A Treasury Inflation-Protected Security has two moving parts: a fixed interest rate set at auction, and a principal value that rises and falls with the Consumer Price Index. Every six months, the Treasury pays the fixed rate on whatever the principal is at that point. When prices rise, the principal grows and so does each interest payment. At maturity you get back the inflation-adjusted principal or your original principal, whichever is larger.
That is the whole design. The rest of this guide is about what it means for your returns, your taxes and where TIPS fit in a portfolio.
Key takeaways
- TIPS are issued by the US Treasury in 5-, 10- and 30-year terms, with a $100 minimum at TreasuryDirect.
- Inflation adjustments to principal are taxable federally each year even though you don’t receive them until maturity, so TIPS are usually best held in an IRA or 401(k).
- TIPS protect against inflation only if you hold to maturity; their market prices still move with real interest rates in the meantime.
The mechanics, with numbers
Take a hypothetical $1,000 TIPS with a 1.5% fixed rate. That rate is fixed for the life of the bond; Treasury says it is never set below 0.125%.
- Inflation runs 3% over the first year. The principal adjusts to about $1,030.
- Interest is paid on the new principal. Each semiannual payment is half of 1.5% of the current principal. On $1,030, that is about $7.73 instead of $7.50.
- The process repeats. If inflation runs 3% again the next year, principal rises to about $1,061, and payments grow with it.
- Deflation reduces principal. If prices fall, the principal shrinks and interest payments shrink with it.
- At maturity, the floor kicks in. You receive the larger of the adjusted principal or the original $1,000. A long stretch of deflation cannot leave you with less than you put in at issue.
The index used is the non-seasonally adjusted CPI for all urban consumers (CPI-U), applied with a lag of about three months. Treasury publishes daily index ratios so that buyers and sellers can price the adjustment precisely. The full rules are on TreasuryDirect’s TIPS page.
Real yield and the breakeven rate
The yield on a TIPS is quoted as a “real” yield, meaning return above inflation. A regular Treasury of the same maturity quotes a “nominal” yield, which has to cover inflation itself.
The difference between the two is the breakeven inflation rate. If a hypothetical 10-year Treasury yields 4.3% and a 10-year TIPS yields 1.9%, the breakeven is 2.4%. If inflation averages more than 2.4% over the decade, the TIPS comes out ahead. If it averages less, the regular Treasury wins. Buying TIPS is, in effect, a bet that inflation will beat the market’s forecast, or an insurance policy in case it does.
What TIPS don’t protect you from
Price swings before maturity
TIPS trade on the secondary market, and their prices move inversely with real interest rates. When real yields jumped in 2022, many TIPS funds lost money even while inflation was high. If you might sell before maturity, you carry interest-rate risk like any bond.
Your personal inflation
CPI-U tracks an average urban basket. If your costs are dominated by things rising faster, such as health care or local rent, your personal inflation could outrun the index.
Deflation in the meantime
The principal floor applies at maturity. A TIPS bought on the secondary market with an already-inflated principal can lose value if deflation drags principal back down, and the floor only protects the original issue amount.
The phantom income problem
Here is the main drawback for taxable accounts. Each year’s upward adjustment to principal is taxable federal income for that year, even though you don’t receive it in cash until the bond matures or you sell. In a high-inflation year, you can owe tax on more income than the interest payments you actually received. Interest and adjustments are exempt from state and local income tax.
For that reason, many investors hold TIPS inside a traditional IRA, Roth IRA or 401(k), where the annual adjustments create no tax bill. Retirees taking required minimum distributions sometimes use a ladder of TIPS inside their IRA to fund withdrawals year by year.
TIPS vs. I bonds
Both are Treasury products that track inflation, but they work differently. I bonds are savings bonds: they don’t trade, can’t lose value, defer all tax until redemption and are limited to $10,000 per person per year electronically. They can’t be redeemed in the first year and lose three months of interest if cashed before five years. TIPS have far higher purchase limits, trade on the open market and can be held in retirement accounts, but they can lose market value before maturity. Many people use I bonds for a modest emergency reserve and TIPS for larger, longer-term inflation hedging.
Buying TIPS
At auction through TreasuryDirect
Open an account at TreasuryDirect.gov, link a bank account and place a non-competitive bid before an auction. You accept whatever yield the auction sets. The minimum is $100, in $100 increments, and non-competitive bids are limited to $10 million per auction. TreasuryDirect does not offer IRAs, so this route only works for taxable holdings.
Through a brokerage
Most large brokerages let you bid at Treasury auctions or buy existing TIPS on the secondary market, in a taxable account or an IRA, usually with no commission on Treasuries. This is the easiest way to hold individual TIPS in a tax-advantaged account and to build a ladder of maturities.
Through a fund or ETF
TIPS mutual funds and ETFs hold a range of maturities and handle reinvestment for you. Short-term TIPS funds have less price volatility; broad funds have more. A fund never matures, though, so it does not give you the hold-to-maturity guarantee of an individual bond. Check the fund’s duration and expense ratio; our guide on reading a fund fact sheet explains both.
Frequently asked questions
How much of a portfolio should be in TIPS?
There is no single answer. Investors near or in retirement often hold a meaningful share of their bond allocation in TIPS because inflation erodes fixed spending power. Younger investors with mostly stocks may hold little or none.
Can a TIPS interest payment go down?
Yes. The rate is fixed, but it is applied to the current principal. If deflation lowers principal, the next payment is smaller.
What happens when I sell before maturity?
You get the market price plus accrued interest, which may be above or below what you paid. The deflation floor does not apply to a sale.
Are TIPS a good place for an emergency fund?
Not usually. Price swings and phantom taxes make them awkward for cash you may need on short notice. A high-yield savings account or money market fund fits that job better.
