This article is part of the Retirement Financial Life Equation (RFLE) series. It was initially published on February 1, 2023, and updated in February 2026.
The previous articles in this series discussed why retirees might want to own bonds and whether individual bonds might be preferable to bond funds. This article examines a unique category of U.S. Treasury bonds that deserve special consideration in retirement portfolios: Treasury Inflation-Protected Securities, or TIPS.
Within the broader category of U.S. government bonds—Treasury notes, bonds, bills, and savings bonds—TIPS stand apart because they’re specifically designed to protect against inflation. Unlike Treasury and corporate bonds, where principal remains fixed, TIPS principal adjusts up or down based on changes in the Consumer Price Index (CPI). This makes them uniquely suited for the long retirement time horizon most of us face.
But there’s an important nuance: TIPS yields already reflect expected inflation. When TIPS really shine is during periods of unexpected inflation, especially over extended periods. The difference between the yield of a TIPS and a comparable-maturity Treasury bond reflects the discount, which reflects the market’s inflation expectation over that period. This is called the “breakeven point” for nominal and inflation-indexed bonds.
If inflation expectations become reality, TIPS and regular Treasuries will deliver almost identical returns. If inflation runs higher than expected, TIPS will outperform significantly. If actual inflation comes in lower than expected, Treasury yields will rise. In that way, TIPS work like inflation insurance—you’re paying a small premium (accepting a lower starting yield) in exchange for protection against the risk that inflation exceeds expectations.
This structure makes TIPS almost totally risk-free from a principal perspective. Short and intermediate-term TIPS are arguably the safest investments available for maintaining purchasing power. Long-term TIPS carry interest rate risk if you need to sell before maturity, but if held to maturity, they guarantee you’ll receive at least your original principal plus all accumulated inflation adjustments.
How TIPS work
TIPS earn interest at a fixed coupon rate, like any other bond, and pay interest semiannually. The key difference—and what provides inflation protection—is that the bond’s face value adjusts each year based on inflation, as measured by the Consumer Price Index.
Let’s work through a complete example of a five-year TIPS bond to see exactly how this works:
Assumptions:
- Purchase a $1,000 par value TIPS
- Coupon rate: 2.0% (current market rate as of late 2025)
- Term: 5 years
- Variable annual inflation rates (CPI changes)
Year 1:
- Beginning principal: $1,000
- Inflation (CPI): 3.0%
- Inflation adjustment: $1,000 × 1.03 = $1,030
- Interest payment: $1,030 × 2.0% = $20.60 (paid as $10.30 semi-annually)
Year 2:
- Beginning principal: $1,030
- Inflation: 2.5%
- Inflation adjustment: $1,030 × 1.025 = $1,055.75
- Interest payment: $1,055.75 × 2.0% = $21.12 (paid as $10.56 semi-annually)
Year 3:
- Beginning principal: $1,055.75
- Inflation: 2.0%
- Inflation adjustment: $1,055.75 × 1.02 = $1,076.87
- Interest payment: $1,076.87 × 2.0% = $21.54 (paid as $10.77 semi-annually)
Year 4:
- Beginning principal: $1,076.87
- Inflation: 1.5%
- Inflation adjustment: $1,076.87 × 1.015 = $1,093.02
- Interest payment: $1,093.02 × 2.0% = $21.86 (paid as $10.93 semi-annually)
Year 5:
- Beginning principal: $1,093.02
- Inflation: -1.0% (deflation scenario)
- Inflation adjustment: $1,093.02 × 0.99 = $1,082.09
- Interest payment: $1,082.09 × 2.0% = $21.64 (paid as $10.82 semi-annually)
At Maturity:
- You receive the higher of: $1,082.09 (inflation-adjusted) or $1,000 (original par)
- In this case: $1,082.09
- Total interest received over 5 years: $106.76
This example illustrates several crucial points. First, even though the coupon rate is fixed at 2.0%, the actual interest payments vary each period because they’re calculated on the inflation-adjusted principal. Second, the principal can decrease during periods of deflation (Year 5), but it can never fall below the original par value at maturity. Third, if you hold to maturity, you’re guaranteed to receive at least your original investment plus all accumulated inflation.
The market value of TIPS will fluctuate with interest rates, but if you hold them to maturity, the inflation protection is absolute. This is where TIPS differ fundamentally from nominal bonds—with regular Treasuries, rising inflation erodes your purchasing power even though you receive your full principal back. With TIPS, your principal grows with inflation, protecting your purchasing power.
The dynamic 2025-2026 TIPS environment
The TIPS market has experienced a remarkable transformation since my original 2023 article. Back then, we were emerging from a period when TIPS real yields had been negative for years. Today’s environment is completely different and far more favorable for TIPS investors.
