TIPS held to maturity as "bottom" of cash component?

[fnord123]

If the principal goes down (due to deflation) does that act as an offset to other income earned during the same year?  I.e. if someone earned $50K in income, but their tips went down $5K in principal, would they then report $45K AGI on their year-end taxes?

So I poked around in the IRS forms a big (publication 1212 in particular).  Looks like principal reductions can be used to offset the TIPS 1099 interest at least.  What isn't clear is if a deflation-driven yearly principal reduction can apply to interest income from other things the invest holds. I'm betting the answer is no, but cannot find anything clear about it online [/quote]
Yeesh, ok, 2nd answer to my own questions - from form 1212:

Net negative adjustment. A net negative adjustment exists for a tax year when the total of any negative adjustments described in (2) above for the
tax year is more than the total of any positive adjustments for the tax year. Use a net negative adjustment to offset OID on the debt instrument for the tax year. If the net negative adjustment is more than the OID on the debt instrument for the tax year, you can claim the difference as an ordinary loss. However, the amount you can claim as an ordinary loss is limited to the OID on the debt instrument you included in income in prior tax years. You must carry forward any net negative adjustment that is more than the total OID for the tax year and prior tax years and treat it as a negative adjustment in the next tax year.

From reading this gobbledygook, it seems like for a held-to-maturity TIPS bond, one would actually be no more tax-disadvantaged than one would be with a regular treasury held to maturity.  If the net inflation was positive for the TIPS bond when held to maturity, one would realize the "phantom" income as real income when selling the bond.  If the net inflation was negative for the TIPS bond when held to maturity, one would get to deduct the negative OID years as losses, essentially causing phantom income to go to zero in terms of tax payments over the long run, and would get the face value of the TIPS bond back at the end anyway.

The above matches the sentiment I've seen on TIPS over at Bogleheads, where several posts seemed to say that over the long run TIPS are no better or worse than regular treasuries in terms of tax treatment.

I am not a lawyer or accountant, so I could be completely wrong. Hopefully if I am someone will point out where

[Lone Wolf]

The above matches the sentiment I've seen on TIPS over at Bogleheads, where several posts seemed to say that over the long run TIPS are no better or worse than regular treasuries in terms of tax treatment.

I see where you're coming from.

I view the fact that I get taxed on interest payments that I do not (yet) receive as immediate taxation on deferred income.  Basically, I have to pay out from my liquid cash reserves to support securities that will only pay me 5, 10, 20, or 30 years later.  From your view, though, the TIPS are just a part of your cash pile that you are committed to holding until maturity.

[fnord123]

The immediate taxation on deferred income is obnoxious, I agree with you about that.

I guess I need to evaluate that obnoxiousness (and pulled forward tax burden) versus the warm'n'fuzzy feeling of CPI-U indexing.  I realize CPI-U is a flawed metric, but it seems better than nothing in terms of providing a bit of inflation protection in the cash part of the PP.

[moda0306]

The way I see it, the tax piece is simply icing on the cake.  The point is with I Bonds is that, for some reason, they offer better interest rates than 1 year treasuries (sometimes even close to 5-year), and you only have to hold them for a year... if that changes, you get rid of them and buy treasuries... it's that simple.  Yes, you have to hope that the inflation payments are sufficient for 1 year to beat the treasuries, but historically these things have returned extremely well.

It's most likely a slightly subsidized savings vehicle for the middle-class (hence the 5/10k per year limits), so why not take advantage?

[fnord123]

It's most likely a slightly subsidized savings vehicle for the middle-class (hence the 5/10k per year limits), so why not take advantage?

In general, I agree, and have several year's worth of I-Bonds in the cash component of my PP.

However, the current I-Bonds have a non-inflation component of 0%, which stinks.  This contrasts with a 1.75% component on some TIPS with no principal risk if held to maturity, plus greater upside than I-Bonds due to principal indexing that TIPS provide.  These are non-trivial differences.

[MediumTex]

However, the current I-Bonds have a non-inflation component of 0%, which stinks.  This contrasts with a 1.75% component on some TIPS with no principal risk if held to maturity, plus greater upside than I-Bonds due to principal indexing that TIPS provide.  These are non-trivial differences.

I-bonds are re-priced twice a year.  Perhaps the May re-pricing will have a higher fixed rate than zero.

I wouldn't buy any with a fixed rate of zero either.

[Lone Wolf]

However, the current I-Bonds have a non-inflation component of 0%, which stinks.

What is up with this, by the way?  I've been hoping that the I-bond fixed rates for the 2nd half of the year will be better but I simply don't know how these are decided.  For all I know, Treasury may just decide that they hate these things and leave them at 0% forever.

I was thinking about still buying them at 0% if the 2nd half of the year is no better.  With the potential to use them for education tax-free, I'd still been thinking they were worth getting.  But at 0% fixed it does feel like kind of a sucker's play.  What a pity.

The rates for EE bonds are also horrible at the moment so the options for cash aren't as "cool" right now as they have been in the past.

