What Are Treasury Inflation-Protected Securities (TIPS)?

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Treasury Inflation-Protected Securities (TIPS) are marketable U.S. Treasury bonds whose principal is adjusted for changes in the Consumer Price Index. When consumer prices rise, the bond’s principal rises with them. Interest is then paid on that adjusted principal, so both the payments and the amount repaid at maturity track inflation. At maturity, the holder receives the inflation-adjusted principal or the original principal, whichever is greater. TIPS are backed by the full faith and credit of the U.S. government, which makes them the main U.S. government bond built specifically to protect purchasing power.

The key point about TIPS is that the coupon rate is fixed and real (above inflation), while the dollar amounts it produces are not fixed. A conventional Treasury promises a set number of dollars. A TIPS promises a set amount of purchasing power, measured by the CPI.

How Treasury Inflation-Protected Securities work

A TIPS has three moving parts: a fixed coupon rate, a principal amount that is adjusted daily by an index ratio, and a market price that depends on real yields.

The index ratio and adjusted principal

The Treasury does not reset TIPS principal once a year by a rounded inflation figure. It uses an index ratio:

Index ratio = Reference CPI on a given date ÷ Reference CPI on the bond’s dated date

Adjusted principal = Face value × Index ratio

The reference CPI is based on the CPI-U with a lag. The reference CPI for the first day of a month is the CPI-U from three months earlier, and values for other days are interpolated between the figures for two and three months earlier. This lag exists because the CPI is published after the month it measures. In practice, a TIPS reflects inflation that has already been reported, not inflation happening this week.

If the index ratio is 1.05, a $1,000 TIPS has an adjusted principal of $1,050. If later CPI readings fall, the ratio falls and the adjusted principal shrinks, although the repayment at maturity is protected by the floor described below.

Interest payments

TIPS pay interest every six months. The payment is:

Semiannual interest = (Coupon rate ÷ 2) × Adjusted principal on the payment date

The coupon rate is determined at the original auction and stays the same for the life of the bond. The Treasury sets a minimum coupon of 0.125%, so even when the auction’s real yield is zero or negative, the stated coupon is not set below that level. In those cases buyers pay more than face value, which brings their real yield down to the auction result.

TIPS are coupon bonds that pay cash interest twice a year. Zero-coupon versions can be created by stripping TIPS into separate interest and principal pieces through the STRIPS program.

The deflation floor

At maturity the Treasury pays the larger of two amounts: the inflation-adjusted principal or the original face value. If cumulative inflation over the bond’s life is positive, you get the adjusted amount. If cumulative deflation has pushed the adjusted principal below face value, you still get face value.

Two details limit what that floor protects:

1. It covers principal at maturity only. Interest payments during deflation are calculated on the reduced principal and are not restored.
2. It is anchored to the original face value, not to what you paid. Someone who buys an older TIPS in the secondary market after years of inflation pays for a principal that may already be well above face value. If deflation later reduces that principal, the floor only protects the original face amount, which can be far below the buyer’s cost.

Interpreting Treasury Inflation-Protected Securities

The most useful way to read a TIPS is in real terms. Its yield is a real yield: the return above CPI inflation that an investor locks in by buying at a given price and holding to maturity. A conventional (nominal) Treasury’s yield includes compensation for expected inflation plus a real return and other premiums.

The gap between the two gives the breakeven inflation rate:

Breakeven inflation ≈ Nominal Treasury yield − TIPS real yield (same maturity)

Hypothetical example: if a 10-year nominal Treasury yields 4.0% and a 10-year TIPS has a real yield of 1.8%, breakeven inflation is about 2.2% a year. If CPI inflation averages more than 2.2% over the next 10 years, the TIPS will have earned more than the nominal bond. If it averages less, the nominal bond will have earned more. Breakeven is a market-implied figure. It also contains risk and liquidity premiums, so it is not a pure forecast of inflation.

This comparison changes how to judge a TIPS yield that looks low. A 1.8% real yield is not “worse” than a 4.0% nominal yield. They measure different things, and which one wins depends on realized inflation. If inflation runs below breakeven over the holding period, the TIPS will have been the weaker choice, and the protection will have cost something.

Real yields can be negative. A negative real yield means buyers accept a return below inflation in exchange for the inflation linkage and government backing. Even then, the nominal dollars received can rise if inflation is positive, because the principal adjustment adds to the cash value of the bond.

