TIPS vs. I Bonds: The Ultimate Inflation Hedge for Retirement Savers
CORE INSIGHTS
- Principal Protection: Both products hedge inflation, but the mechanism is fundamentally different.
- Tax & Liquidity Trade-Off: I Bonds offer tax deferral but low liquidity; TIPS are liquid but create annual “phantom income” taxes in taxable accounts.
- Purchase Limits: I Bonds are capped at $10,000 per person per year, while TIPS have no practical investor cap in the open market.
Inflation is the quiet enemy of retirement wealth. Both TIPS (Treasury Inflation-Protected Securities) and Series I Savings Bonds are U.S. Treasury tools built to preserve purchasing power. But they behave very differently in real portfolios—especially around liquidity and taxes.
The Tax Trap of TIPS (Scenario):
Imagine holding $50,000 of TIPS in a taxable brokerage account.
• If inflation runs 3%, your principal may rise by about $1,500.
• That $1,500 adjustment is taxable this year, even if you didn’t sell or receive cash.
This “phantom income” is why TIPS are usually better inside IRAs or 401(k)s.
Imagine holding $50,000 of TIPS in a taxable brokerage account.
• If inflation runs 3%, your principal may rise by about $1,500.
• That $1,500 adjustment is taxable this year, even if you didn’t sell or receive cash.
This “phantom income” is why TIPS are usually better inside IRAs or 401(k)s.
Visualizing Liquidity and Tax Efficiency
The chart below summarizes how each inflation hedge fits a retirement strategy.
*Scores are illustrative. Purpose: show the strategic trade-offs clearly.*
“Many savers use I Bonds as a ‘no-market-volatility’ inflation-protected cash reserve, while TIPS are often used as the inflation-hedging sleeve inside retirement accounts.”
Strategic Comparison
| Feature | TIPS | I Bonds |
|---|---|---|
| Mechanism | Principal adjusts with CPI; interest paid on the inflation-adjusted principal. | Composite rate = fixed rate + inflation rate; interest compounds inside the bond. |
| Purchase Limit (Annual) | No practical cap in brokerage markets. | $10,000 per person per year (electronic only). |
| Liquidity | High (tradable daily, price can fluctuate). | Low (cannot redeem for 12 months; 3-month interest penalty if redeemed before 5 years). |
| Tax Treatment | Inflation adjustment taxed annually as ordinary income (“phantom income”). Best in IRA/401(k). | Federal tax deferred until redemption; exempt from state/local tax. Great for taxable accounts. |
Actionable Steps for Hedging Inflation
1
Prioritize tax location for TIPS
If you buy TIPS, hold them in tax-advantaged accounts whenever possible to avoid paying taxes on inflation adjustments you haven’t received in cash.
If you buy TIPS, hold them in tax-advantaged accounts whenever possible to avoid paying taxes on inflation adjustments you haven’t received in cash.
2
Use I Bonds for intermediate cash needs
I Bonds are ideal for money you won’t touch for at least 12 months (emergency-fund layer, future down payment, or “safe” retirement buffer).
I Bonds are ideal for money you won’t touch for at least 12 months (emergency-fund layer, future down payment, or “safe” retirement buffer).
3
Plan redemption timing
Redeeming I Bonds before 5 years costs the last 3 months of interest. Build your cash plan so you’re not forced to redeem early.
Redeeming I Bonds before 5 years costs the last 3 months of interest. Build your cash plan so you’re not forced to redeem early.
The Bottom Line: Which Inflation Hedge Should You Use?
- Choose I Bonds if: you prioritize tax deferral, want a stable inflation-linked cash reserve, and can live with the $10k annual cap.
- Choose TIPS if: you need scale or liquidity, and you’ll hold them inside a 401(k)/IRA (or a TIPS ETF) to avoid phantom-income taxes.
Frequently Asked Questions
Q. What is the key difference between TIPS and I Bonds?
TIPS are marketable Treasury securities whose principal adjusts with inflation and can be traded daily. I Bonds are non-marketable savings bonds purchased through TreasuryDirect, with a composite interest rate that resets with inflation.
Q. Which investment is more liquid?
TIPS are more liquid because they trade on the open market. I Bonds can’t be redeemed during the first 12 months, and redeeming before 5 years costs the last 3 months of interest.
Q. How is the inflation adjustment taxed?
I Bond interest is tax-deferred until redemption. TIPS inflation adjustments are taxable each year as ordinary income (phantom income), so TIPS are often best held in IRAs or 401(k)s.
Disclaimer: This article is for educational purposes only. Treasury rules and rates change over time. Interest on both TIPS and I Bonds is exempt from state and local income tax. Consult a qualified professional for personal advice.