Loading the player...

What are 'Treasury Inflation Protected Securities - TIPS'

Treasury inflation protected securities (TIPS) refer to a treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the U.S. government and because the par value rises with inflation, as measured by the Consumer Price Index, while the interest rate remains fixed.

BREAKING DOWN 'Treasury Inflation Protected Securities - TIPS'

Interest on TIPS is paid semiannually. TIPS can be purchased directly from the government through the TreasuryDirect system, in $100 increments with a minimum investment of $100, and are available with 5-, 10-, and 30-year maturities.

Because the semiannual inflation adjustments of a TIPS bond are considered taxable income by the IRS, even though investors don't see that money until they sell the bond or it reaches maturity, some investors prefer to get TIPS through a TIPS mutual fund or exchange traded fund (ETF), or to only hold them in tax-deferred retirement accounts to avoid tax complications. Purchasing TIPS directly, however, allows investors to avoid the management fees associated with mutual funds. TIPS are also valuable because they are exempt from state and local income taxes.

Example of Treasury Inflation Protected Securities Adjustments

Suppose an investor owns $1,000 in TIPS at the end of the year, with a coupon rate of 1%. If there is no inflation as measured by the CPI, the investor will receive $10 over the year in coupon payments. If inflation rises by 2%, however, the $1,000 principal will be adjusted upward by 2% to $1,020. The coupon rate will still be the same at 1% but it will be multiplied by the new principal amount of $1,020 to get an interest payment of $10.20. On the other hand, if inflation was negative, as in deflation, with prices as measured by the CPI falling 5%, the principal would be adjusted downward to $950. The resulting interest payment would be $9.50 over the year.

At maturity, the investor would receive the principal equal to either the original principal of $1,000 or an adjusted higher principal, if applicable. The interest payments during the life of the bond are subject to being calculated from a lower principal, but the investor is never at risk of losing the total principal of TIPS if held to maturity. The investor can sell TIPS for less than the initial principal in the secondary market, however, before maturity.

Risks of Treasury Inflation Protected Securities

TIPS usually carry interest rates lower than other government or corporate securities, so they are not necessarily optimal for income investors. Their advantage is mainly inflation protection, but if inflation is minimal or nonexistent, their utility decreases. Another risk associated with TIPS is a higher tax bill. The adjustments of principal are considered income for tax purposes, although investors do not receive the adjustments, but instead receive the coupons that result from them. Thus, investors may be subject to tax on "phantom income," with the gain in principal outweighing the coupons received.

RELATED TERMS
  1. TIPS Spread

    TIPS spread compares the yield of the Treasury Inflation Protection ...
  2. Inflation Protected

    The types of investments that provide protection against inflation ...
  3. Form 4070: Employee's Report Of ...

    A tax form distributed by the Internal Revenue Service (IRS) ...
  4. IRS Publication 531

    A document published by the Internal Revenue Service (IRS) that ...
  5. Coupon Rate

    The yield paid by a fixed income security. A fixed income security's ...
  6. IRS Publication 1244: Employee's ...

    A document published by the Internal Revenue Service (IRS) that ...
Related Articles
  1. Investing

    Inflation Protected Securities: How They Work

    Learn how the U.S. Treasury inflation-protected securities (TIPS) work, which considerations investors should keep in mind and for whom TIPS are most suitable.
  2. Investing

    Using the TIPS Spread to Predict Inflation (TIP, ATPIX)

    Learn how analysts and investors use the TIPS spread to forecast inflation rates, and how accurate the TIPS spread has been as an inflation predictor.
  3. Investing

    2 Popular Inflation Protected "TIPS" Bond ETFs in 2016 (TIP, IPE)

    Learn about how Treasury Inflation Protected Securities (TIPS) work, and discover two of the more popular ETFs that invest in TIPS.
  4. Investing

    Treasury Inflation-Protected Securities (TIPS)

    Treasury inflation-protected securities are treasury securities that make adjustments for inflation as reflected in the Consumer Price Index.
  5. Investing

    Introduction to Treasury Inflation-Protected Securities (TIPS)

    If you want to protect your portfolio from inflation, all you need are a few TIPS.
  6. Financial Advisor

    Why the TIPS Rally Might Not Be Real

    The influx of money into TIPS that ended in April is probably not an indicator that real inflation is on the horizon.
  7. Investing

    The 4 Best Inflation-Protected Funds To Invest In (SCHP)

    Discover how Treasury inflation-protected securities (TIPS) work, and learn about five funds in this segment that make good investments.
  8. Investing

    4 Best High-Yielding Inflation Protected (TIPS) Bond ETFs (LTPZ, TIP)

    Learn how to protect a portion of your portfolio against the effects of inflation, and discover four different investments that can help you achieve that goal
  9. Personal Finance

    When To Tip? And How Much?

    Good service can be rewarded through tipping. Find out which services commonly require a tip, and how much you should give.
  10. Investing

    TIPS Inflows Surge Post-Election

    Investors have flocked to TIPS in the wake of Donald Trump winning the U.S. presidential election.
RELATED FAQS
  1. It is now 6 month after you just purchased a $1,000 face value TIPS ...

    The correct answer is d. TIPS are a special type of Treasury note or bond that offers protection from inflation. When you ... Read Answer >>
  2. How does the amount of the principal fluctuate depending on inflation?

    Read about the impact of inflation on your principal balances, and learn why inflation harms lenders and bondholders at the ... Read Answer >>
  3. Why Do Most of My Mortgage Payments Start Out as Interest?

    When you make a mortgage payment, the amount paid is a combination of an interest charge and principal repayment. Over the ... Read Answer >>
  4. What are some safe fixed-income investments?

    Learn what types of fixed income securities provide investors with safe options for protecting principal and providing steady ... Read Answer >>
Hot Definitions
  1. Profitability Index

    An index that attempts to identify the relationship between the costs and benefits of a proposed project through the use ...
  2. Restricted Stock Unit

    Compensation offered by an employer to an employee in the form of company stock. The employee does not receive the stock ...
  3. Operating Ratio

    A ratio that shows the efficiency of a company's management by comparing operating expense to net sales. Calculated as:
  4. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  5. Pro Forma

    A Latin term meaning "for the sake of form". In the investing world, it describes a method of calculating financial results ...
  6. Trumpcare

    The American Health Care Act, also known as Trumpcare and Ryancare, is the Republican proposal to replace Obamacare.
Trading Center