Example of Treasury Inflation-Protected Securities

The figures below are hypothetical and chosen to show the mechanics. They are not Treasury auction results.

Assumptions: $10,000 face value, 1.50% coupon rate, reference CPI of 300.0 on the dated date, bought at face value at auction, held to maturity.

Year one, inflation of 3%:

Total interest in year one is about $153.38, compared with $150.00 if the principal had stayed at $10,000. The bigger effect is the $300 added to principal. That amount is not paid out in cash during the year. It accumulates and is paid at maturity (or captured in the sale price if you sell).

A deflation year: suppose that after the first year the reference CPI falls from 309.0 to 299.73, a drop of 3%. The index ratio becomes 0.9991, and adjusted principal falls to about $9,991. The next interest payments are calculated on that smaller amount. If the bond matured at that point, the floor would apply and the Treasury would pay $10,000 rather than $9,991.

At maturity after cumulative inflation: if the reference CPI has risen to 375.0 by maturity, the index ratio is 1.25, and the holder receives $12,500 in principal plus the final interest payment of 0.75% × $12,500 = $93.75.

Tax effect in year one (federal): the investor reports the $153.38 of interest received plus the $300 increase in principal as income. A holder in a 24% federal bracket would owe roughly $108.81, while having received only $153.38 in cash. In a deflation year, the downward principal adjustment generally offsets interest income first. Tax situations differ, so the treatment for a specific return belongs with a tax professional.

Why are Treasury Inflation-Protected Securities important?

TIPS address a risk that conventional bonds leave fully with the investor: unexpected inflation. A 30-year nominal Treasury bought at a 4% yield pays the same dollars whether inflation averages 1% or 6%. At 6% inflation, those fixed dollars lose purchasing power quickly. A TIPS transfers that risk back to the issuer, because the principal scales with the CPI.

That makes TIPS useful in several roles:

• Matching future real spending. Retirees and people approaching retirement often plan around expenses that rise with prices. A TIPS maturing in a given year delivers a principal amount that has kept pace with CPI inflation, which can line up with spending needs in that year. Some investors build ladders of TIPS maturing in successive years for this purpose.
• Liability matching for institutions. Pension funds and insurers with obligations tied to inflation use inflation-linked bonds to hedge them.
• A market measure of inflation expectations. The breakeven rate derived from TIPS and nominal Treasuries is widely followed as a gauge of what bond investors expect inflation to be.
• State and local tax exemption. As with other Treasury securities, TIPS income is free from state and local income tax, which matters more to investors in high-tax states.

The Treasury began issuing TIPS in January 1997, citing investor demand for an inflation-linked government security.

Maturities and how TIPS are sold

The Treasury currently issues TIPS with 5-, 10- and 30-year maturities. A 20-year TIPS was issued for a period and discontinued in 2009, with the 30-year maturity used for long-dated issuance. New TIPS are sold at auction, and the Treasury also reopens existing issues, selling more of a bond that is already outstanding.

You can buy TIPS in four main ways:

1. TreasuryDirect. Buy at auction directly from the Treasury with a noncompetitive bid, starting at $100 and in $100 increments. Noncompetitive bidders accept the yield set at the auction. TreasuryDirect accounts cannot hold IRA assets, and to sell a TIPS before maturity you must first transfer it to a bank or broker (Treasury securities generally need to be held at least 45 days before such a transfer).
2. A brokerage or bank. Brokers can place auction bids and also buy existing TIPS in the secondary market, where prices are set by real yields at that moment. This is the usual route for holding individual TIPS in an IRA.
3. TIPS mutual funds. Funds hold a portfolio of TIPS and are bought and sold at the fund’s net asset value (NAV), calculated once per trading day. They charge management fees.
4. TIPS ETFs. These hold similar portfolios but trade on exchanges throughout the day like stocks. See how ETFs work for the general mechanics.

