“TIPS” to Inflation-Proof Your Account
by Richard
Today’s subject is Inflation Protected Bonds.
There is a sure fire way to tell when the government offers you a good deal. They make it hard to get and offer you much less than what you would normally want. This applies to yesterdays post on ROTH IRAs, as it does to any other account whose funding is capped at a relatively low level.
As a nation, we seem to have a national policy supporting the devaluation of the dollar. I’m not even sure it will be the world’s primary reserve currency if this trend continues. If this ignites a recurrence of inflation, as I fear it may, you need to seriously look at inflation protected bonds.
Getting TIPSy
For your non-taxable accounts, there are any number of mutual funds and exchange traded funds that specialize in TIPS (Treasury Inflation Protected Securities), and there is no restriction or limit on purchases. These bonds pay the inflation increment as an adjustment to principal, rather than interest, and the total yield, including the nominal interest paid plus this principal adjustment is taxable as current income in the year received. You literally will owe a tax on funds not actually paid out in current interest payments. No fun in your taxable accounts, but no problem in your tax free accounts.
Bond…I-Bond
The problem arises for those who want inflation protected bonds held outside of non-taxable accounts, and the solution is known as I-Bonds. Through last year, an individual could purchase $60,000 face value of I-Bonds ($30,000 in paper I-bonds sold by financial institutions) and $30,000 sold in electronic entry form at treasurydirect.gov. Naturally, since this was a reasonably generous allowance for individuals, the government has just drastically reduced this funding cap. The same politicians who will be sending you $600 in emergency relief money, on the condition that you go out and spend it on something you neither want or need, have almost wiped out this means of surviving the ongoing devaluation of our currency.
We will be putting our “stimulus” rebate into I-Bonds, and recommend you do the same, at a time when neither political party shows any sense of spending restraint.
This year, inexplicably, as inflation forces gather strength, the government has capped the limit for an individual at $10,000. ($5,000 in paper I-bonds and $5,000 electronic issue). A married couple can double this cap, by switching spousal social security numbers as the “primary”. Even with the lower limits, or perhaps, especially in view of the new limits, you need to seriously consider this investment option.
Unlike TIPS, the inflation adjustment is added incrementally to the nominal interest, twice each year, in May and November. But the real kicker is in taxation. The bond holder can elect to defer taxes until maturity, which is 30 years. This is, in effect, a non-qualified annuity with absolutely none of the oppressive fees and riders normally charged in the private annuity market. Better still, they are totally exempt from all local and state taxation.
The rules are simple enough. The bonds may not be redeemed in the first year of issuance. After 12 months, and before 60 months, there is a 3 month interest penalty on premature redemptions. They simply lop off your last three months interest, but you get all principal and interest up to that cutoff date. After five years, you can redeem at your convenience without any penalty whatsoever. Make sure you redeem after 30 years, because in their typically ham fisted manner, the government simply stops paying interest after 30 years.
In essence, after five years (even after one year) the bond holder has a “put” which is the right to sell or redeem at the face value of the bond, no matter what the then current bond market is yielding. You can sell your TIPS taxable inflation protected bonds at any time, but only for what the market is then offering. The only way to guarantee redemption at the full face value is to hold TIPS bonds for the full 30 year maturity.
Imagine a working couple, age 40, who funds the $20,000 maximum for thirty years, and retires at age 70. They could then start drawing down each bond at its 30 year maturity and have a 30 year self-liquidating ladder of inflation hedged income, lasting them all the way to age 100. This would hopefully be in addition to their Roth IRA and 401K rollover.
This will never be your highest returning investment. Just the one that helps you keep your balance and sanity as market conditions fluctuate.
