Treasury Inflation Protected Securities (TIPS) are marketable Treasury securities whose principal and interest payments are adjusted for inflation.  Competitive bidding at auction sets the security’s fixed interest (or coupon) rate.  Like all marketable U.S. Treasury securities, TIPS are backed by the full faith and credit of the United States.

Interest payments on TIPS are made semiannually.  They’re based on a principal amount that is adjusted for inflation using the Consumer Price Index for Urban Consumers (CPI-U).  The Treasury refers to this process as indexing and determine the index ratio by dividing the current CPI-U level by the CPI-U level that applied when the securities were issued.

As measured by the index, the underlying value of the principal changes at the same rate as the CPI-U.  And, since interest payments are a fixed percentage of the principal, they also change along with the principal.

At maturity, if inflation has risen and increased the value of the underlying security during its term, Treasury pays the owner the higher inflation-adjusted principal.  On the other hand, if deflation occurred over the life of the security and decreased the security’s value, Treasury pays the owner the original face value of the security.

TIPS are available to individuals as well as institutional investors.  You can buy TIPS in $1,000 increments in terms of 5, 10, and 20 years directly from the Treasury or through your financial institution or broker.  All Treasury securities are sold in single-price auctions, which means everyone gets the same price –equivalent to the highest accepted yield at that auction.

Using TreasuryDirect ® or Legacy Treasury Direct to make purchases.

You can set up a secure account directly with the Treasury, where you hold your securities electronically.  Perhaps the easiest way to buy is online through TreasuryDirect.  Or, if you use Legacy Treasury Direct, you can also buy TIPS over the Internet or by phone or mail.  Only noncompetitive bids are accepted.

Through a Financial Institution or Broker.

Your broker/dealer or financial institution holds the securities on your behalf, and you can arrange purchases and sales through them.  Both noncompetitive and competitive purchases are available.  These securities are eligible for stripping by authorized brokers/dealers through the STRIPS program.

For guidance on how to buy securities, see the Treasury website or call Legacy Treasury Direct at 1-800-722-2678.

TIPS Are Liquid.  You can buy and sell TIPS in the secondary market before maturity.  Of course, the value of a security sold in the secondary market before maturity is subject to market valuation.  This may result in either a capital gain or loss, depending on the prevailing market price at the time of the sale.

Tax Issues with TIPS.  Earnings from TIPS are exempt from state and local income taxes, as are other U.S. Treasury securities.  TIPS owners pay federal income tax on interest payments the same year they receive those payments, and on growth in principal in the year it occurs.  Investors holding TIPS will have two tax statements each year: an IRS Form 1099-INT showing the interest we paid and a 1099-OID showing the increase or decrease in the security’s principal value.  (NOTE: TreasuryDirect customers are notified when their statements are ready, and they can then print a copy from their online account.  Legacy Treasury Direct customers receive their tax statements by mail.) 

It’s possible to get a 1099-OID with a negative amount.  In this case, it means deflation occurred after you bought the TIPS, which reduced the security’s principal below par value – what you paid for it – or below what it was during the last tax year.  The Treasury only reports negative OID amounts to you, not to the IRS.

You can find additional information on TIPS by calling Legacy Treasury Direct at 1-800-722-2678 (outside the U.S.: 304-480-6464) or by visiting the Treasury website at www.treasurydirect.gov.

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