Inflation is a major risk for investors, especially those investing in fixed-income investments such as bonds.
Treasury Inflation-Protected Securities (TIPS) and I-Bonds are two U.S. government bonds with an inflation-based component. This means that they can offer some protection against rising inflation.
Despite that similarity, the two types of bonds have some key differences that mean they play different roles in your portfolio.
What are TIPS?
TIPS are a type of U.S. government bond. They come with maturities of 5, 10, and 30 years. Individual investors and other entities, such as mutual funds, can purchase TIPS. You can find TIPS mutual funds if you’d rather avoid purchasing TIPS directly.
Like other Treasury securities, TIPS are marketable. That means you can trade them with other investors before maturity. That adds some liquidity, making getting cash for your bonds easier if needed.

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TIPS’ inflation protection comes from regular adjustments to the bond’s principal value. The bond’s face value rises when inflation is positive and falls when inflation is negative.
When a TIPS matures, the amount of money you receive as a return of principal will be the higher of the original principal amount or the inflation-adjusted amount. That means that even if you hold TIPS during a deflationary period, you’ll get back the money you originally invested.
TIPS pay interest every six months based on the bond’s interest rate and its inflation-adjusted face value. You receive the interest payments as cash, meaning you can use them as a source of income.
Pros and Cons of TIPS
Pros
- No effective limit on purchases. You can only purchase up to $10,000 in I-Bonds each year but TIPS have a limit into the millions. The main restriction is that you must buy them in $100 increments.
- Marketability offers liquidity. You can sell TIPS to other investors on the open market, making them more liquid than I-Bonds, which have a mandatory holding period.
- Interest paid as cash. When TIPS earn interest, that interest is paid to the bondholder as cash, meaning you can rely on TIPS as a source of regular income.
- Capital appreciation. The principal value of TIPS rises with inflation, which means you may earn capital gains in addition to interest payments.
Cons
- Poor tax treatment. You have to pay taxes both on the interest payments you receive and the principal adjustments of the bonds in the year those adjustments occur. That will boost your taxable income. Holding TIPS in tax-advantaged spaces, like an IRA can help avoid this.
- Volatility. TIPS can rise and fall in value. If rates rise, TIPS will tend to lose value even if their face values increase. This can pose problems for investors who plan to sell their TIPS before they mature.
- Deflation risk. If deflation occurs, it reduces the face value of TIPS. While you’ll get, at a minimum, the amount you paid for the bond back when it matures, a reduced face value will lower the amount of interest the bond earns.
What Are I-Bonds?
I-Bonds are a type of U.S. government savings bond that offers inflation protection. They have a maturity of 30 years, but you can cash the bond after 12 months. Cashing the bond before 5 years have elapsed incurs a penalty of 3 months’ interest.
Unlike TIPS, which are marketable securities, I-Bonds can only be redeemed with the government. You cannot sell them to other investors. That, combined with the waiting period and potential penalty for cashing the bonds makes them less flexible than TIPS.
The inflation-protection aspect of I-Bonds lies in how their interest rates are calculated. I-Bonds are sold with a fixed rate of interest. An inflation adjustment is then added to that fixed rate. Every six months, the government adds the interest payment to the bond’s value and updates the inflation-adjusted rate.
For example, imagine you buy an I-Bond for $1,000. It has a fixed rate of 2%, and the current inflation adjustment is 3%, making its total interest rate 5%.
After six months, the interest payment of $25 increases the bond’s value to $1,025. The government also changes the inflation adjustment to 4%, so for the next six months, the bond will earn a total rate of 6%.
These semiannual inflation adjustments and interest payments happen until you choose to redeem the bond or it matures after thirty years.
Keep in mind that interest payments are added to the bond’s value. This means you can’t access the interest until you redeem the bond, so you can’t use I-Bonds as a source of income.
There are also limits on the value of I-Bonds you can purchase. Each year, you can buy up to $10,000 in electronic I-Bonds.
Pros and Cons of I-Bonds
Pros
- Better tax treatment. You don’t realize any return on I-Bonds until you redeem them, meaning you can time redemption for optimal tax treatment. They’re also exempt from state and local taxes.
- Tax-free when used for education. In addition to letting you time redemption for better tax treatment, earnings from I-Bonds are exempt from federal taxes when you use the money for educational expenses.
- Flexible maturity. TIPS have set maturities from the time you buy them. I-Bonds have a maturity of 30 years, but after five years you can redeem them at any time of your choosing without paying a penalty.
Cons
- Purchase limits. You can buy no more than $10,000 worth of I-Bonds each year.
- No regular income. Interest payments are added to the bond’s value, which you receive at redemption. You can’t use I-Bonds as a source of income.
- Early redemption penalties. You can’t redeem I-Bonds at all for at least a year after buying them. Redemptions within five years of purchase incur a penalty equal to three months’ interest.
