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Mechanics of TIPS and I Bonds
Old 11-28-2005, 09:45 PM   #1
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Mechanics of TIPS and I Bonds

I am unclear about a few things concerning tips and I Bonds.
First of all: Do you receive any money in interest prior to maturity, or is it only when you cash in the bond or when it matures that you receive the interest?

Is this how it works. Suppose you have $100,000 in TIPS paying 1.80% interest with a 5.5% inflation rate. At the end of the first 6 months. Is that combined 7.3% credited to your account. Then say the next six months the posted inflation rate drops to 4.5%. Are you then credited 6.3%. Etcl, etc. until your maturity?

Do I bonds work the same way?
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Re: Mechanics of TIPS and I Bonds
Old 11-28-2005, 11:52 PM   #2
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Re: Mechanics of TIPS and I Bonds

With I-bonds, you don't receive any interest until you cash them. There's of course the 1-year lockup and the 5-year withdrawal penalty. The principal just keeps getting larger and larger.

TIPS pay a fixed rate based on the principal (the par amount, initially). This principal is adjusted per the CPI. You will receive semi-annual payments with TIPS, payable to your checking account.

Note that you're taxed on the TIPS "phantom" income yearly, though you only receive the fixed rate interest.
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Re: Mechanics of TIPS and I Bonds
Old 11-29-2005, 02:36 PM   #3
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Re: Mechanics of TIPS and I Bonds

Quote:
Originally Posted by eridanus
With I-bonds, you don't receive any interest until you cash them. There's of course the 1-year lockup and the 5-year withdrawal penalty. The principal just keeps getting larger and larger.
Another clarification: with I-bonds, you can choose whether you want to declare income earned each year on the bonds and then pay taxes each year on that income (even though you haven't cashed them in).

Quote:
Originally Posted by eridanus
TIPS pay a fixed rate based on the principal (the par amount, initially). This principal is adjusted per the CPI. You will receive semi-annual payments with TIPS, payable to your checking account.

Note that you're taxed on the TIPS "phantom" income yearly, though you only receive the fixed rate interest.
Another clarification that may not have been apparent from eridanus' comments: your interest payments are based on the inflation-adjusted principal, so (assuming no deflation), your interest payments will always be increasing as your fixed rate is multiplied by your increasing inflation-adjusted principal.
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