"The tax treatment is similar to that of zero-coupon bonds or original-issue discount bonds in that the increased value is taxed as 'phantom' income, even though the holder has not received cash for the inflation adjustment," explained FRC's Dow. In a sense they are saying the same thing except why does he say the funds like Vanguard pay out a "phantom" income when they pay out a REAL quarterly inflation adjustment and dividend? I thought this "phantom" income only applyed to the actual TIPS? I suspect it's just this "FRC's Dow" making a mistake of some sort. Even if there were "phantom income", one could always just redeem the fund shares equivalent to this income to materialize it. To achieve the same outside of a fund, one would have to sell a bond, which is a much more distasteful experience: not only would one have to cash in entire bonds at a time ($1000 face value; more with the inflation adjustment; even more if your broker has larger minimums), but the relatively slow market in TIPS will help ensure you take a sizable loss on the bid/ask spread.Outside of a tax-deferred account, I-Bonds might be a reasonable alternative to TIPS, especially in the higher tax brackets. The tax deferral abilities of I-Bonds might well make up for their lower real yields, compared to TIPS, if held for a long time.
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