If you’re looking for an investment option that’s less volatile than the stock market, your options aren’t limited to savings accounts. Both TIPS bonds and Series I savings bonds are investments that help you protect your principal while earning over a period of time. Both are safer investments that do not carry the potential for rewards of riskier investments. Below we break down how each works and cover which might be the right choice for you. Keep in mind that investing can be a very individualized activity that requires specific advice for your unique financial situation. This is why you may want to talk to a financial advisor first before deciding to invest in either.
What are Series I Savings Bonds?
Series I savings bonds are a low-risk savings product that you can purchase directly from TreasuryDirect. This site allows investors to buy Treasury securities directly from the US government. Series I savings bonds earn interest throughout their life and are protected against inflation.
Here’s how the links work for each of the main components:
Profits: I bonds have an annual interest rate that has two parts. One part comes from a fixed interest rate and the other part comes from a six-month inflation rate. These bonds earn interest monthly, although it is not paid to investors until the bond is redeemed. Series I savings bonds earn interest for up to 30 years.
Redemption: You can’t redeem I bonds until you’ve held them for at least a year. However, if you redeem them after less than five years, you give up the previous three months of interest. After five years, there is no such penalty for redemption.
Taxes: Series I bonds do not pay their earnings to investors until they are redeemed. This means investors pay no taxes on the gains until the redemption. Thus, I bonds can be held in a taxable account without worrying about tax consequences, at least until the year of redemption. Upon redemption, the Series I Notes are subject to federal income tax, but not to state or local income tax.
Purchase Limits: Bond purchases are limited to $10,000 per calendar year, per social security number. There is an additional $5,000 limit on paper bonds if you use your tax refund to buy them.
What are TIPS?
Treasury Inflation-Protected Securities (TIPS) are a Treasury security designed to provide protection against inflation. With TIPS, the principal or face value fluctuates with inflation (or deflation), as measured by the Consumer Price Index (CPI). Then, when the TIPS mature, you are paid the adjusted or principal – whichever is higher. TIPS are purchased at auction through TreasuryDirect and through banks, brokers and dealers.
Here’s how each of TIPS’ main components works:
Profits: TIPS receives interest payments twice a year. payments for TIPS are based on the interest rate set at the auction. The principal amount will be adjusted according to inflation, which in turn determines the interest payment.
Redemption: Unlike I-bonds, TIPS are marketable securities, meaning they can be sold in the secondary market, such as through a broker. Because of this, restrictions on redemption after a certain number of years are not as important for TIPS. However, they have terms of 5, 10 and 30 years.
Taxes: The inflation adjustment and interest payments on TIPS are taxable each year, even if you haven’t sold them yet and haven’t received your income from the security. This can be mitigated by keeping TIPS in a tax-deferred account, but these accounts may also have annual limits. Therefore, the tax treatment of I-bonds is generally more favorable than that of TIPS.
Purchase Limits: There are both competitive and non-competitive auctions for TIPS. Non-competitive auctions have a purchase limit of $5 million per auction. Competitive auctions have a limit of 35% of the bid amount. It is worth noting that I-bonds can only be purchased by individuals, while both individuals and institutions such as mutual funds can purchase TIPS. This may explain the large difference in purchase limits.
Should you buy bonds or TIPS?
There is no simple answer to whether you should buy I-bonds or TIPS. Both I bonds and TIPS have their strengths and weaknesses. In particular, I-bonds have favorable tax treatment, while TIPS have much higher purchase limits. Let’s take a closer look at which option might be right for you.
You should consider buying I-bonds during periods of inflation because they offer one of the safest and highest inflation-adjusted yields available. You also won’t be ready for tax payments until you sell the bond because the product doesn’t make regular interest payments. However, if you have a lot of capital to grow, then this may not be the best option because you are limited to buying $10,000 per year, or $15,000 if the last $5,000 comes from tax refunds.
TIPS also offer a level of inflation protection, but their principal values, not their interest rates, are adjusted to incorporate inflation. There are almost zero market restrictions with TIPS, allowing you to invest quite a bit if you want to. TIPS are also a better choice if you are looking for the investment to be more liquid than a Series I Bond allows.
While you can always buy both, which you should prioritize depends on your situation and goals. It’s always a good idea to meet with a financial advisor before making a final decision.
The bottom line
I Bonds and TIPS are two Treasury securities that you can buy directly through TreasuryDirect. TIPS, however, can also be purchased on the open market, such as through a broker. Both I-bonds and TIPS provide protection against inflation for individuals – or institutions, in the case of TIPS. Both have advantages for investors and can strengthen a portfolio, regardless of economic conditions.
A financial advisor can guide you through important financial decisions, such as determining your investment strategy. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors serving your area, and you can interview your advisors at no cost to decide who is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Deciding how to invest can be a challenge, especially when you don’t know how much your money will grow over time. SmartAsset’s investment calculator can help you calculate how much your money will grow to help you decide which type of investment is right for you.
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