I Bonds and TIPS: Inflation-Protected Savings Options

When inflation spikes, suddenly everyone wants to know about I Bonds and TIPS. These government-backed securities offer something unique: protection against inflation. Here's how they work and when they make sense for your portfolio.

What Are I Bonds?

I Bonds (Series I Savings Bonds) are savings bonds sold by the U.S. Treasury that earn interest based on a combination of:

1. Fixed rate: Set when you buy, stays constant
2. Inflation rate: Adjusts every 6 months based on CPI

Current mechanics:

• Interest = Fixed rate + Inflation rate
• Rate adjusts May 1 and November 1
• Interest compounds semiannually
• Your principal is always protected

I bond Rules and Limitations

Purchase limits:

• $10,000 per person per year (electronic)
• Additional $5,000 with tax refund (paper)
• Can buy for children, spouse, trusts

Holding period:

• Must hold at least 1 year
• Redeem before 5 years: lose last 3 months interest
• After 5 years: no penalty

Where to buy:

• TreasuryDirect.gov (only place for electronic I Bonds)
• Paper I Bonds via tax refund only

I Bond Strategies

Emergency Fund Supplement

• After 1 year, becomes accessible
• Earns more than savings accounts
• Maintains purchasing power

Short-Term Goals (3-5 years)

• Inflation protection for known future expenses
• Better than CDs during high inflation
• down payment savings, major purchases

Part of Bond Allocation

• Replaces some traditional bonds
• Inflation protection regular bonds lack
• Tax-deferred growth

What Are TIPS?

TIPS (Treasury Inflation-Protected Securities) are Treasury bonds whose principal adjusts with inflation:

How they work:

• Face value increases with inflation (CPI)
• Fixed interest rate paid on adjusted principal
• At maturity, receive greater of adjusted or original principal

Example:

• Buy $1,000 TIPS at 1% interest
• Inflation is 3%
• After 1 year: Principal = $1,030, interest paid on $1,030 = $10.30
• Total value: $1,040.30 (vs. $1,010 from non-TIPS)

TIPS vs. I Bonds Comparison

When to Choose I Bonds

I Bonds are better when:

• You want state/local tax exemption
• You prefer tax deferral
• You have under $10,000/year to invest
• You don't need immediate liquidity
• You want simplicity

I Bond drawbacks:

• Purchase limits
• 1-year lockup
• Must use TreasuryDirect (clunky website)
• Not in investment accounts

When to Choose TIPS

TIPS are better when:

• You want to invest more than $10,000
• You need liquidity
• You want TIPS in a retirement account (tax-advantaged)
• You're using TIPS funds/ETFs

TIPS drawbacks:

• Phantom tax (taxed on inflation adjustment you haven't received)
• Prices fluctuate (can lose money if sold before maturity)
• More complex

TIPS Funds and ETFs

If you want TIPS exposure beyond I Bonds:

Popular options:

• Vanguard Short-Term TIPS ETF (VTIP)
• iShares TIPS Bond ETF (TIP)
• Schwab U.S. TIPS ETF (SCHP)

Advantages of funds:

• No purchase limits
• Liquidity
• Can hold in IRA (avoids phantom tax)
• diversification across maturities

Considerations:

• Expense ratios (usually low, 0.03-0.20%)
• Price fluctuates with interest rates
• Not guaranteed to match inflation perfectly

Building an Inflation-Protected Portfolio

Conservative Approach

• I Bonds: $10,000/year
• High-yield savings for emergency fund
• Short-term TIPS fund for additional bonds

Moderate Approach

• I Bonds: $10,000/year
• TIPS: 20-30% of bond allocation
• Stocks: 60-70% of portfolio (long-term inflation hedge)

Aggressive Approach

• I Bonds for near-term needs
• Mostly stocks (best long-term inflation hedge)
• Minimal traditional bonds

I Bond Step-by-Step Purchase

Tax Considerations

I Bonds

• Federal tax only (no state/local)
• Tax deferred until redemption
• Can be tax-free if used for education (income limits apply)

TIPS

• Federal tax on interest AND inflation adjustments annually
• Hold in IRA/401(k) to avoid phantom tax
• No state/local tax

Common Questions

Q: What happens if we have deflation? I Bonds: Rate can't go below zero; you won't lose principal TIPS: Principal can decrease, but you get at least original principal at maturity

Q: Should I bonds replace my emergency fund? Not entirely. Keep 1-3 months in accessible savings; I Bonds can back the rest after the 1-year lockup.

Q: Are I Bonds worth it when inflation is low? Less compelling than during high inflation, but still protect purchasing power. The fixed rate component provides some return regardless.

Q: Can I buy I Bonds for my kids? Yes! Each child can have their own TreasuryDirect account with their own $10,000 annual limit.

When NOT to Use Inflation-Protected Securities

The Bottom Line

I Bonds and TIPS fill a specific role: inflation-protected savings for money you'll need in the medium term (1-10 years). They're not:

• A replacement for stocks (long-term growth)
• A replacement for emergency savings (need immediate access)
• A get-rich-quick investment

But for protecting purchasing power on money you're setting aside for specific goals, they're valuable tools—especially I Bonds with their simplicity and tax benefits.