Welcome back to the Financial Freedom Show with Rob Berker. In the article, we will delve into the world of bonds and explore the differences between TIPS (Treasury Inflation-Protected Securities) and I Bonds. Both of these bonds are designed to protect investors against inflation, but they have distinct characteristics that set them apart.
We will examine their similarities and differences, discuss how they can be utilized in a portfolio, and even touch on how I Bonds can be advantageous for saving for a child’s education. So, let’s get started!
Similarities between TIPS and I Bonds
1. Bonds Issued by the U.S. Government: Both TIPS and I Bonds are bonds issued by the U.S. government, which means they have virtually no credit risk. They are considered to be one of the safest investment options available.
2. Protection against Inflation: Both TIPS and I Bonds serve as a hedge against unexpected increases in inflation. They are designed to protect investors by adjusting their returns based on changes in the Consumer Price Index (CPI).
3. Utilization of the Consumer Price Index: Both bonds rely on the Consumer Price Index (CPI) for adjustments based on inflation. The CPI measures the average change in prices of goods and services consumed by urban households.
4. Available through Treasury Direct: Both TIPS and I Bonds can be purchased directly from the federal government via Treasury Direct, a website operated by the U.S. Department of the Treasury. While TIPS can also be purchased through other avenues, buying I Bonds directly from the government is the primary method.
5. Exemption from State and Local Taxes: Both TIPS and I Bonds offer a tax advantage. The interest payments received from these bonds are exempt from state and local taxes, providing additional benefits to investors.
Differences between TIPS and I Bonds
1. Purchasing Options: TIPS can be purchased through various channels, including ETFs (Exchange-Traded Funds) and mutual funds, as they are traded on the secondary market. On the other hand, I Bonds can only be bought directly from the federal government through Treasury Direct.
2. Purchase Limits: There are limitations on the amount one can invest in I Bonds. Currently, individuals are restricted to buying up to $10,000 worth of I Bonds per year, with an additional $5,000 allowed from tax refunds. However, there are no specific limits for purchasing TIPS, except for institutional buyers.
3. Inflation Adjustment Mechanisms: I Bonds have a dual-rate structure, comprising a fixed rate and an inflation rate. The fixed-rate remains unchanged throughout the bond’s life, while the inflation rate adjusts semiannually based on the CPI. In contrast, TIPS adjust the principal balance to account for inflation, while maintaining a fixed interest rate.
4. Interest Rates: Bonds’ interest rates are determined by adding the fixed rate and the inflation rate. The fixed rate on I Bonds is currently set at zero per cent, while the inflation rate fluctuates. TIPS, on the other hand, have interest rates that can go negative, as their yields are influenced by market conditions.
5. Tax Treatment: I Bonds allow investors to defer taxes on interest and principal adjustments until the bond matures or is redeemed. In contrast, TIPS require annual taxation of both interest and principal adjustments. This makes TIPS more suitable for tax-advantaged accounts rather than taxable accounts.
6. Maturity: I Bonds have a fixed maturity of 30 years, while TIPS offer options with maturities of 5, 10, or 30 years
In summary, TIPS and I Bonds share some similarities as they are both issued by the U.S. government, provide protection against inflation, utilize the Consumer Price Index for adjustments, and can be purchased through Treasury Direct. Additionally, both offer tax advantages by exempting interest payments from state and local taxes.
However, there are notable differences between the two. TIPS can be purchased through various channels, including ETFs and mutual funds, while I Bonds can only be bought directly from the government. There are also purchasing limits for I Bonds, but no specific limits for TIPS, except for institutional buyers.
The inflation adjustment mechanisms differ as well. I Bonds have a fixed rate and an inflation rate that adjusts semiannually, while TIPS adjust the principal balance to account for inflation while maintaining a fixed interest rate.
Interest rates for I Bonds are determined by adding the fixed rate and inflation rate, with the fixed rate currently set at zero per cent. TIPS, on the other hand, can have negative interest rates based on market conditions.
Tax treatment varies as well. I Bonds allow investors to defer taxes on interest and principal adjustments until maturity or redemption, while TIPS require annual taxation of both interest and principal adjustments, making them more suitable for tax-advantaged accounts.
Regarding maturity, I Bonds have a fixed maturity of 30 years, while TIPS offer options with maturities of 5, 10, or 30 years.
Understanding the similarities and differences between TIPS and I Bonds is crucial for investors looking to incorporate inflation-protected bonds into their portfolio or those seeking to save for specific goals, such as a child’s education. By considering these factors, investors can make informed decisions and choose the bond that aligns with their investment objectives and preferences.
Thank you for joining us on this exploration of TIPS and I Bonds. Be sure to tune in next time for more valuable insights into the world of finance and investment.