Key Differences Between TIPS and I-Bonds
TIPS | I-Bonds | |
Marketability | Yes | No |
Where to Buy | TreasuryDirect or from other investors | TreasuryDirect |
Purchase Limits | No realistic limit for individuals.
Up to $10 million for non-competitive bids, up to 35% of the offered amount for competitive bids. |
$10,000 per person per year |
Purchase Increments | $100 | $25 |
Inflation Adjustments | Face value adjusted based on CPI-U | Interest rate changed semi-annually based on CPI-U |
How Interest is Paid | Semi-annual payments made in cash | Semi-annual payments added to the value of the bond |
Tax Treatment | Interest payments and face value adjustments are subject to federal income tax in the year they occur. TIPS are exempt from state and local taxes. | No tax until the bond is redeemed. I-Bonds are exempt from state and local taxes and exempt from federal taxes if used for educational expenses. |
Maturity | 5, 10, or 30 years | 30 years |
Early Redemption | No | Redeemable after 12 months, with a penalty of 3 months’ interest if redeemed before 5 years have passed. |
How Each Fits in Your Portfolio
TIPS and I-Bonds are both good choices for investors who want to protect their portfolios from the effects of inflation, but they play very different roles in your portfolio. Which you choose will largely depend on your goals.
TIPS
TIPS, as fixed-income securities that make regular cash payments, are generally a good fit for investors who want to turn their portfolio into a source of income.
If you’re confident that you want to own bonds for a source of income and are willing to give up some amount of yield for inflation protection, buying TIPS directly from the government can be a good way to accomplish that goal, especially if you can hold the TIPS in a tax-advantaged account to give you more control over taxation of the bonds.
Investors can also get exposure to TIPS through mutual funds, which isn’t an option for I-Bonds. If you prefer to invest primarily through mutual funds, TIPS funds will offer the inflation protection you’re looking for.
I-Bonds
I-Bonds can play a few roles in your portfolio that TIPS cannot.
For example, I-Bonds are the clear winner if you’re looking to save for education, such as a child’s college tuition, and need to add bonds to your education savings.
They offer tax-free returns when used to qualify for education expenses. Though using a 529 to invest in TIPS could offer similar tax benefits, I-Bonds let you avoid the restrictions of 529s while keeping the option to use the bonds to pay for college without paying taxes.
I-Bonds also offer more predictability than TIPS. Because the market value of TIPS can rise or fall depending on inflation and market rates, you may not get as much money as you expect if you have to sell your TIPS before they mature.
With I-Bonds, you know exactly how much money you’ll receive when redeeming the bond, making them better for people who value predictability and don’t expect to hold the bonds for their full 30-year term.
How Does Dropping Inflation Impact Each?
Easing inflation will have a big impact on both TIPS and I-Bonds in the coming months and years.
Recall that TIPS have a fixed interest rate but that their face values adjust based on inflation. As inflation falls, the face value of TIPS will rise more slowly. The Fed has also begun to cut its benchmark interest rate, which will likely cause bond rates to fall.
Falling bond rates mean that existing TIPS and other bonds will see their market values rise.
If you believe that inflation will continue to ease, leading to further rate cuts, purchasing TIPS could provide a source of income and capital appreciation as falling rates lead to rising bond prices.
I-Bonds, on the other hand, have an interest rate determined by a fixed rate plus an inflation-based component. As inflation falls, the rate on all I-Bonds, including existing ones, will fall as the inflation-based component of their rate is reduced.
The current fixed rate for I-Bonds is 1.3%. If easing inflation leads to further rate cuts from the Federal Reserve, the fixed-rate portion of the I-Bond rate could also fall. However, any bonds already purchased will retain their existing fixed rate.
If you believe that further rate cuts are coming but still to hedge against future increases in inflation, buying I-Bonds now before the fixed-rate component of their overall interest rate drops could be a good idea.
If you believe that the Fed will maintain rates or even need to raise rates in the near future, you may be able to secure a higher fixed-rate component for I-Bonds by waiting until the next rate announcement.
The Bottom Line
I-Bonds and TIPS are both types of bonds that offer a form of inflation protection.
TIPS are a more traditional bond, offering regular income in the form of interest payments while I-Bonds function more like savings bonds, giving the holder more control over when to redeem the bond and realize the income.
If you’re looking to add inflation protection to your portfolio, consider the pros and cons of each to decide which is right for your financial goals.
2 thoughts on “TIPS vs. I-Bonds: Which to Use for Inflation Protection in Your Portfolio”
I am quite comfortable with my Money Market Fund paying ~4%. Some of the return is State tax free. I bonds and TIPS are too complicated and too restricted for me. I don’t see the allure. My Soc Security payments are already indexed for inflation.
Is there not an income exclusion on using I bonds for education that would apply to most POF readers?