Indexed Treasury Bonds

Indexed treasury bonds, also known as inflation-indexed treasury bonds, came about because Congress wanted the U.S. Treasury Department to issue out some of its debt in the form of a bond. These bonds were given to individuals and were designed to cut out the rate of inflation on an investment. With an inflation indexed treasury bond, both the investor and the one who issued the bond are both protected from the rising cost of inflation for the duration of the bond. Unlike other types of bonds, the interest and maturity value of an indexed treasury bond are adjusted by the rate of inflation during the bond's term. This keeps the bond's value current with inflation and is thus less risky for conservative investors.

Indexed treasury bonds were introduced by the U.S. Treasury in January of 1997. They are bought at face value and have a maturity of varying years, although the most common is ten years. There are also no fees associated with indexed treasury bonds. Like regular conventional bonds, also called nominal bonds, indexed bonds pay interest at fixed intervals. The main difference between indexed treasury bonds and more conventional bonds is that payments on conventional bonds are set in nominal dollars. Indexed bonds are set in real terms using the current inflation rate. This is why conventional bonds put investors at risk due to inflation.

Taxes on indexed treasury bonds are not paid until the bond reaches maturity and is redeemed. So until that time comes, the tax on both the interest and the principle can be deferred. Even after the bond is cashed out, you can still get a break on the taxes if the bond was used for educational purposes. The indexed bonds are best for investors who are conservative and do not like to risk their money on the ups and downs of the stock market nor want their principle value to be reduced by inflation. The problem, however, is that while the bond's principle amount is indexed to the rate of inflation, a tax must be paid for every dollar of inflation that the bond is not subject to. So in the end, investors might actually be paying twice the amount of tax as a conventional bond.