Inflation-protected Treasury notes (TIPs) protect investors from inflation and are sold through Treasury auctions or brokers. The principal increases with the consumer price index, but there is a trade-off for a lower yield. TIPs mature in 5, 10, or 20 years and are subject to federal income tax. Upon maturity, the principal is automatically deposited into a designated bank account.
An inflation-protected Treasury note (TIP) is a special type of note or bond that the US Department of the Treasury uses to finance public debt. At the same time, inflation-protected Treasuries offer investors protection from the ups and downs that result from inflation. These securities are also called Treasury inflation-indexed securities.
These securities are typically purchased in multiples of $100 US dollars (USD) through Treasury Department public auctions. Bids can also be placed through a bank, broker, or government-authorized dealer. Auction dates for Treasury Bills and Treasury Notes are announced in major newspapers and online news releases on the department’s website. Investors can also subscribe to email notifications.
Inflation is an increase in the cost of goods and services. As inflation rises, the basic amount an investor puts into an inflation-protected Treasury security, known as principal, increases simultaneously at the same rate as the consumer price index (CPI). On the other hand, during deflationary times, when prices fall, capital also falls.
The CPI is a weighted average of the prices of a basket of consumer goods and services. It is used to measure increases and decreases in the cost of living of consumers. Although the CPI experiences some volatility over time, an inflation-protected Treasury is considered a safe investment because capital is not compromised when the CPI falls. If deflationary pressures cause the interest-adjusted principal to fall below the original investment amount, the original principal is paid in full upon maturity.
But there is a trade-off for that piece of mind. Inflation-Protected Treasuries (TIPS) offer a lower yield. The US Department of the Treasury provides an online TIPS Inflation Index Reports page to help investors calculate changes in principal, based on changes in the CPI.
Inflation-protected Treasuries pay interest every six months at a fixed rate and pay principal to the investor at maturity. They mature in terms of 5 years, 10 years and 20 years. For example, a 10-year TIPS note may have a semi-annual interest rate of 4% or 3.875%, with yields of 4.075% or 3.937%.
Interest on an inflation-protected Treasury security is exempt from state and local income taxes, but is subject to federal income tax. Federal income tax on interest payments is applied in the year the interest is received. With respect to capital growth, federal income tax applies in the year in which it occurs.
An inflation-protected Treasury security can be held to maturity or sold before the maturity date. Upon maturity, the principal can be used to purchase another security. Investors need not take any special action to redeem TIPS. The Treasury Department will automatically deposit the principal into a previously designated bank account.
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