Now that inflation is on the rise, you’re likely to hear more about Treasury Inflation Protection securities, or TIPs for short. TIPs are US Treasury bonds designed to provide investors with protection in times of rising inflation. But there are numerous factors to consider, including tax implications, before committing to TIPs.
How does it work? TIPs have unique investment components. Essentially, the TIP principal increases with inflation and decreases with deflation based on changes in the Consumer Price Index (CPI). When the security matures, you are paid either the adjusted principal or the original principal, whichever is greater.
TIPs pay interest twice a year at a fixed rate. The rate is applied to the adjusted principal. As with principal, interest payments increase with inflation and decrease with deflation.
Recent real TIP yields have been in negative territory, spooking some investors. However, due to the inflation component, they can still provide a positive overall return.
How are TIPs purchased? You can buy them directly from Uncle Sam online through the TreauryDirect program at www.treasurydirect.com. Alternatively, you can purchase TIP through a broker or at a bank. Of course, the online method is usually easier and more convenient.
TIPs are issued with maturities of five, ten or 30 years. (So you can buy TIPs today that won’t expire until 2052.) You can hold these securities until they expire or sell them before the expiration date. Because TIPs are obligations of the US government, like regular Treasury bonds, they are generally considered one of the safest investments out there.
What are the tax consequences? Unlike their close cousins, US Series I bonds, TIPs do not benefit from tax deferral. Semi-annual adjustments for inflation on a TIPS bond are treated as taxable income today, even though you don’t actually receive the money until you sell the bonds. or reach maturity. This is generally seen as a disadvantage of TIPs.
In contrast, you have more tax flexibility with Series I Bonds. If you do nothing, interest income is deferred until you sell the bonds or they mature, whichever comes first. Alternatively, you can choose to pay taxes on the I bonds annually.
For this reason, some investors include TIPs in their qualified retirement plan accounts and IRAs, where allowed, so the annual income is effective tax-deferred until withdrawals are made. This avoids any current tax consequences.
Discuss this option with your professional financial and tax advisors if you are willing to invest in TIP. Compare them to I Bonds and other investments that offer inflation protection. Then make an informed decision.
Source: www.cpapracticeadvisor.com