As of late December 2025, TIPS real yields are significantly positive across the entire yield curve. The most recent 5-year TIPS auction (December 2025) yielded 1.433% real return above inflation. The upcoming 10-year TIPS auction scheduled for January 22, 2026, is expected to yield approximately 2.0-2.2% real return. These are the highest real yields we’ve seen since 2009, representing a generational opportunity for inflation-conscious investors.
Compare this to four years ago, when a similar December 2021 TIPS auction yielded a -1.508% return. That negative real yield meant investors were accepting returns below inflation in exchange for safety. Today’s positive real yields mean you’re guaranteed to earn 1.4-2.2% above whatever inflation runs, providing genuine purchasing power growth if held to maturity.
The dramatic shift reflects several factors. The Federal Reserve’s aggressive interest rate increases in 2022-2023 to combat inflation pushed all rates higher. The bond market trauma of 2022, when bonds fell 13% alongside an 18% stock market decline, reset yields across the board. And perhaps most importantly, inflation expectations have normalized after the 2021-2022 spike, removing the panic premium that drove TIPS real yields to deeply negative levels.
For retirees building Tier 2 income portfolios, this represents a crucial inflection point. TIPS at 2.0%+ real yields provide inflation-adjusted income that’s actually meaningful—not the near-zero real returns of the 2010-2021 period. At current yields, a $200,000 TIPS allocation could generate $4,000 annually in real, inflation-protected income, with both the income and principal growing automatically with CPI.
The five-year breakeven inflation rate as of late 2025 sits at approximately 2.4-2.5%. This means the market expects inflation to average 2.4-2.5% annually over the next five years. If actual inflation exceeds that rate, TIPS will outperform nominal Treasuries. If it runs below 2.4%, nominal Treasuries would have been the better choice. But given that core CPI has been above 3% for much of 2025 and the Fed’s 2% target has proven elusive, current breakeven rates appear reasonable, if not conservative.
Recent performance (since the 2022 bond crisis)
TIPS funds were not immune to the 2022 bond market collapse, but they demonstrated their value proposition during the recovery. My short-term TIPS ETF (STIP) lost -2.41% in 2022—a painful loss but considerably better than the -13% average bond fund loss that year. The key lesson: TIPS funds have interest rate risk just like regular bond funds when rates rise sharply.
However, the divergence in performance since 2022 tells an important story. While nominal bond funds struggled to recover their losses through 2023-2024, TIPS funds benefited from both falling rates and continued inflation adjustments. STIP’s yield climbed from roughly 4% in early 2023 to approximately 4.5-5.0% by late 2025, reflecting both a higher real-yield environment and ongoing inflation accruals.
The current yield on short-term TIPS funds (0-5 years maturity) runs about 4.5-5.0%, while intermediate TIPS funds yield 5.0-5.5%. These yields combine the fixed real rate (1.4-2.0%) with expected inflation adjustments. The actual total return will depend on whether inflation exceeds or falls below expectations, but the inflation protection is built in automatically.
For retirees who experienced the 2022 bond crisis firsthand, TIPS offer psychological benefits beyond their mathematical appeal. Watching your bond funds drop 10-15% while inflation raged at 8-9% felt like getting hit twice. TIPS cushion that blow—yes, the market value drops when rates rise, but the principal adjusts upward with inflation, partially offsetting the pain. And if held to maturity, you’re guaranteed to recover your inflation-adjusted principal regardless of interim price fluctuations.
TIPS as Tier 2 income in the RFLE framework
In the Retirement Financial Life Equation framework, TIPS naturally fit into Tier 2 as a stable, reliable source of income. They’re not guaranteed lifetime income like Social Security (Tier 1), but they provide a predictable cash flow with unique inflation protection that most Tier 2 sources lack.
A well-structured TIPS allocation serves multiple functions in Tier 2. The semi-annual interest payments provide current income, though at current 2% real yields, a $100,000 TIPS position generates only $2,000 annually before inflation adjustments—modest compared to the 3.5% dividend stocks or the 4-4.5% nominal bond yields. The real value lies in inflation protection rather than in maximizing current income.
The principal adjustments happen automatically in the background. Each month, the inflation index is updated based on the CPI, and your TIPS principal adjusts accordingly. You don’t receive this adjustment until maturity (or sale), but it accrues continuously. This means your purchasing power protection happens silently throughout your retirement, not just at maturity.
For retirees concerned that long-term inflation will erode their fixed income, TIPS address a specific fear: that the $50,000 annual income your bonds generate today might only buy $35,000 worth of goods in 15 years. With TIPS, both your principal and your effective income grow with inflation. If inflation runs 3% annually for 15 years (compounding to 56% cumulative inflation), your TIPS principal grows 56% right alongside it.
