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On money

TIPS bonds' value depends on inflation, interest rates

By HELEN HUNTLEY, Times Staff Writer

© St. Petersburg Times, published February 10, 2002

TIPS bonds' value depends on inflation, interest rates

Q. I never see anything written about the TIPS bonds the government was promoting for protection against inflation. How do they work? Are they a good deal?

A. Treasury Inflation Protected Securities, otherwise known as TIPS, are popular with insurance companies and many retirement savers. About $6-billion worth were sold at the Treasury's most recent auction in January. They don't get a lot of press because inflation has been under control, which means people are not terribly worried about it.

TIPS are Treasury notes sold in increments of $1,000. They pay a return in two forms: a twice-yearly interest payment based on a rate fixed at the time of purchase and an addition to principal based on the change in the Consumer Price Index. Both are taxed as current income even though you don't actually get the addition to principal until the note is sold or redeemed. This arrangement makes TIPS a better deal for people saving for retirement in tax-sheltered accounts than for retirees investing for income. Whether they are a great deal depends on what happens to inflation and interest rates while you own them.

You can buy TIPS directly from the government through the Treasury Direct program twice a year in January and July. Both are considered 10-year notes, although those purchased in July mature in 9.5 years. The notes also can be purchased on the secondary market through a brokerage firm any time. Information about Treasury Direct is available on the Internet (www.treasurydirect.gov) or by calling toll-free (800) 722-2678.

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Q. Recently I have received several invitations to attend a free seminar with lunch or dinner to discuss financial topics, including how to lower or avoid the tax on Social Security benefits. I am elderly and unable to attend these seminars, but I would like to know how it can be done. Can you explain?

A. Whether you are taxed on your Social Security benefits depends on how much other income you have. The "secret" to reducing that tax is to reduce your other income. The people running these seminars probably are selling annuities. If you buy an annuity with after-tax dollars, the payments you receive will be considered part income, part principal. The part that represents return of your own money is not really income so it does not count in determining the taxability of your Social Security benefits.

Does that make an annuity such as this a great deal? Not necessarily. One problem is that although it may be described as a "fixed" annuity, the interest rate often is guaranteed for a shorter period than the term of the annuity. After the guarantee is up, the insurance company can lower the rate it pays you, but if you don't like it, you usually have to pay a penalty to get your money out. Also keep in mind that annuities defer taxes, not eliminate them.

If you don't need the income, you could revamp your portfolio to emphasize growth rather than income or consider another tax-deferred investment such as U.S. savings bonds. If you don't need the income or the assets, you could give some money to your heirs, reducing the size of your estate.

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Q. I have a $10,000 loss on a security that I carried over from tax year 2000 to 2001. What happens if I can't use a full $3,000 of it on my 2001 tax return? Can I just use part and carry the rest over to 2002?

A. Don't fret. The law permits you to deduct up to $3,000 in capital losses against ordinary income each year, carrying over any excess. That means if your taxable income is so low that you can only use $2,000 worth of losses on your 2001 return, the extra $8,000 can be carried over to 2002.

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Online money map

If you're shopping for a mortgage or thinking about making extra payments to pay yours off early, check out the calculators at Mortgage Math (www.mortgagemath.com). Among other things, they'll permit you to compare renting to buying, figure out how much house you can afford and determine the impact of extra payments on the length of your mortgage.

-- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.

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