TIPS (Treasury Inflation-Protected Securities) Field Guide in 2024 

Larry, Managing Editor

Updated on:

tips treasury inflation protected securities

TIPS, short for Treasury Inflation-Protected Securities, are U.S. government bonds designed to protect investors against inflation. TIPS are popular with investors and savers looking to preserve their cash’s purchasing power. TIPS are indexed to inflation, and your investment principal will fluctuate based on the inflation rate. 

Key Points:

  • TIPS are a type of U.S. government bond that protects your cash from inflation and have become increasingly popular in recent years as inflation has increased.
  • TIPS have a principal that changes based on the inflation rate. When the CPI rises, the principal is adjusted upwards. If the CPI falls, the principal is adjusted downwards. This adjustment happens every six months.
  • At maturity, if your TIPS inflation-adjusted principal is lower than your original invested principal, you will receive your original principal. You will always receive the higher of your original principal or inflation-adjusted principal.

What Are TIPS?

TIPS, or Treasury Inflation-Protected Securities, are a U.S. Treasury bond designed to help investors protect against inflation. TIPS are indexed to inflation to protect investors from the negative effects of inflation. 

TIPS are issued with maturities of 5, 10, and 30 years. These are much longer than the maturities of Treasury bills, which have maturities of less than a year.

The U.S. Treasury auctions TIPS several times a year.

  • 5-year TIPS are auctioned in April and October. Reopening auctions occur in June and December.
  • 10-year TIPS are auctioned in January and July. Reopening auctions occur in March, May, September, and November.
  • 30-year TIPS are auctioned in February. Reopening auctions occur in August.

The key difference between TIPS and other Treasury bonds is that the interest rate for TIPS does not change. Instead, the TIPS principal is adjusted up or down based on inflation.

Compare this to I Bonds, another inflation-protected asset whose interest rate is updated every six months based on inflation.

How Do TIPS Work?

The principal value of TIPS changes in line with inflation, determined by the Consumer Price Index. Although the interest rate on TIPS stays the same, the interest payments fluctuate as they are based on the adjusted principal amount that reflects inflation changes.

When TIPS matures, the investor receives either the adjusted or the original principal, whichever is higher. This means you will always receive your original investment principal back. 

TIPS are tax-liable but can be held in tax-advantaged accounts, such as a Roth IRA or 401(k), to defer taxes on adjustments.

Let’s dive into each component:

  1. Principal Adjustment: The principal amount of TIPS changes based on the Consumer Price Index for All Urban Consumers (CPI-U), a measure of inflation. If the CPI rises, the principal is adjusted upwards. If the CPI falls, the principal is adjusted downwards.
  2. Interest Payments: TIPS pay interest twice a year at a fixed rate. However, the rate is applied to the adjusted principal. If inflation rises, the interest payments will increase because they are calculated based on the higher principal. Conversely, if deflation occurs, interest payments will decrease.
  3. Maturity: Upon maturity, you receive the greater of the adjusted or original principal. This means, at the minimum, you will always receive your original principal back if you hold the TIPS to maturity.
  4. Tax Considerations: Be aware that in the U.S., the increase in the principal due to inflation adjustments is taxable for the year in which it occurs, even though you won’t receive the principal until the TIPS mature. This is called “phantom income” and will have tax implications.
  5. Liquidity: TIPS can be sold in the secondary market before maturity, but their value will be subject to market conditions, including changes in interest rates and perceptions of future inflation. Selling before maturity can result in capital gains or losses.

What Happens to TIPS in Periods of Inflation and Deflation?

Here’s how TIPS behave in periods of inflation and deflation:

  1. Inflation:
    • Principal Adjustment: During inflationary periods, the principal value of TIPS is adjusted upwards according to the inflation rate as measured by the Consumer Price Index for All Urban Consumers (CPI-U).
    • Interest Payments: The interest rate on TIPS is fixed, but since it’s applied to the adjusted principal, the actual interest payments will increase during periods of inflation.
    • Capital Preservation: By adjusting the principal for inflation, TIPS help preserve the purchasing power of the investor’s capital.
  2. Deflation:
    • Principal Adjustment: During deflationary periods, the principal value of TIPS is adjusted downwards according to the deflation rate. However, at maturity, investors will receive the higher adjusted principal or the original principal amount, ensuring they do not lose their initial investment.
    • Interest Payments: As with inflation, the interest rate is fixed but applied to the adjusted principal. So, during periods of deflation, the actual interest payments will decrease.
    • Capital Preservation: The feature of receiving at least the original principal at maturity protects investors during deflationary periods, though the interest payments will be lower.

