When prices rise quickly, money sitting in a regular savings account can lose purchasing power even while the balance stays the same. Two investments issued by the US Treasury are designed specifically to address that problem: Series I Savings Bonds, usually called I bonds, and Treasury Inflation-Protected Securities, known as TIPS. Both adjust for inflation and both are backed by the full faith and credit of the US government, but they work in very different ways and suit different goals.
How I bonds work
I bonds earn a composite interest rate made up of two parts: a fixed rate that stays the same for the life of the bond, and a variable inflation rate that is reset every six months based on changes in the Consumer Price Index. New rates are announced each May and November. Interest is added to the bond and compounds semiannually, and the bond can keep earning for up to 30 years. Because the value of an I bond never goes down, you will not see a market loss on your statement, even when interest rates rise.
There are some important rules. Electronic I bonds are purchased directly through TreasuryDirect, and each person can buy up to $10,000 per calendar year. You must hold an I bond for at least 12 months before you can cash it in, and if you redeem it before five years, you give up the last three months of interest. That makes I bonds a poor fit for money you might need next month, but a solid option for savings you can leave alone for a while.
How TIPS work
TIPS are Treasury securities sold with maturities of 5, 10 and 30 years. Instead of changing the interest rate, TIPS adjust the principal. When inflation rises, the principal value increases, and the fixed interest rate is paid every six months on that adjusted amount, so your interest payments grow along with prices. At maturity you receive either the inflation-adjusted principal or the original principal, whichever is greater.
Unlike I bonds, TIPS can be bought in any amount through TreasuryDirect or a brokerage account, and they can be sold before maturity on the secondary market. That flexibility comes with a trade-off. TIPS prices move with interest rates, so if you sell early, you could receive more or less than you paid. Many investors hold TIPS through mutual funds or exchange-traded funds, which provide diversification but also fluctuate in value.
I bonds are built for savers who want a value that never drops. TIPS are built for investors who want inflation protection with larger amounts and more flexibility.
Taxes are different, too
Interest from both I bonds and TIPS is subject to federal income tax but exempt from state and local income tax. With I bonds, you can usually defer federal tax until you cash the bond in or it stops earning interest, and the interest may be tax free if used for qualified higher education expenses and you meet income limits. With TIPS held in a taxable account, the yearly increase in principal is generally taxable in the year it occurs, even though you will not receive that money until the bond matures or is sold. Some investors call this phantom income, and it is one reason many people prefer to hold TIPS inside retirement accounts.
Which one is right for you?
I bonds tend to suit people building a medium-term cash reserve, saving for a goal five or more years away, or wanting a simple, low-maintenance way to keep up with inflation. The annual purchase limit, however, means they are rarely enough on their own for larger portfolios. TIPS tend to suit investors who want to protect a meaningful portion of a long-term portfolio, particularly retirees and pre-retirees who are concerned about rising living costs.
Many households use both. I bonds can hold part of an emergency fund that is not needed immediately, while TIPS or a TIPS fund can form part of a diversified retirement allocation alongside stocks and other bonds. The right mix depends on your timeline, tax situation and how much flexibility you need.
If you are unsure how inflation-protected investments fit into your overall plan, the advisors at Money Growth Plus can help you compare the options, estimate the tax impact and decide how much of your savings belongs in each. Inflation does not have to quietly shrink your hard-earned money.