I Bonds and TIPS: How Inflation-Protected Bonds Work

The years after 2020 reminded every saver of something the previous decade had let them forget: cash and ordinary bonds lose ground when prices rise. A retiree who locked in a 2 percent bond yield watched inflation run well past it. That experience sent a wave of investors toward I bonds and TIPS, the two Treasury instruments built specifically to keep pace with the consumer price index.

The two are often mentioned together, but they behave very differently. One has a purchase cap, no market price, and tax deferral. The other trades freely, scales to any portfolio size, and creates a tax quirk in taxable accounts that trips up many investors. Knowing which is which matters more than knowing that both are inflation-protected.

This guide explains how each one works, how they are taxed, how to buy them, and where they realistically fit in a plan for a high-income household. It is educational and general. Whether either belongs in your portfolio depends on your accounts, bracket, and what the safe money is for.

How I Bonds Work

Series I savings bonds are issued by the US Treasury and sold directly to individuals through TreasuryDirect. They are not traded on any market. You buy them from the government, you hold them, and you redeem them with the government.

The interest rate has two parts. A fixed rate is set when you buy and stays with that bond for its 30-year life. A variable inflation rate is announced every May and November based on the change in the consumer price index over the prior six months. The composite rate is roughly the sum of the two. When inflation is high, the variable component is large; when inflation is low or negative, it shrinks, though the composite rate cannot go below zero.

Interest accrues monthly and compounds semiannually. You do not receive it in cash. It is added to the bond's value and paid out when you redeem.

Rules That Shape the Decision

• Purchase limit. Each person can buy up to $10,000 of electronic I bonds per calendar year through TreasuryDirect, and a couple can each buy the full amount. Investor.gov has a general overview of Treasury and savings bond products at investor.gov.
• One-year lockup. You cannot redeem an I bond in the first 12 months.
• Early redemption penalty. Redeeming before five years forfeits the last three months of interest. After five years there is no penalty.
• Tax treatment. Interest is exempt from state and local income tax. Federal tax is deferred until redemption unless you elect to report it annually. An education exclusion exists but phases out at income levels well below most physician or executive incomes.
• Maturity. I bonds earn interest for 30 years.

How TIPS Work

Treasury Inflation-Protected Securities are marketable Treasury bonds issued in 5, 10, and 30-year maturities. Unlike I bonds, they trade on the secondary market, so you can buy any amount in a brokerage account and sell whenever you like at the market price.

The inflation protection works through the principal rather than the interest rate. A TIPS bond's principal is adjusted with the consumer price index, and the bond pays a fixed coupon on that adjusted principal. If you own a TIPS with a 1.5 percent coupon and inflation raises the principal from $10,000 to $10,400, the coupon payment rises from $150 to $156 per year. At maturity, you receive the adjusted principal or the original principal, whichever is greater.

Because TIPS trade, their prices move with real interest rates. If real yields rise after you buy, your TIPS will show a loss on the statement even though inflation protection is intact. Hold to maturity and the price swings do not matter; sell early and they do. This is the same logic that applies to any Treasury in a bond ladder.

The Phantom Income Problem

The tax wrinkle that makes TIPS awkward in taxable accounts is that the annual inflation adjustment to principal is taxable as interest in the year it occurs, even though you will not receive that money until the bond matures or is sold. In a high-inflation year, a taxable TIPS holder can owe federal tax on income they have not been paid. For a high earner, this pushes TIPS toward tax-deferred accounts, where the adjustment is not taxed annually. The IRS addresses inflation-indexed debt in Publication 550.

Like all Treasuries, TIPS interest and adjustments are exempt from state and local tax.

TIPS Funds vs Individual TIPS

TIPS mutual funds and ETFs offer easy diversification and handle the tax reporting, but they never mature. Their price moves with real rates, and in 2022 many TIPS funds fell double digits even as inflation ran hot, because real yields rose sharply. Individual TIPS held to maturity deliver the inflation-adjusted principal regardless. For a specific spending goal, individual TIPS are the cleaner tool. For a general inflation-hedged bond allocation in a retirement account, a short or intermediate TIPS fund is reasonable.

I Bonds vs TIPS: Side by Side

The differences come down to scale, liquidity, and tax mechanics.

