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I bond vs TIPS

By Jude Wallis

I bonds credit a composite rate from a fixed rate and a twice-yearly inflation rate. TIPS move principal with prices and pay a fixed coupon on that principal. 1.2 percent fixed and 1.5 percent semiannual inflation produce 4.218 percent. $1,000 of TIPS par after three years at 2 percent is $1,061.21.

 Series I bondTIPS
Where inflation shows upInside the composite rate that is credited to the bond.Inside the principal, which then feeds the coupon payment.
Worked rate or principalA 0.012 fixed rate and 0.015 semiannual inflation produce a 0.04218 composite, or 4.218 percent.$1,000 of par at 2 percent inflation for three years becomes $1,061.21. A 1 percent coupon on that principal is $10.61.
If inflation is lowerA zero fixed rate and the same 0.015 inflation produce 3 percent.$1,000 at 3 percent for one year becomes $1,030, and the 1 percent coupon is $10.30.
Can the value be marked down by real yields?No market quote. Rising real yields do not write a new price on the bond.Yes. Price is the present value of indexed payments discounted at a real yield.
Holding rulesNo redemption in the first 12 months. An early-redemption penalty can apply before five years.Tradable before maturity, with ordinary Treasury settlement.
Tax in a taxable accountFederal tax, usually deferrable until redemption. State income tax generally does not apply.Coupon interest and upward principal adjustments are generally federal taxable when they accrue, including phantom income.
On this page

Two inflation designs, not two nicknames for one bond

An I bond's composite rate is c=f+2i+fic = f + 2i + fi. With f=0.012f = 0.012 and i=0.015i = 0.015, that is 0.04218, or 4.218 percent. How Series I bonds work is that formula.

A TIPS keeps a fixed coupon rate and moves the principal. In a simplified annual model, $1,000 at 2 percent for three years becomes $1,061.21, and a 1 percent coupon on that principal is $10.61. How TIPS work is that principal path.

Nominal rate is the stated rate before inflation. Real rate is growth in purchasing power. The I bond's fixed component is the closest piece of its formula to a real rate before tax. A TIPS real yield is a market price.

Liquidity and tax sit beside the formula

An I bond cannot be sold to another investor. The first year is locked, and redeeming before five years generally forfeits the most recent three months of interest. TIPS trade, so a holder who needs cash before maturity meets a real-yield price rather than a Treasury redemption window.

In a taxable account, TIPS inflation adjustments can be taxable before the added principal is paid in cash. I bond interest can often be deferred until redemption. Neither fact changes the composite-rate identity or the principal identity.

The inflation calculator converts a price change into purchasing-power terms. The real return calculator places a nominal rate next to inflation. This is educational material, not financial advice.

Worked examples

I bond composite from 1.2 and 1.5 percent

A Series I bond has a fixed rate of 0.012 and a semiannual inflation rate of 0.015. What is the composite rate?

  1. Double the semiannual inflation rate: 2×0.015=0.032 \times 0.015 = 0.03.
  2. Interaction: 0.012×0.015=0.000180.012 \times 0.015 = 0.00018.
  3. Add: 0.012+0.03+0.00018=0.042180.012 + 0.03 + 0.00018 = 0.04218, which is 4.218 percent.

A fixed rate of 0.012 and semiannual inflation of 0.015 produce a composite of 0.04218, or 4.218 percent.

TIPS principal after three years at 2 percent

A TIPS has par of $1,000. Use 0.02 inflation each year for three years and a 1 percent annual coupon. What are adjusted principal and the annual coupon amount?

  1. Iterate principal: 1000(1.02)3=1061.2081000(1.02)^3 = 1061.208, which rounds to $1,061.21.
  2. Coupon on that principal: 1061.208×0.01=10.612081061.208 \times 0.01 = 10.61208, which rounds to $10.61.

After three years at 0.02 inflation, $1,000 of par becomes $1,061.21 of adjusted principal. The 1 percent annual coupon amount is $10.61.

Zero fixed rate on an I bond

A Series I bond has a fixed rate of 0 and a semiannual inflation rate of 0.015. What is the composite rate?

  1. Double the semiannual inflation rate: 2×0.015=0.032 \times 0.015 = 0.03.
  2. The interaction term is 0×0.015=00 \times 0.015 = 0.
  3. Add: 0+0.03+0=0.030 + 0.03 + 0 = 0.03, which is 3 percent.

A fixed rate of 0 and semiannual inflation of 0.015 produce a composite of 0.03, or 3 percent.

TIPS principal after one year at 3 percent

A TIPS has par of $1,000. Use 0.03 inflation for one year and a 1 percent annual coupon. What are adjusted principal and the annual coupon amount?

  1. Adjust principal: 1000×1.03=10301000 \times 1.03 = 1030, so $1,030.
  2. Apply the 1 percent coupon: 1030×0.01=10.31030 \times 0.01 = 10.3, so $10.30.

After one year at 0.03 inflation, $1,000 of par becomes $1,030. The 1 percent annual coupon amount is $10.30.

Common questions

Which one has no market price risk?

The I bond has no secondary-market quote, so real yields do not mark it down. It still has holding-period and redemption rules. TIPS have a market price that moves with real yields.

Do both use CPI-U?

Yes, as the inflation input, with different machinery. The I bond uses a six-month CPI-U change inside a composite rate. TIPS use an index ratio on principal.

Keep reading

This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.