TIPS (Treasury Inflation-Protected Securities) are issued by the U.S. Treasury with maturities of 5, 10, and 30 years. Unlike conventional Treasuries, the principal value of TIPS adjusts semiannually based on changes in the Consumer Price Index (CPI). The fixed coupon rate is applied to the adjusted principal, so coupon payments rise with inflation and fall with deflation. At maturity, the investor receives the greater of the adjusted principal or original par value, providing a deflation floor.
The real yield of TIPS is the stated coupon rate, since the inflation component is handled through principal adjustment. The breakeven inflation rate is the difference between the nominal Treasury yield and the TIPS real yield for the same maturity — it represents the inflation rate at which TIPS and nominal Treasuries would provide the same total return.
A critical tax consideration: phantom income. The inflation adjustment to principal is taxable as ordinary income in the year it accrues, even though the investor doesn't receive cash until maturity. This makes TIPS held in taxable accounts less tax-efficient; they are generally better suited to tax-advantaged accounts (IRAs, 401(k)s).
TIPS are backed by the full faith and credit of the U.S. government, eliminating credit risk. Their primary risk is real interest rate risk — if real rates rise, TIPS prices fall.
> Exam tip: On the Series 65/66 and CFP, understand the phantom income tax problem for TIPS in taxable accounts. Know how to calculate the breakeven inflation rate and understand that TIPS real yields can be negative in high-demand environments. The deflation floor (never below original par at maturity) is a key protective feature.