TIPS and I Bonds: Inflation-Protected Securities for Your Portfolio
TIPS and I Bonds are the only investments that guarantee you keep pace with inflation. TIPS adjust principal with CPI. I Bonds pay a fixed plus inflation rate. Here's how they work and whether you should own them.
Treasury Inflation-Protected Securities (TIPS) and Series I Savings Bonds are the two primary inflation-protected investments offered by the US government. Both adjust with inflation as measured by the Consumer Price Index (CPI), but they differ significantly in structure, liquidity, purchase limits, and tax treatment. Understanding these differences helps you decide which belongs in your portfolio.
Real-world example: You buy $10K of TIPS with a 1.5% coupon when inflation is 3%. The principal adjusts to $10,300. Interest: $10,300 x 1.5% = $154.50. Total return: $300 inflation adjustment (not realized until maturity if held) plus $154.50 interest = $454.50. An I Bond with the same $10K and a 1.30% fixed rate plus 3.00% inflation earns a 4.30% composite rate = $430 in first-year interest, tax-deferred until redemption.
TIPS: How They Work
TIPS are marketable Treasury securities whose principal adjusts with CPI. If inflation rises 3%, the principal increases 3%. If deflation occurs, principal decreases but never below par at maturity. Interest is paid semiannually at a fixed coupon rate applied to the adjusted principal. TIPS are available in 5-year, 10-year, and 30-year maturities. Current real yields are approximately 1.5% to 2.5% above inflation, varying with market conditions. Understanding Treasury securities helps contextualize how TIPS fit within the broader bond market.
I Bonds: How They Work
Series I Savings Bonds earn a composite rate consisting of a fixed rate (set at purchase and locked for the bond's life) plus a variable inflation rate that resets every six months in May and November. The recent composite rate was approximately 4.3% (1.30% fixed + 3.00% inflation). The annual purchase limit is $10,000 per person via TreasuryDirect, with an additional $5,000 possible through a tax refund using IRS Form 8888. I Bonds cannot be redeemed in the first 12 months, and redeeming before 5 years forfeits the last 3 months of interest. Building inflation protection into your portfolio often involves both TIPS and I Bonds.
Tax Treatment Comparison
TIPS inflation adjustments are taxable as income each year even though the adjustment is not received until maturity — this phantom income makes TIPS less suitable for taxable accounts. They are best held in IRAs or 401(k)s. I Bonds offer tax deferral: federal tax is not owed until the bond is redeemed, and interest is exempt from state and local taxes. I Bond interest can also be used tax-free for qualified education expenses if income limits are met. Bond ladder strategies with TIPS can provide predictable real income in retirement accounts.
How to Buy
TIPS can be purchased through TreasuryDirect.gov (new issues at auction), through a brokerage (secondary market), or via ETFs. Popular TIPS ETFs include TIP (iShares TIPS Bond ETF, 0.19% ER), VTIP (Vanguard Short-Term TIPS, 0.04% ER), and SCHP (Schwab TIPS, 0.03% ER — the cheapest option). I Bonds can only be purchased through TreasuryDirect.gov — they cannot be held at a brokerage or in an IRA. Bond investing for beginners should start with understanding these purchase mechanics.
What's the difference between TIPS and I Bonds?
TIPS are marketable securities with unlimited purchase capacity, more liquidity, and inflation adjustments that are taxable annually. I Bonds have a $10K annual purchase limit, offer tax deferral until redemption, state tax exemption, and a potential education tax break. TIPS are better for larger allocations in retirement accounts. I Bonds are better for smaller savings with tax advantages and a fixed-rate locked component. Retirement planning often benefits from including both types.
Are TIPS a good investment for retirement?
Yes, TIPS are excellent for retirement portfolios, especially for those in or near retirement. They provide guaranteed real income that keeps pace with inflation, reducing the risk of outliving your savings. Holding TIPS in traditional IRAs or 401(k)s avoids the phantom income tax problem. A TIPS ladder can provide predictable inflation-adjusted income for 5 to 30 years. For retirees, replacing some nominal bonds with TIPS provides crucial inflation protection for essential expenses.
How are I Bonds taxed?
I Bond interest is subject to federal income tax but exempt from state and local taxes. Federal tax is deferred until the bond is redeemed or reaches final maturity (30 years). You can report interest annually instead of deferring, but deferral is usually preferred. If used for qualified education expenses, I Bond interest can be completely tax-free, subject to income phase-out limits. This makes I Bonds attractive for college savings alongside 529 plans.
How much in I Bonds can I buy per year?
The annual limit is $10,000 per person per calendar year through TreasuryDirect. You can purchase an additional $5,000 using your federal tax refund via IRS Form 8888. A married couple can buy $20,000 per year ($10,000 each) plus up to $10,000 more from tax refunds. You can also gift I Bonds to others (purchased in your account, delivered later), which is a strategy some use to accumulate more over time.
Related Resources
Inflation Protection Guide
How to shield your portfolio from rising prices using TIPS, I Bonds, commodities, and real estate.
Bonds Investing for Beginners
Understand the basics of bond investing, including Treasury, corporate, and municipal bonds.
Retirement Planning Guide
Build a retirement plan that accounts for inflation, taxes, and longevity risk.