• Purchase limits. I bonds: capped per person per year. TIPS: unlimited.
• Where to buy. I bonds: TreasuryDirect only. TIPS: any brokerage account, at auction or on the secondary market, plus funds.
• Liquidity. I bonds: locked for 12 months, penalty before five years, then redeemable at full value any time. TIPS: sellable any business day at market price, which may be above or below what you paid.
• Price risk. I bonds: none; value never declines. TIPS: real interest rate risk if sold before maturity.
• Inflation mechanism. I bonds: variable rate resets every six months. TIPS: principal adjusts with CPI.
• Federal tax timing. I bonds: deferred until redemption. TIPS: coupon and inflation adjustment taxed annually in taxable accounts.
• State tax. Both exempt.
• Deflation. I bonds: composite rate floors at zero. TIPS: principal at maturity floors at original par, but interim adjustments can reduce value.
• Best account. I bonds: taxable only (they cannot be held in an IRA). TIPS: tax-deferred accounts for individuals, or taxable if you accept the phantom income.

Where I Bonds and TIPS Fit for High Earners

For a household with a seven-figure portfolio, the I bond limit is a rounding error. That does not make I bonds useless, but it does define their role. For TIPS, the constraint is the tax treatment, which points toward retirement accounts.

I Bonds as an Emergency Reserve Layer

After the first year, an I bond is a liquid, state-tax-free, inflation-matching reserve that never loses value. That is a good description of what an emergency fund should be. A couple who buys the annual limit each for a few years can build a meaningful inflation-protected cushion behind their high-yield savings account. The one-year lockup means I bonds should sit behind, not in front of, immediately available cash. Our guide to how much emergency fund you need covers the sizing question.

TIPS in a Retirement Income Plan

TIPS scale, which makes them suitable for the job I bonds cannot do: guaranteeing a specific real income for a specific span of years. A retiree who buys individual TIPS maturing in each of the next ten years has locked in ten years of spending in inflation-adjusted dollars, backed by the Treasury. Held inside a traditional IRA, the phantom income problem disappears and maturing TIPS can fund required distributions.

This is one of the more robust ways to cover the early retirement years when a poor market plus high inflation would do the most damage. It is not free: TIPS real yields are lower than the expected real return on stocks. The trade is certainty for expected return, and it should be sized to the spending that truly needs to be certain, not to the whole portfolio.

What Neither Does

Inflation-protected bonds protect the safe portion of a portfolio. They do not replace the growth portion. Over long periods, a diversified stock portfolio has historically outpaced inflation by a wide margin, and that is where most of a 40-year-old's inflation defense should sit. I bonds and TIPS are for the money you cannot afford to have shrink in real terms over the next several years. The Bureau of Labor Statistics publishes the CPI data that drives both instruments at bls.gov.

Practical Steps and Common Mistakes

The mechanics are simple once you know where each instrument lives.

• Set up TreasuryDirect early. Account setup can take time, and I bonds cannot be bought anywhere else. Keep login details somewhere your executor can find; TreasuryDirect holdings are easy to overlook in an estate.
• Do not buy I bonds with money you need in the next 12 months. The lockup is absolute.
• Hold TIPS in tax-deferred accounts unless you have a specific reason to accept annual tax on the inflation adjustment.
• Know the difference between a TIPS fund and a TIPS bond. The fund can lose money when real rates rise. The bond held to maturity cannot lose inflation-adjusted principal.
• Do not over-allocate. A retiree who moves the entire portfolio into TIPS has solved inflation for the next decade and created a growth problem for the decades after.

I bonds and TIPS solve the same problem at different scales. I bonds are a small, safe, tax-deferred reserve that never loses value, limited by the annual purchase cap. TIPS are a marketable tool that can anchor years of inflation-adjusted retirement income, best held where the annual adjustment is not taxed. Neither replaces the growth assets that do the heavy lifting against inflation over a career, but both do a specific job well when sized correctly. If you want help deciding how much of your safe money belongs in each, our investment management team can walk through it, or you can reach out here.

Tony Colunga · Founder, Attend Wealth

Tony leads Attend Wealth, a fee-based wealth management firm in Atlanta serving professionals, families, physicians, and business owners. Advisory services are held to a fiduciary standard. More about Attend