The strategic question is allocation size. I currently hold about 14.5% of my bond allocation in short-term TIPS (STIP), which represents roughly 8% of my total portfolio. This provides meaningful inflation insurance without over-concentrating in a single bond category. The rest of my Tier 2 bonds consist of short-term bond index funds, total bond market funds, and investment-grade corporate bonds—none of which provide inflation protection.
Some retirees prefer higher TIPS allocations, particularly those with minimal equity exposure who rely heavily on fixed income. A conservative retiree with a 60-70% bond allocation might hold 30-40% in TIPS, providing substantial inflation protection while maintaining nominal bonds for higher current income. The tradeoff is accepting lower starting yields on the TIPS portion in exchange for inflation insurance.
My current TIPS allocation
My retirement portfolio’s fixed-income allocation has evolved since the original 2023 article, though the core philosophy remains unchanged. I’m currently allocated approximately 45% to bonds and 10% to cash, representing 55% of my overall portfolio in fixed income. Here’s the current breakdown
I’ve increased my TIPS allocation slightly from 10% to 15% of bonds over the past year as real yields reached attractive levels above 2%. I’ve also simplified by eliminating some smaller positions and consolidating into core holdings. The money market fund yielding about 4.5-4.8% as of late 2025 serves as my emergency fund and immediate spending needs—much higher than the 3.9% it yielded in early 2023.
The real yield of my TIPS position (approximately 2.0% above inflation) means that portion of my portfolio provides purchasing power growth even in an inflationary environment. The nominal bond portion currently yields 4.0-4.8%, providing higher income but with inflation risk. Together, they create a balanced fixed-income foundation for Tier 2 income that addresses both current needs and long-term inflation protection.
Individual TIPS, TIPS funds, or TIPS ladders?
You have three ways to invest in TIPS, each with distinct advantages and appropriate use cases.
TIPS Funds (ETFs or Mutual Funds) offer the simplest approach. You buy shares representing a diversified portfolio of TIPS across various maturities. The fund handles all the complexity—tracking inflation adjustments, reinvesting maturing bonds, and managing the portfolio. You receive distributions that include both interest and inflation adjustments, and your share price reflects current market values.
Quality short-term TIPS funds include iShares 0-5 Year TIPS Bond ETF (STIP) with 0.03% expenses, Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) at 0.04%, and Schwab U.S. TIPS ETF (SCHP) at 0.04%. For broader maturity exposure, Vanguard Inflation-Protected Securities Fund (VAIPX) and Fidelity Inflation-Protected Bond Index Fund (FIPDX) both charge just 0.05-0.06%.
TIPS funds work well for investors who want simplicity, need liquidity (can sell any day), prefer professional management, want automatic diversification across multiple TIPS, or have modest amounts to invest (you can buy a single share). The downside is you’re buying a basket of bonds at current market prices and yields, which vary daily. You’ll also pay a small expense ratio, though 0.03-0.06% is negligible.
Individual TIPS can be purchased through TreasuryDirect.gov (for non-retirement accounts) or through brokerages such as Fidelity, Vanguard, or Schwab (including IRAs). You can buy new TIPS at auction, typically offered with maturities of 5, 10, and 30 years, several times a year. Or you can buy existing TIPS on the secondary market.
Individual TIPS make sense when you know exactly when you’ll need the money, want to guarantee a specific real yield to maturity, prefer owning the actual securities rather than fund shares, have large amounts to invest (minimum $1,000 at auction, often $10,000-25,000 minimums on secondary market), or want to build a TIPS ladder matching specific future expenses.
The complexity is higher—you need to understand inflation-adjusted pricing in secondary markets, handle semiannual interest payments yourself, track each bond’s inflation accruals for tax purposes, and manually reinvest interest payments if desired. But the benefit is complete control and guaranteed outcomes if held to maturity.
TIPS Ladders represent the most sophisticated approach, particularly relevant in light of the groundbreaking 2025 Morningstar research. A TIPS ladder involves buying individual TIPS maturing in successive years to match your planned withdrawals. For example, you might buy TIPS maturing in 2027, 2028, 2029, continuing through 2056 if building a 30-year ladder.
The Morningstar 2025 study found that a 30-year TIPS ladder supporting a 4.5% inflation-adjusted withdrawal rate had a 100% success rate over the study period—dramatically higher than the 3.9% “safe” withdrawal rate for stock/bond portfolios, and with complete inflation protection. This represented perhaps the single most important retirement research finding of 2025.
Current TIPS real yields of 2.0-2.2% make this strategy genuinely viable for the first time in 15+ years. A $500,000 portfolio could build a proper 30-year TIPS ladder generating $22,500 annually ($500,000 × 4.5%), with both the income and remaining principal adjusting automatically for inflation. At age 60, you’d have certainty about your inflation-adjusted income through age 90.