Limitations of Treasury Inflation-Protected Securities

Price risk before maturity

The inflation guarantee works on principal and interest, not on market price. TIPS prices move inversely to real yields. When real yields rise, existing TIPS fall in price, and long maturities fall the most. A rough approximation:

Approximate price change ≈ −Duration × Change in real yield

Hypothetical example: a TIPS with a duration of 8 years loses roughly 8% of its market value if its real yield rises by 1 percentage point, regardless of what the CPI does that month. This is what happened in 2022. Inflation was high, so principal adjustments were large, but the Federal Reserve raised rates sharply and real yields jumped. TIPS and TIPS funds posted losses that year. Holders who kept individual bonds to maturity are still repaid the adjusted principal, but anyone selling early realizes the market price. TIPS work as a long-term hedge against rising living costs, not as a short-term trade on an inflation report.

Taxes on income you have not received

The annual principal adjustment is taxable as federal income when it accrues, even though it is paid only at maturity or sale. In a taxable account during high inflation, the tax bill on this “phantom income” can exceed the cash interest received, as the example above shows. Holding TIPS in a tax-advantaged account such as an IRA avoids the annual mismatch. TIPS funds handle the issue differently: they typically pass inflation adjustments to shareholders as distributions, so fund holders receive cash along with the tax liability, but fund payouts can be uneven from year to year.

CPI is not your personal inflation rate

TIPS are indexed to CPI-U, a broad national measure. A household’s spending mix (healthcare, housing, tuition, location) may rise faster or slower than that index. TIPS hedge CPI inflation, not every cost a specific investor faces. The indexing lag also means the bond responds to inflation a few months after it happens.

Market size and trading costs

The TIPS market is much smaller than the market for nominal Treasuries. Trading in individual TIPS can involve wider bid-ask spreads than nominal Treasuries, and during market stress, prices can move sharply when many holders try to sell at once. Funds add management fees on top of the bonds’ own returns.

Opportunity cost

TIPS are designed to preserve purchasing power with low default risk. They are not built to compete with stocks over long periods. A portfolio weighted heavily toward TIPS gives up the higher expected return of riskier assets in exchange for that stability. Over periods of strong equity markets, TIPS have trailed stocks such as those in the S&P 500, which is the expected trade-off for a lower-risk asset.

TIPS vs. other bonds readers confuse them with

TIPS vs. nominal Treasuries

Hypothetical example: a $1,000 nominal Treasury with a 3% coupon pays $15 every six months for its whole life and returns $1,000. A $1,000 TIPS with a 1% coupon pays $5 at first, but if the index ratio climbs to 1.20, it pays $6 per period and returns $1,200 at maturity.

TIPS vs. I bonds

Series I savings bonds are also issued by the Treasury and also linked to CPI-U, but they are a different product:

• Marketability. TIPS are marketable and can be sold to other investors at market prices. I bonds are nonmarketable and can only be redeemed with the Treasury.
• Price risk. I bonds do not lose value when interest rates rise; their redemption value only grows. TIPS prices fluctuate with real yields.
• Rate structure. An I bond’s rate combines a fixed rate with an inflation rate that resets every six months, and interest compounds into the bond’s value instead of being paid out. TIPS pay a fixed real coupon in cash twice a year.
• Purchase limits and holding rules. I bonds carry annual purchase limits and a minimum holding period, with an interest penalty for early redemption within the first five years. TIPS have no comparable limits for buyers.
• Taxes. I bond interest can be deferred until redemption; TIPS adjustments are taxed annually in a taxable account.

TIPS vs. TIPS funds

An individual TIPS held to maturity has a known real return from the day it is bought, plus the deflation floor at maturity. A TIPS fund has no maturity date. It continuously buys and sells bonds to maintain a target duration, so its value keeps moving with real yields and there is no date on which you are guaranteed the adjusted principal. Funds offer easy diversification, daily liquidity and small minimums. Individual bonds offer a defined endpoint.

TIPS vs. other “inflation-protected” assets

Stocks, real estate, commodities and floating-rate notes are sometimes described as inflation hedges. None is contractually tied to the CPI the way TIPS are. Floating-rate Treasury notes reset with short-term Treasury bill rates, which may follow inflation indirectly through Federal Reserve policy but are not indexed to prices. Other governments issue their own inflation-linked bonds tied to their national price indexes.

The Bottom Line

TIPS suit retirees, savers and institutions that need future spending power tied to CPI inflation. Individual bonds held to maturity in a tax-advantaged account such as an IRA deliver the clearest result, avoiding both early-sale price risk and the annual tax on phantom income. Investors who may sell early or expect inflation below breakeven should weigh the price swings and the return given up compared with nominal Treasuries and stocks.