Do Treasury Inflation-Indexed Securities Benefit Retirees?
Can TIPS Really Hedge Against Inflation?
Are U.S. Treasury inflation-indexed securities (TIPS or Series I savings bonds) a good investment vehicle for retirement accounts? The answer is: it depends.
Like all investment vehicles, knowing whether inflation-indexed securities are right for you requires an education. Here are some of the most important financial aspects of inflation-indexed securities for retirees to consider.
How TIPS Work
TIPS are semi-annually adjusted for inflation for the purpose of calculating the interest distributed to holders.
For example, a 10-year, 3% interest-bearing TIPS purchased for $10,000 on January 1, 2011, would be reassessed on June 1, 2011. Using a 3% rate of inflation (based on the Consumer Price Index), the value of the security for interest calculation would be $10,300 ($10,000 x 1.03). The semi-annual interest paid to the holder would amount to $154.50 ($10,300 x 3% divided by 2).
If on January 1, 2012, the rate of inflation has dropped to 2%, the value would be adjusted to $10,200 ($10,000 x 1.02). Interest paid would be $152 ($10,200 x 3% divided by 2).
Inflation Protection
Many retirees worry about inflation and the effect it will have on the future buying power of their limited incomes. U.S. Treasury inflation-indexed securities do provide protection against the effects of inflation on your investments.
However, for purposes of calculating interest payments, the value can be negatively impacted by deflation as well.
Using the example above, if the Consumer Price Index reflects 1% deflation, the interest calculation would be made on $9,900 ($10,000 less 1%). The 3% interest rate always remains constant, so the interest payment at the six-month mark would be $148.50 ($9,900 x 3% divided by 2).
Beware Taxation
The old adage, "Nothing is certain except death and taxes," is true for inflation-indexed securities as well. There can be unfavorable tax consequences if you hold your TIPS in taxable accounts. This is because principal adjustments for inflation are considered current interest for the purposes of tax liability calculations, which means inflation adjustments produce immediate regular taxable income. There are no deferrals available.
As a result, it is highly recommended that if your hold TIPS in your retirement portfolio, you do so in an IRA. The issue to consider when depositing TIPS into an IRA is your annual contribution limit and taking the amount of your TIPS into account along with any and all other deposits.
Security
Obviously, one of the strongest benefits to purchasing TIPS is that they are backed by the U.S. government. While deflation can affect the value of the bonds negatively for the purpose of interest calculations, the government guarantees to payout at maturity at least the principal value at the time of purchase, which provides an additional hedge of protection to retired investors.
More from this Contributor:
How Will Quitting Work Early Affect Your Retirement Plans?
Dollar Cost Averaging
Forever Stocks to Buy and Hold
Like all investment vehicles, knowing whether inflation-indexed securities are right for you requires an education. Here are some of the most important financial aspects of inflation-indexed securities for retirees to consider.
How TIPS Work
TIPS are semi-annually adjusted for inflation for the purpose of calculating the interest distributed to holders.
For example, a 10-year, 3% interest-bearing TIPS purchased for $10,000 on January 1, 2011, would be reassessed on June 1, 2011. Using a 3% rate of inflation (based on the Consumer Price Index), the value of the security for interest calculation would be $10,300 ($10,000 x 1.03). The semi-annual interest paid to the holder would amount to $154.50 ($10,300 x 3% divided by 2).
If on January 1, 2012, the rate of inflation has dropped to 2%, the value would be adjusted to $10,200 ($10,000 x 1.02). Interest paid would be $152 ($10,200 x 3% divided by 2).
Inflation Protection
Many retirees worry about inflation and the effect it will have on the future buying power of their limited incomes. U.S. Treasury inflation-indexed securities do provide protection against the effects of inflation on your investments.
However, for purposes of calculating interest payments, the value can be negatively impacted by deflation as well.
Using the example above, if the Consumer Price Index reflects 1% deflation, the interest calculation would be made on $9,900 ($10,000 less 1%). The 3% interest rate always remains constant, so the interest payment at the six-month mark would be $148.50 ($9,900 x 3% divided by 2).
Beware Taxation
The old adage, "Nothing is certain except death and taxes," is true for inflation-indexed securities as well. There can be unfavorable tax consequences if you hold your TIPS in taxable accounts. This is because principal adjustments for inflation are considered current interest for the purposes of tax liability calculations, which means inflation adjustments produce immediate regular taxable income. There are no deferrals available.
As a result, it is highly recommended that if your hold TIPS in your retirement portfolio, you do so in an IRA. The issue to consider when depositing TIPS into an IRA is your annual contribution limit and taking the amount of your TIPS into account along with any and all other deposits.
Security
Obviously, one of the strongest benefits to purchasing TIPS is that they are backed by the U.S. government. While deflation can affect the value of the bonds negatively for the purpose of interest calculations, the government guarantees to payout at maturity at least the principal value at the time of purchase, which provides an additional hedge of protection to retired investors.
More from this Contributor:
How Will Quitting Work Early Affect Your Retirement Plans?
Dollar Cost Averaging
Forever Stocks to Buy and Hold
Published by Martha Fry - Featured Contributor in Business & Finance
Martha Fry works as a freelance writer and editor. An accountant who worked at Peat, Marwick & Mitchell and Price Waterhouse, she also does financial consulting and often writes on business and personal fina... View profile
- Bond Laddering: The Basics of Income InvestingBond laddering - the matching of a series of bonds to expected income needs - can help seniors and others manage risk and secure a safe and reliable retirement income.
- Understanding the National DebtPeople look at the national debt clock with all of the trillions of dollars seeming to spiral out of control second by second at thousands of dollars per minute their jaws dropping to the floor. That is because they...
- Investment Tips: Buy U.S. Savings Bonds for Your RetirementThe average American saves very little for his retirement. Despite that, Social Security will provide only about 41% of his working income, even though he may need 70-90% or more to survive. One way to take up the sla...
- Author Declares Falling Dollar is Saving the Mortgage Market"The worry that the Dollar could free-fall does not seem to worry foreign investors today."
- Rate of Inflation and Level of Unemployment in FocusAn examination of the proposition that there exists a correlation between the rate of inflation and the level of unemployment.
- Are Inflation-Indexed Bonds Right for You?
- Retirement Planning
- Monte Carlo Retirement Planning
- Inflation Bonds
- The First Step of Personal Retirement Planning
- Retirement Planning Information
- Understanding Private Student Loan Interest Rates
6 Comments
Post a CommentWell done!
good job!
Very interesting
Thanks for the financial education.
What happens when the government won't admit that there is inflation?
helpful info