I Bonds vs TIPS

I Savings Bonds and Treasury Inflation Protected Securities both offer inflation protection. This article compares the similarities and differences between the two instruments. The Treasury Department has an excellent comparison table, but their language isn't the easiest to understand. We elaborate and explain in more details here.

Market Price Fluctuation
After TIPS are issued, they can be bought and sold on the secondary market. If the real interest rate goes down, the TIPS go up in value. They can be sold on the secondary market for their true market value. I Bonds can only be redeemed at accrued value from the U.S. Treasury. If you have high fixed rate I Bonds, your only option is holding on to them until maturity. Advantage: TIPS.

On the other hand, if the real interest rate goes up, I Bonds can be redeemed at accrued value (after 12 months after issuance) while TIPS go down in value. Advantage: I Bonds.

Pricing Transparency
The TIPS prices (and yields) are set by the market. The I Bonds fixed rates are set by the U.S. Treasury. As the bond issuer, the U.S. Treasury has an incentive to set the fixed rates on I Bonds as low as they can get away with it. Investors do not necessarily get a "fair" yield from I Bonds. Advantage: TIPS.

Purchase Limits and Fees
There is no practical limit for purchasing TIPS. I Bonds are limited to $5,000 a year in paper and $5,000 a year in electronic bonds per Social Security Number. TIPS can be bought through a mutual fund. I Bonds cannot be bought through a mutual fund. TIPS can be bought in an IRA. I Bonds cannot be bought in an IRA. Advantage: TIPS.

There is no fee for purchasing I Bonds. There is no fee for purchasing TIPS at auction from TreasuryDirect or through certain brokerage firms if the order is placed online. As of May 2008, Fidelity[1] and Schwab[2] charge no fee for auction orders placed online. Vanguard Brokerage Services[3] charges $10 for online auction orders unless you are Voyager and above. All brokers charge a markup for secondary market orders. If you hold a TIPS mutual fund, you will pay a management fee; Vanguard charges 0.20%, and 0.11% for Admiral shares. Advantage: I Bonds.

Inflation Adjustment
I Bonds are adjusted for inflation every six months. TIPS are adjusted for inflation every day. Advantage: TIPS.

Interest Accrual and Payments
Interests on I Bonds are accrued until the bonds are redeemed. TIPS pay out interests every six months. Whether one is better than another depends on whether the investor needs the interest payment or not.

Tax Treatment
I Bonds are tax deferred. Taxes are due in the year when the I Bonds are redeemed, unless the investor elects to pay tax on the interests every year. If the I bonds are used to pay educational expenses, the interest may be fully or partially tax-free, depending on your income[4]. Interest payments and inflation adjustments on TIPS are taxable every year. For this reason, it's often suggested that investors hold TIPS in a tax deferred account. There is no practical way to hold I Bonds in a tax deferred account. Advantage: I Bonds.