[Pkg Man]

However, the current I-Bonds have a non-inflation component of 0%, which stinks.

What is up with this, by the way?  I've been hoping that the I-bond fixed rates for the 2nd half of the year will be better but I simply don't know how these are decided.  For all I know, Treasury may just decide that they hate these things and leave them at 0% forever.

I was thinking about still buying them at 0% if the 2nd half of the year is no better.  With the potential to use them for education tax-free, I'd still been thinking they were worth getting.  But at 0% fixed it does feel like kind of a sucker's play.  What a pity.

The rates for EE bonds are also horrible at the moment so the options for cash aren't as "cool" right now as they have been in the past.

I bought I and EEs in two batches.  The I bonds purchased mid2010 had a small but positive fixed rate, while the latter ones had zero.  I still purchased them as compared to a 1 year T-bill the rate was higher (due to the inflation component).  As rates begin to rise I will likely redeem them and just pay the 3-month interest penalty.

[pplooker]

Wow, you're all much more sophisticated about I bonds than I am.  I just buy a certain amount every X number of weeks or days and pay no attention to the current rates.

[Austen Heller]

Current I-Bonds have a non-inflation component of 0%, which stinks.  This contrasts with a 1.75% component on some TIPS with no principal risk if held to maturity, plus greater upside than I-Bonds due to principal indexing that TIPS provide.  These are non-trivial differences.

I was considering holding some long-dated TIPS as part of the CASH component of the PP, when I came across this old thread.  The majority of the thread had been hijacked into an I-bond discussion, but I'm wondering: did the OP or anyone else ever enact this strategy?

Today (Sept 2013), I-bonds still have a 0% fixed rate, and 30-year TIPS are now yielding around 1.5% Real.  Seems like long TIPS deserve serious consideration.  Of course, you would be best served to hold the individual TIPS to maturity, and do so in a tax-advantaged account such as a Roth IRA, but as long as you can meet these criteria, the long TIPS seem like the way to go.  If anyone is considering this, and would like to buy as cheaply as possible (no commissions or bid/ask spreads), the next Treasury auction takes place in the middle of October.

William Bernstein discusses the benefits of long-dated TIPS in his pamphlet "Ages of the Investor" - highly recommended!  TIPS are specifically recommended as a component of a LMP - Liability Matching Portfolio, a way to make sure you are able to meet your obligations as retirement approaches.

[fnord123]

I never implemented this, mostly because I found additional ways to buy I-Bonds (in child's name + in a living trust).

When my current high yielding (sad when ~3% is high yielding) CDs run out in 2015, which currently are the bottom of my cash component and have a similar role as TIPS were proposed in this thread, I may roll them into TIPS if the 5Y CD rate is still sub-3%.

Did anyone else try this btw?  Still seems to me a good strategy if the TIPS are held in tax-advantaged space.

[modeljc]

I never implemented this, mostly because I found additional ways to buy I-Bonds (in child's name + in a living trust).

When my current high yielding (sad when ~3% is high yielding) CDs run out in 2015, which currently are the bottom of my cash component and have a similar role as TIPS were proposed in this thread, I may roll them into TIPS if the 5Y CD rate is still sub-3%.

Did anyone else try this btw?  Still seems to me a good strategy if the TIPS are held in tax-advantaged space.

Bill Gates is buying WIW and WIA.  It current yield is 3.6% and sells at a 15% discount.  I got some at year end for $11.20 for a VP.  It has a duration of 7 years.  When you consider that inflation has averaged at 4.2% for 40 years this looks OK when you consider the long 30 year Treasury is at 3.8%.

The tax treatment is better as it is a closed end fund.

[fnord123]

WIW and WIA both invest up to 40% of their funds in non-US gov't stuff.  WIW even invests in stuff that is below investment grade.  As such, these seem to be more appropriate for the VP than the PP.

[modeljc]

WIW and WIA both invest up to 40% of their funds in non-US gov't stuff.  WIW even invests in stuff that is below investment grade.  As such, these seem to be more appropriate for the VP than the PP.

My site says 77% is in US tips.  Yes I bought it for the VP.

[yankees60]

Medium Tex--

Can you expand a bit as to why you like I-bonds?

Thanks,
Adam

1. Total deferral of taxes on interest until redemption (up to 30 years)

2. Zero interest rate risk

3. Zero prinicipal risk

4. Full faith and credit of U.S. government

5. Complete liquidity (redeem at the bank on the corner any time you want)

What's not to like?

Exhibit A of what I just wrote about.

Zero mention of if you are transforming an existing portfolio of any significant amount into a Permanent Portfolio the I Bonds portion of it would be tiny. Not so with TIPS.

Vinny

[yankees60]

Current I-Bonds have a non-inflation component of 0%, which stinks.  This contrasts with a 1.75% component on some TIPS with no principal risk if held to maturity, plus greater upside than I-Bonds due to principal indexing that TIPS provide.  These are non-trivial differences.

