Investing in TIPS comes with a few key differences from traditional bonds. This includes perks, as well as limitations. 

For example, TIPS are tax-advantaged and income taxes are not applicable until the TIPS have matured, or have been sold by the investor. 

Investors can review the performance history of TIPS using the S&P U.S TIPS Index. 

Issuance & Maturity 

The U.S Department of Treasury issued TIPS through periodic auctions, usually with maturities of 5, 10, or 30 years. When an investor buys a TIPS bond, they have the guarantee from the government that the principal amount of the bond will not be eroded by inflation over the course of its lifetime. 

This ensures that the purchasing power of the principal investment stays intact. However, this comes with a tradeoff of lower interest rates. 

When the TIPS mature, if the principal is higher than the original amount, investors receive the increased amount. If the principal is equal to or lower than the original amount, investors receive the original amount. 

Interest Payments

As already mentioned, the interest paid on TIPS is typically lower than other treasury bonds. The interest payments on TIPS are calculated based on the inflation-adjusted principal. 

The formula used to calculate the interest payments is:

Interest Payment = (Adjusted Principal) x (Fixed Coupon Rate) / 2

When TIPS are initially issued, they come with a fixed coupon rate. This rate remains constant throughout the life of the bond and is used to calculate the semi-annual interest payments. Interest on TIPS is paid once every six months. 

Principal Adjustments 

The principal value of TIPS adjusts with changes in the CPI. The principal is adjusted upward if there is inflation and downward if there is deflation.

This adjustment ensures that the bond's real (inflation-adjusted) value remains relatively constant. TIPS have a minimum purchase price of $100 and can be bought using the TreasuryDirect platform of the U.S Department of Treasury. 

Tax Treatment

While TIPS pay interest income, investors do not pay taxes on the inflation-adjusted portion of the interest until they sell the TIPS or they mature. 

This feature is known as "phantom income" and can reduce the tax burden for TIPS investors.

TIPS investments come with their fair share of advantages and drawbacks and considering them is important for long-term investors to decide whether investing in TIPS is the right course of action for their financial objectives. 

Pros

• Inflation Protection: TIPS are specifically designed to protect investors from inflation. The principal value of TIPS increases with inflation, which helps maintain the purchasing power of your investment. This feature can be especially valuable during periods of rising prices
• Safety: TIPS are backed by the U.S. government, making them one of the safest investments available. They carry very low default risk because they are considered risk-free assets. This makes them a suitable choice for risk-averse investors
• Predictable Income: TIPS provide a predictable stream of income through their fixed semi-annual interest payments. These payments are guaranteed and typically rise with inflation, providing a stable income source

Cons

• Lower Nominal Yields: Compared to other fixed-income investments, TIPS generally offer lower nominal yields because a portion of the return is tied to inflation adjustments. As a result, investors looking for high current income may find TIPS less appealing
• Market Price Volatility: The market prices of TIPS can be sensitive to changes in interest rates and inflation expectations. When interest rates rise, the market value of existing TIPS may decline. This can result in capital losses for investors who need to sell before maturity
• Taxation of Phantom Income: While TIPS interest payments are subject to federal income tax, investors do not receive this income in cash. Instead, it is added to the principal value and taxed annually, even though it is not received until maturity or sale

• Treasury Inflation-Protected Securities, or TIPS, are securities with an adjustable principal to maintain its purchasing power during times of high inflation
• Interest rates paid by TIPS are fixed and lower than most other types of bonds issued by the United States Department of Treasury
• TIPS pay interest on a biannual basis and are taxed upon sale or maturity, in conjunction with the principal 
• The principal of TIPS are adjusted in accordance with the Consumer Price Index (CPI), which measures inflation