TIPS

Treasury Inflation-Protected Securities — state tax-exempt.

TIPS adjust their principal based on the Consumer Price Index (CPI), providing inflation protection.

How TIPS Work

Real Yield (fixed at auction) + Inflation Adjustment = Total Return

Tax Complication: Phantom Income

The inflation adjustment to principal is federally taxable in the year it occurs, even though you don't receive the cash until maturity. This creates "phantom income" — you owe tax on money you haven't received.

Tax Treatment

Component	Federal	State
Coupon interest	Taxable	Exempt
Inflation adjustment	Taxable (phantom income)	Exempt

Best practice: Hold TIPS in tax-advantaged accounts (IRA, 401k) to avoid annual tax on the inflation adjustment. In taxable accounts, consider I-Bonds instead (tax-deferred).