I was considering holding some long-dated TIPS as part of the CASH component of the PP, when I came across this old thread.  The majority of the thread had been hijacked into an I-bond discussion, but I'm wondering: did the OP or anyone else ever enact this strategy?

Today (Sept 2013), I-bonds still have a 0% fixed rate, and 30-year TIPS are now yielding around 1.5% Real.  Seems like long TIPS deserve serious consideration.  Of course, you would be best served to hold the individual TIPS to maturity, and do so in a tax-advantaged account such as a Roth IRA, but as long as you can meet these criteria, the long TIPS seem like the way to go.  If anyone is considering this, and would like to buy as cheaply as possible (no commissions or bid/ask spreads), the next Treasury auction takes place in the middle of October.

William Bernstein discusses the benefits of long-dated TIPS in his pamphlet "Ages of the Investor" - highly recommended!  TIPS are specifically recommended as a component of a LMP - Liability Matching Portfolio, a way to make sure you are able to meet your obligations as retirement approaches.

A William Bernstein / TIPS mention!!!

Vinny

[jhogue]

Vinny,

TIPS have terrible tax treatment. I-bonds are tax deferred.

TIPS go negative in a deflation. I-bonds do not.

Now is a great time to start building your Deep Cash I-bond ladder. I-bonds currently yield 2.22%, easily beating everything from a 3 month T-bill to a 30 year T-bond.

[yankees60]

Vinny,

TIPS have terrible tax treatment. I-bonds are tax deferred.

TIPS go negative in a deflation. I-bonds do not.

Now is a great time to start building your Deep Cash I-bond ladder. I-bonds currently yield 2.22%, easily beating everything from a 3 month T-bill to a 30 year T-bond.

Except for the MAJOR caveat that I-Bonds have a severe annual purchase limitation. As a single person without any trusts that leaves a maximum purchase of $15,000 of them during 2020?

TIPS in a retirement account solve the not tax deferred problem.

One would have to assess what are the probabilities of deflation. And, IF deflation, would not the TIPS still have retained their purchasing power from original purchase?

My bottom line need and reason for purchasing them is safety being paramount with return being a low priority.

Vinny

[jhogue]

Vinny,

1. You are correct that one of the limitations of I-bonds is that they have annual limits. Therefore, building an I-bond ladder is part of a long-term strategy to follow for a number of years.That's why we call it "Deep Cash."

2. If you put TIPS in a tax deferred account to shield them from exposure to annual taxes on their interest, they will squeeze out that much space that might be used to tax defer another asset. I-bonds are always tax deferred and therefore expand the amount of tax deferred space in your overall portfolio. That is always a good thing, but even more important once you retire and can no longer add to your tax deferred account with regular income. I-bonds are also not subject to Required Minimum Distributions, while TIPS held in a tax deferred account are subject to RMDs when you reach 70 1/2 (age 72 with the passage of the SECURE Act).

3. TIPS are not guaranteed to retain their principal value in a Japan-like deflation. They can--and have--dropped into negative territory from time to time. On the other hand, the principal of I-bonds is backed by the full faith and credit of the US Treasury.

I-bonds won't make your rich, but they will make you feel secure.

[yankees60]

I have read on them, and I think I understand how they work.  The thing is, I can't really figure out how the fixed rate is determined.  

I also have no idea how the fixed rate is determined.  For all I know, it may be arbitrary.  Really makes me curious, especially with it sitting at 0% fixed rate right now.

One thing I like about I-bonds is that you get some real inflation protection (as their rates are indexed to CPI-U.)  T-bills of course also "slightly" compensate you for inflation via their interest rate but typically with a rate lower than the I-bond composite rate.  Plus, you pay taxes on the interest from t-bills while I-bond taxes can be deferred for 30 years.  So with t-bills I think you really do get a bit of a bad deal on your cash when inflation comes because you must pay the government tax money on the inflation it has caused.  (I find this very annoying.)

The variable rate is based on the CPI-U (which from what I understand includes food and energy but not health care.)  This tends to put I-bond rates at rates that are competitive with slightly longer-term treasury securities but without the interest rate risk.

They have the following disadvantages:
1. Setting up a TreasuryDirect account involves some rigmarole.
2. They have an irritating $5,000 per year limit from TreasuryDirect, plus an additional $5,000 per year limit as paper bonds.
3. When you walk into the bank and ask to purchase them, the teller may look at you like you have two heads.  Apparently nobody really bothers to buy these things except the occasional granny.  So it's just Lone Wolf and the grannies rockin' the I-bonds.  (Speaking only for my local branch -- it sounds like MT has been buying these for years!)
4. They cannot be traded on the secondary market.  You can either cash them in or hold on to them.
5. You must hold on to them for five years to avoid having to forfeit any interest.

I'm afraid that MT might be right that they'll try to discontinue them.  The ever-shrinking limits kind of hint at that.  Me and the grannies will get together and have a good cry when that happens.

Over 9+ years later.....NOT YET!

Vinny