TIPS can be a prudent investment for those looking to preserve capital and maintain purchasing power in the face of varying inflation rates.

Example of TIPS With Real Numbers

Let’s walk through some examples of TIPS with real numbers during rising inflation.

The principal value of TIPS is adjusted upwards according to the inflation rate as measured by the Consumer Price Index for All Urban Consumers (CPI-U).

Because the interest payments are twice a year every six months, the compounding adjustment on the inflation-adjusted principal only occurs with each interest payment (every six months).

Here’s a table that illustrates an example of a situation where you buy $1,000 worth of 5-year TIPS and assume the interest rate is 1.00% with a constant annual inflation rate of 2.50%.

TIPS Inflation Example

Year Semi-annual Period Principal Annual Interest Rate Annual Inflation Inflation Adjusted Principal Semi-Annual Interest Payment
1 1 $1,000.00 1.00% 2.50% $1,012.50 $5.06
1 2 $1,012.50 1.00% 2.50% $1,025.16 $5.13
2 1 $1,025.16 1.00% 2.50% $1,037.97 $5.19
2 2 $1,037.97 1.00% 2.50% $1,050.95 $5.25
3 1 $1,050.95 1.00% 2.50% $1,064.08 $5.32
3 2 $1,064.08 1.00% 2.50% $1,077.38 $5.39
4 1 $1,077.38 1.00% 2.50% $1,090.85 $5.45
4 2 $1,090.85 1.00% 2.50% $1,104.49 $5.52
5 1 $1,104.49 1.00% 2.50% $1,118.29 $5.59
5 2 $1,118.29 1.00% 2.50% $1,132.27 $5.66

Let’s look at what happens to TIPS in a deflationary period, assuming the annual inflation rate is now a constant negative 2.50%.

TIPS Deflation Example

Year Semi-annual Period Principal Annual Interest Rate Annual Inflation Rate Inflation Adjusted Principal Semi-Annual Interest Payment
1 1 $1,000.00 1.00% -2.50% $987.50 $4.94
1 2 $987.50 1.00% -2.50% $975.16 $4.88
2 1 $975.16 1.00% -2.50% $962.97 $4.81
2 2 $962.97 1.00% -2.50% $950.93 $4.75
3 1 $950.93 1.00% -2.50% $939.04 $4.70
3 2 $939.04 1.00% -2.50% $927.31 $4.64
4 1 $927.31 1.00% -2.50% $915.71 $4.58
4 2 $915.71 1.00% -2.50% $904.27 $4.52
5 1 $904.27 1.00% -2.50% $892.96 $4.46
5 2 $892.96 1.00% -2.50% $881.80 $4.41

You can quickly see that the inflation-adjusted principal used to calculate your interest payments goes down, and thus, your interest payments also accordingly go down.

Remember: if you hold your TIPS until maturity, even if your inflation-adjusted principal is less than what you originally invested, you will receive your original investment back. This means your principal is floored. The U.S. government will guarantee the greater of the original or inflation-adjusted principal.

How Long Do I Have to Hold TIPS?

There is a minimum holding period of 45 days if you purchase TIPS through TreasuryDirect.

If you buy through a bank or brokerage, there is generally no minimum holding period.

In both cases, you can liquidate your TIPS in the secondary market.

What is Break-Even Inflation?

Break-even inflation is the difference between the yield of a Treasury bond and an inflation-linked bond, both of the same maturity length. Here’s the formula:

Break-even Inflation = “Treasury Bond Yield” minus “Inflation-Linked Bond Yield

Say the interest rate of a TIPS is 2%, whereas a Treasury Bond is paying 5%. The break-even inflation rate, therefore, would be 3%, calculated as the T-Bond rate of 5% less than the TIPS rate of 2%. 

If inflation averages 3% over the life of both bonds, there would be no difference between owning the TIPS and the T-Bond.

However, if inflation exceeds 3%, the TIPS would be a better investment.

