Series I Savings Bonds If inflation runs hot, TIPS principal and payments rise with it. Standard notes don’t. TIPS usually start with a lower coupon rate to reflect that inflation adjustment. If inflation protection is what you’re after, the note is not the tool.