What are TIPS and how do they protect against inflation?

TIPS – Treasury Inflation-Protected Securities – are government bonds whose principal rises with inflation, as measured by the Consumer Price Index. Because your interest is paid as a fixed rate on that growing principal, both your interest payments and your final payout climb when prices climb, preserving purchasing power. If deflation occurs, you still get back at least your original principal at maturity. TIPS differ from I-bonds in important ways: you can buy unlimited amounts, they trade in brokerage accounts and TIPS funds, and they come in 5-, 10-, and 30-year maturities. One quirk for taxable accounts is 'phantom income' – the annual inflation adjustment to principal is taxed federally even though you don't receive it until maturity, which is why many investors hold TIPS inside an IRA. They're a core tool for retirees worried about inflation eroding fixed income.