However, TIPS ladders require substantial capital ($250,000 absolute minimum, $500,000+ realistic), comfortable accepting complete portfolio depletion by age 90, tolerance for complexity (managing 30 separate bonds), acceptance that 4.5% might not cover all retirement needs (you’d need other income sources), and the discipline to hold to maturity rather than selling during market swings.
For most retirees, TIPS funds provide the optimal balance of inflation protection, simplicity, and liquidity. For younger retirees (60s) with larger portfolios, substantial inflation concerns, and 30-year time horizons, TIPS ladders warrant serious consideration, according to Morningstar research. For those with specific known expenses at specific future dates, individual TIPS can precisely match those obligations.
Tax considerations
TIPS present unique complications that make them better suited to tax-deferred accounts like IRAs than to taxable accounts.
The critical issue is “phantom income.” Each year, as your TIPS principal adjusts for inflation, that adjustment is taxable as ordinary income even though you don’t actually receive the money until the bond matures or you sell it. This creates a cash flow problem—you owe taxes on income you haven’t received.
For example, if you own $100,000 in TIPS and inflation runs 3% in a given year, your principal adjusts to $103,000. You owe federal (and possibly state) income tax on that $3,000 inflation adjustment, even though you only received the semi-annual interest payments. At a 24% federal tax rate, that’s $720 in taxes owed on phantom income.
Additionally, all TIPS income—both the interest payments and the inflation adjustments—is taxed as ordinary income at your marginal tax rate, not at the preferential capital gains rates. There’s no tax advantage like with municipal bonds (tax-free) or qualified dividends (0-20% rates). TIPS are fully taxable at ordinary income rates, which can reach 37% federal plus state taxes.
For these reasons, TIPS work best in IRAs, 401(k)s, or other tax-deferred accounts. The phantom income isn’t taxable annually because the entire account grows tax-deferred. You only pay taxes when you withdraw from the IRA in retirement, at which point you’re hopefully in a lower tax bracket. The inflation accruals compound tax-free within the IRA, maximizing their value.
In taxable accounts, consider holding nominal bonds or dividend-paying stocks instead. Qualified dividends enjoy preferential tax treatment (0-20%), municipal bonds are federal tax-free, and you have complete control over when you realize capital gains or losses. Save your IRA space for TIPS, which benefit most from tax deferral.
One exception: if you’re in the 0% or 10-12% federal tax bracket in retirement, the phantom income tax problem is minimal. The inflation adjustments get taxed at very low rates, making taxable account TIPS holdings more viable. But for most retirees in the 22-24% brackets or higher, keep TIPS in IRAs.
Should you invest in TIPS?
TIPS make sense for your portfolio if several conditions align. First, you’re concerned about inflation over your retirement time horizon. Second, you’re building or maintaining Tier 2 income and want inflation protection. Third, you have an IRA or 401(k) space to hold them tax-efficiently. Fourth, you’re willing to accept 2.0-2.2% real returns in exchange for inflation insurance. Fifth, you understand you’re protecting purchasing power, not maximizing current income.
TIPS work particularly well for retirees who lived through the 2021-2022 inflation spike and don’t want to experience that purchasing power erosion again, those with minimal equity exposure who rely heavily on bonds, anyone building a 30-year TIPS ladder strategy per the Morningstar research, people who won’t need to sell before maturity (can hold through interest rate volatility), or those wanting absolute safety with inflation protection.
They’re less appropriate if you need maximum current income (nominal bonds and dividend stocks yield more), you’re in high tax brackets holding in taxable accounts (phantom income problem), you expect deflation or persistently low inflation below 2%, you have very short time horizons (under 5 years), or you’re unwilling to accept 2.0% real yields when nominal bonds yield 4.5%.
The current environment makes TIPS more attractive than at any point in the past 15 years. Real yields above 2% provide meaningful growth in purchasing power. Inflation expectations appear reasonable at breakeven rates of 2.4-2.5%. The 2022 bond crisis reminded everyone that inflation can surge unexpectedly. Morningstar TIPS ladder research provides a compelling case for larger allocations.
For my situation—73 years old, 9 years into retirement, conservative risk tolerance, substantial concern about long-term inflation—maintaining 15% of my bonds in TIPS feels appropriate. It’s enough to provide meaningful protection if inflation averages 3-4% over the next 15-20 years, but not so much that I sacrifice current income. The remaining 84% of bonds generate the cash flow I need for spending, while the TIPS provide purchasing power insurance.
If you’re building your Tier 2 income portfolio today, consider TIPS as part of your bond allocation. Not 100%, but perhaps 15-30% depending on your inflation concerns, time horizon, and need for current income versus future purchasing power protection. At current real yields, you’re getting paid reasonably well for that insurance—far better than the negative real yields of 2020-2021 when TIPS buyers were paying for the privilege of inflation protection.