Inflation-Protected Securities: TIPS vs I-Bonds Explained

Inflation quietly erodes the purchasing power of every dollar you hold. When consumer prices rise, a fixed coupon bond or a traditional savings account may fail to keep pace, leaving long-term investors poorer in real terms. That is why the U.S. Treasury offers special products designed to help savers stay ahead of rising prices. Treasury Inflation-Protected Securities (TIPS) and Series I Savings Bonds, usually shortened to I-Bonds, both adjust their value in line with inflation, but they do so in different ways and with different rules. Understanding how each works will help you choose the right tool to protect your hard-earned wealth.

What Are Inflation-Protected Securities?

Inflation-protected securities are debt instruments whose principal or interest payments rise with an official measure of prices, typically the Consumer Price Index for All Urban Consumers (CPI-U). By linking payouts to inflation, these securities aim to deliver a “real” return—growth above and beyond the rate at which living costs increase. The U.S. Treasury is the largest issuer, but many foreign governments and even some corporations offer similar products. In the American market, the two most accessible vehicles are TIPS, which trade in the bond market, and I-Bonds, which function more like a savings product purchased directly from the Treasury.

How TIPS Work

Treasury Inflation-Protected Securities are marketable bonds with maturities of 5, 10, or 30 years. Each TIPS issue carries a fixed coupon rate announced at auction. What makes them unique is that the par value—or principal—adjusts semiannually based on changes in the CPI-U. If the index rises 3 percent in a six-month span, the principal of a $1,000 bond becomes $1,030. The fixed coupon is then applied to this higher base, so subsequent interest payments also grow. Should prices fall and the CPI-U decline, the principal adjusts downward; however, at maturity you are guaranteed to receive at least the original par value, ensuring deflation cannot reduce the amount of money returned.

Buying and Selling

Investors can purchase TIPS directly at auction through TreasuryDirect in $100 increments, or buy and sell them on the secondary market via a brokerage account. Because they are tradable, their price fluctuates with changes in real interest rates and market inflation expectations. A TIPS investor thus faces potential capital gains or losses if the security is sold before maturity.

How I-Bonds Work

Series I Savings Bonds are non-marketable, meaning they may not be traded or resold. Instead, individual investors buy them directly from the Treasury in electronic form (from $25 to $10,000 per calendar year) or paper form using a federal tax refund (up to $5,000). An I-Bond earns interest from two separate components: a fixed rate set at purchase that lasts for the life of the bond, and a variable inflation rate that resets twice a year in May and November based on the CPI-U. The two portions combine to form a composite semiannual rate, which is then added to the bond’s value, leading to compounding growth.

Holding Period Rules

I-Bonds can be redeemed after 12 months, but if you cash in within the first five years you forfeit the last three months of interest as a penalty. They mature in 30 years, at which point interest no longer accrues. Because they are not tradable, their value cannot decline below your purchase price; they are insulated from market volatility, creating a simple, risk-free way to match inflation.

TIPS vs I-Bonds: Head-to-Head Comparison

Minimum Purchase and Liquidity: TIPS require at least $100 and can be liquidated at any time through the secondary market, although the sale price may be above or below par. I-Bonds have a lower electronic minimum of $25 but are locked for one year and carry a three-month interest penalty if redeemed before five years.

Market Risk: TIPS’ market value fluctuates with real yields. If interest rates rise, the price of an existing TIPS drops, potentially causing a short-term capital loss. I-Bonds do not face price risk because they are not tradable.

Inflation Adjustment Method: TIPS adjust principal and, by extension, coupon payments, creating a stream of rising cash flow. I-Bonds accrue composite interest that compounds inside the bond until redemption.

Purchase Limits: There is no annual cap on how many TIPS an individual can buy beyond auction sizes and available funds. I-Bonds cap purchases at $10,000 electronically plus $5,000 via tax refund per person per year.

Deflation Protection: Both securities guarantee you will never receive less than original principal; however, TIPS’ interim market price can fall below par, whereas an I-Bond’s redeemable value will not drop.

Tax Considerations

Interest income from TIPS is taxable at the federal level in the year it is earned, even though the inflation adjustment to principal is not paid out until the bond is sold or matures. This so-called “phantom income” can create a tax bill without corresponding cash flow. Many investors therefore hold TIPS in tax-advantaged retirement accounts when possible. I-Bond interest, on the other hand, is tax-deferred until redemption or maturity and is exempt from state and local income taxes. Additionally, if I-Bond proceeds are used for qualified higher-education expenses and you meet income limits, federal taxes may be waived entirely.

When Does Each Make Sense?

Choose TIPS if you need larger amounts of inflation protection, want the flexibility to trade, and are comfortable managing interest-rate risk. Institutional investors, retirement plans, and individuals building ladders for predictable future cash flows often prefer TIPS. They can also be paired with short-term corporate bonds or stocks to create a diversified real-return portfolio.

Opt for I-Bonds if you desire a worry-free, principal-protected alternative to a savings account for emergency funds or medium-term goals. The tax deferral feature makes them especially attractive for high-income earners and those planning for education costs. Their annual cap may limit their role in very large portfolios, but the simplicity and zero market volatility are hard to beat.

Key Takeaways

Inflation-protected securities safeguard your purchasing power by tying returns to the CPI-U. TIPS are tradable bonds whose principal and coupons adjust with inflation, offering unlimited purchase size but exposing holders to market price swings and taxable phantom income. I-Bonds are non-marketable savings bonds that compound tax-deferred interest and guarantee you will never lose principal, though they impose annual purchase caps and early-withdrawal penalties. Many investors hold both, using I-Bonds for cash reserves and TIPS for long-term, scalable inflation hedging in retirement portfolios. By matching the right product to your specific liquidity needs, tax situation, and investment horizon, you can build a resilient strategy that keeps pace with rising prices and preserves the real value of your money.