Treasury Inflation-Protected Securities (TIPS)

A Treasury Inflation-Protected Securities (TIPS) are bonds sold by the U.S. Treasury whose value is linked to the inflation rate. TIPS are issued for maturities of 5, 10, and 20 years. A TIPS pays a fixed annual interest rate that is determined when the TIPS is issued. You can hold a TIPS until maturity or sell it on the secondary bond market before it matures.

If you think inflation will be significant in the future and you want to protect the purchasing power of your original investment, you could buy TIPS.

The principal value of a TIPS is adjusted every six months according to changes in inflation as measured by the Consumer Price Index (CPI). If the CPI increases, the principal increases. If the CPI goes down, the principal decreases. Every six months the the amount of interest paid depends on the inflation adjusted principal. If the CPI has increased, the interest payment increases. If the CPI has decreased, the interest payment decreases.

If you hold a TIPS until maturity, you will receive the inflation adjusted principal or the original principal whichever is greater. You will never receive less than your original principal.

Each year a TIPS owner must pay tax on so-called phantom income that results from inflation adjustments to the principal even though you do not actually receive the adjusted principal until the TIPS mature. To avoid the annual tax liability, your should only hold TIPS in a tax-sheltered retirement account. Become familiar with the tax implications of TIPS before you buy them.

You can buy TIPS from a broker, at a federal reserve bank, or on the Internet at TreasuryDirect, the site offered by the the Bureau of Public Debt, which is under the U.S. Department of Treasury. The site offers a comprehensive FAQ section that will answer your questions about U.S. Treasury products and how you buy and sell them.

For more information about TIPS see Treasury Inflation-Protected Securities (TIPS) In Depth at TreasuryDirect and What You Should Know About U.S. Inflation Protected Securities at The Bond Market Association.

Updated August 19, 2007.