If inflation is lower than 3%, the Treasury Bond would be the better investment since it provides a higher fixed yield.

When Do I Earn Interest on TIPS?

TIPS pay interest every six months. The interest rate is a fixed rate determined at auction. However, the interest payments can vary because they are applied to the adjusted principal; hence, they can increase with inflation or decrease with deflation.

How Safe Are TIPS?

TIPS are backed by the full faith and credit of the U.S. government, which signifies a guarantee for the timely payment of principal and interest.

At maturity, you will receive either the original or the inflation-adjusted principal, whichever is higher.

How Do I Buy TIPS?

You can acquire TIPS in a few ways, including at an auction, secondary market, or through a mutual fund or ETF. Let’s walk through each method below.

Buying TIPS at an Auction

Purchasing TIPS at auction is a direct method of acquiring them at their initial issuance. Brokerages like Fidelity, Schwab, and others facilitate participation in these auctions, where investors can buy up to $10 million worth of TIPS. Alternatively, TreasuryDirect is a government platform allowing individuals to buy Treasury products directly from the U.S. Treasury at auction, with competitive or non-competitive bidding options. This includes TIPS, any type of Treasury bill or bonds, savings bonds, and other safe investments such as floating rate notes.

You can always check the TIPS schedule on the TreasuryDirect website.

Buying TIPS on the Secondary Market

After the auction, TIPS are traded on the secondary market. Investors can buy or sell TIPS at market prices through brokerages like Fidelity. This provides more flexibility, but prices may vary from the initial auction price due to market conditions.

Buying TIPS Through a Mutual Fund or ETF

Investing in TIPS through mutual funds or ETFs provides a more diversified exposure. Platforms like Vanguard or Fidelity offer various funds or ETFs focusing on TIPS. This method offers management by professionals, diversification, and ease of trading, but comes with management fees.

Tax Considerations for TIPS

TIPS come with particular tax considerations that differentiate them from other fixed-income securities. 

Similar to other Treasury bonds, the interest income from TIPS is exempt from state and local taxes, but it’s subjected to federal income tax.

Additionally, the inflation adjustments to the principal, which occur to maintain the bond’s purchasing power, are taxable by the IRS in the year they occur, even though investors will only receive these adjustments upon the sale or maturity of the bond. This scenario can result in phantom income, where investors are taxed on income not yet received, potentially increasing their tax liability.

To navigate this, some investors may hold TIPS in tax-advantaged accounts such as Individual Retirement Accounts (IRAs) or 401(k)s. This could defer or potentially eliminate the tax on these adjustments until the securities are sold or reach maturity.

Moreover, if TIPS are sold before maturity, any gains may be subject to capital gains tax. The rate of this tax will depend on the holding period of the bond; long-term capital gains from assets held for more than a year are usually taxed at a lower rate than short-term capital gains. 

Is There a Limit To How Much TIPS I Can Buy?

TIPS have a very high purchase limit. The maximum purchase for TIPS is $10 million per auction. You can buy an unlimited amount of TIPS on the secondary market.

Choosing Between TIPS and Other Savings Products

Savings I Bonds are another popular savings tool to protect against inflation. I Bonds are low-risk savings bonds issued by the U.S. Treasury that pay an interest rate comprised of a fixed and variable component.

I Bonds and TIPS provide inflation protection but differ in various aspects, such as tax treatment, liquidity, and purchase limits. I Bonds offer tax deferral on interest until redemption, and state/local tax exemption, while TIPS interest and inflation adjustments are taxed federally each year (sometimes known as phantom income).

I Bonds have a more restrictive purchase limit of $15,000 per year, whereas TIPS do not have a purchase limit. I Bonds also lack liquidity, while TIPS can bought and sold freely in the secondary market.

Should You Buy TIPS?

TIPS can be a complicated investment to wrap your head around. If you plan to hold TIPS until maturity, you will always receive your original principal back at the minimum. However, the journey may be difficult, as TIPS have a fluctuating market price. Morningstar analyzed that real interest rates on TIPS declined from 2015 through 2022. While TIPS are an investment that guarantees security as long they are held to maturity, we believe they should be reserved for the more advanced investor who is able to hold the bond and ignore it until they’re redeemd.