To attract investors during low-interest environments, the federal government introduced a new type of Treasury security that increases in value and payout along with the rate of inflation. The new bonds, technically known as Treasury Inflation-Indexed Securities, are referred to as TIPs (an acronym for Treasury Inflation-Protected Securities). Treasury Inflation Securities are designed to help you maintain the true worth of your investment regardless of the rate of inflation.
Like other Treasury securities, Treasury Inflation Securities pay interest twice a year and are exempt from state and local taxes. They are issued in 10-year terms. During times of inflation, Treasury Inflation Securities not only pay a higher return, they also increase in value. The principle increases, so when they reach maturity, you would receive more money than you actually paid in initially.
Here is how it works: Using the Consumer Price Index as a guide, the value of the principal is adjusted to reflect the effects of inflation. A fixed interest rate is paid semiannually on the adjusted amount. At maturity, if inflation has increased the value of the principal, the investor receives the higher value. If deflation has decreased the value, the investor nevertheless receives the original face amount of the security.
Here are some more important tips on Treasury Inflation Securities:
- The interest rate, which is set at auction, remains fixed throughout the term of the security.
- The principal amount of the security is adjusted for inflation, but the inflation-adjusted principal will not be paid until maturity.
- Semiannual interest payments are based on the inflation-adjusted principal at the time the interest is paid.
- The index for measuring the inflation rate is the nonseasonally adjusted U.S. City Average All Items Consumer Price Index for Urban Consumers (CPI-U), published monthly by the bureau of labor statistics.
- The auctions process uses a single-price auction method that is the same as that currently used for all of Treasury's marketable securities auctions.
- At maturity, the securities will be redeemed at the greater of their inflation-adjusted principal or par amount at original issue.
Although What are Treasury Inflation Securities tend to pay a lower interest rate initially than T-bonds or notes, that could change over the term of the bond. Either way, the adjustable rate feature assures you that your What are Treasury Inflation Securities will always outpace inflation.
