Both I Bonds and Treasury Inflation-Protected Securities (TIPS) offer principal protection and purchasing power protection. They each have built-in features to combat rising inflation risks, but they do it in different ways.
This comparison of the differences between TIPS and I Bonds can help guide you when you're making a decision as to which type of investment is best for you.
- I Bonds and TIPS are investments that protect your principal and purchasing power.
- Individuals can only buy $10,000 worth of I Bonds in a single calendar year, while $5 million in TIPS can be purchased at any single auction
- You can sell TIPS anytime you want, but you can't sell I Bonds for at least a year after purchase. TIPS can be bought for various terms, and I Bonds earn interest for 30 years.
- Both are adjusted for inflation using the consumer price index, and both are subject to federal income taxes.
According to the TreasuryDirect.gov site, the total value of electronic I Bonds you can buy in a single calendar year is capped at $10,000 per person as of 2021. You can buy an additional $5,000 in paper bonds if you direct your tax refund toward the purchase. There's a $25 minimum for each bond purchased, and you can even specify the bond value to the penny, such as $25.99.
You can buy up to $5 million in TIPS at any single auction using Treasury Direct. There's a $100 minimum.
Minimum Terms of Ownership
TIPS have no minimum term of ownership. You can sell them on the secondary market at any time. You can't sell I Bonds until 12 months after you purchase them, and you'll forfeit three months' interest if you redeem them before you've owned them for five years.
Interest and any increase in principal from inflation adjustments are taxed each year when you buy TIPS. You can be taxed on income you haven't received yet, because you don't receive an increase in the principal of the bond until you sell it.
Interest is added to the value of an I Bond and only taxed upon redemption. This feature may make it more tax-efficient to own TIPS in tax-deferred retirement accounts, depending on the state you live in and your tax bracket. While TIPS are subject to federal taxes, they are exempt from state and local taxes. Consult with a qualified tax professional to determine whether this strategy will work in your particular situation.
Performance During a Time of Deflation
TIPS can go down in value in a deflationary environment, but they'll always be worth at least the original principal amount at redemption.
I Bonds can never go down below the bond's value in the prior month. Any upward inflation adjustments you've received can't be eroded by a period of later-occurring deflation.
TIPS are issued in 5-, 10-, and 30-year terms.
I Bonds pay interest for 30 years. You can redeem them after 12 months, but if you do so prior to five years, you'll forfeit the last three month's interest. I-Bond rates are adjusted each May and November. The total rate is the sum of the fixed rate and the variable inflation-indexed rate.
As of December 2021, the fixed rate was 0.00%, and the variable rate was 3.56% on a semi-annual basis. For the six months beginning November 2021 through April 2022, you thus would receive a rate of 7.11% annually for every new bond you purchased.
How the Inflation Adjustment Works
TIPS principal is adjusted by changes in the consumer price index, either up or down. The interest rate is determined at issue. The dollar amount paid will depend on the principal value of the bond so a higher amount of interest will be paid out if the principal is adjusted upward based on increases in inflation.
The variable portion of an I Bond's interest rate is set every six months. It's based on the consumer price index. This variable rate is paid out in addition to a fixed rate that is determined when the bond is issued.
Where to Buy and Keep These Investments
TIPS can be purchased online through TreasuryDirect or from a bank or broker. You can use a noncompetitive bid and take the market yield. If you go through a bank, broker, or dealer, you can make a competitive bid to specify your desired rate. However, with the competitive bid, you might not get the investment or amount you want, due to your entered competitive price.
I Bonds are only available online through TreasuryDirect or in paper form using your federal tax income refund.
Frequently Asked Questions (FAQs)
Is it better to buy TIPS or short-term bonds when interest rates rise?
TIPS provide better protection than short-term bonds when interest rates rise. Both TIPS and short-term bonds are better positioned for rising interest rates than long-term bonds, but only TIPS will adjust payments as rates rise.