TIPS

TIPS are Treasury bonds whose principal is indexed to the consumer price index. The principal adjusts monthly with CPI-U, and the fixed coupon is paid on the adjusted principal, so both interest and the final payment rise with inflation. Maturities run 5, 10, and 30 years, sold at Treasury auctions and tradable on the secondary market. At maturity, the payment is the greater of the inflation-adjusted or the original principal, a built-in deflation floor.

The trade-off is taxation: the inflation adjustment is taxed as income in the year it accrues, even though the cash arrives at maturity, which is why TIPS belong in tax-advantaged accounts. The market prices them against nominal Treasuries through breakeven inflation: a 4.5% nominal yield against a 2.2% TIPS real yield implies 2.3% of priced inflation.

The mechanics run on an adjustment cycle. A $1,000 par bond with a 2% coupon under 3% inflation sees its principal adjust to roughly $1,030 over the year, and the semiannual coupons pay on the adjusted principal: roughly $10.30, then $10.40. At maturity the Treasury pays the greater of the adjusted or the original principal, so deflation cannot leave the holder below par. The coupon rate is fixed for the life of the bond; the dollars it applies to are not.

The comparison to nominal Treasuries runs through breakeven inflation. A nominal yielding 4.5% against a TIPS real yield of 2.2% prices 2.3% of inflation: if CPI averages 3% over the decade, the TIPS return compounds to roughly 5.2%, beating the nominal by about 0.7 points a year. If inflation averages 1.5%, the nominal wins by 0.8. The taxation is the part holders miss: the adjustment is taxed annually on money not yet received, which in a taxable account at the 24% bracket costs $72 a year per $10,000 bond under 3% inflation. In a Roth, the same adjustment compounds untaxed, which is why account placement is the first decision, not the yield.

Retirement spending is inflation-exposed for 30 years, and TIPS are the bond sleeve that matches future liabilities directly: a 10-year TIPS ladder funds a known cost in 2036 at today's purchasing power. The deflation floor makes them the only bond that cannot lose to both markets and prices at once.

I watched a colleague named Brent (yes, that Brent) buy $50,000 of TIPS in a taxable account, then owe phantom-income tax on an inflation adjustment he had not received in cash. The bill was roughly $360 a year at the 24% bracket, paid from his checking account. The bond was fine; the account placement was not.

The highest-leverage thing most Americans can do is hold TIPS where the phantom income does not sting, and match maturities to known future spending instead of trading them. Price the ladder against nominal yields with the bond yield calculator and the inflation component with the inflation calculator. The hedge is the maturity match, not the ticker.