Time to buy inflation protection? -- Page 2

CDIPs pay a stated, fixed interest rate just like a traditional CD, but interest is paid semiannually on the inflation-adjusted principal. Just as with TIPS, if inflation occurs throughout the time you own the CDIP, your interest payments will rise as inflation rises and, at maturity, you'll receive an inflation-adjusted principal.

As with traditional CDs, they're FDIC-insured.

Newly issued CDIPs can be purchased each week through financial advisers, LaSalle Bank or Standard Federal Bank. CDIPs are available in $1,000 denominations, and are offered in five-year and 10-year maturities.

CDIPs have a survivor's option. If you die, your heirs can return the CDIP to the bank and receive the fully accreted value.

As with TIPS, you're taxed annually on the inflation adjustments to the principal, even though you don't receive the money until maturity. CDIPs are subject to federal and state taxes, and local taxes, if applicable.

Unlike many brokerage CDs, CDIPs are not callable, but a commission is built into the price you pay for the CDIP.

"TIPS have been incredibly successful, but my read is that the vast majority of TIPS purchases have been done by the institutional market -- money managers, pension funds and mutual funds," says Patrick Kelly, managing director at LaSalle Broker Dealer Services Division in Boca Raton, Fla.

"We're trying to provide a solution. You get the product, you get FDIC insurance, you can buy a $1,000 CD with the same structure, same features and [not pay a premium]. We're taking a successful product and delivering it to Main Street in a CD form."

Inflation-Protected InterNotes
IPIs (pronounced "Ippies") are inflation-protected corporate bonds issued under the InterNotes program, which is designed to make individual bond purchases easier for individual investors.

With IPIs it's the interest payment that is adjusted for inflation; the adjustment is pegged to the CPI. The coupon, or interest payment, has two components -- a fixed amount, which is stated when you buy the bond, and an inflation-adjusted amount that is calculated monthly. Interest is paid monthly.

The principal remains the same; at maturity you receive the amount you invested. Because of this, investors don't have to worry about paying tax on phantom income.

IPIs are available at par, which is $1,000. A commission is built into the price you pay for the bond.

Check with your brokerage firm or visit www.internotes.com to see which companies are offering IPIs. Some IPIs come with the survivor's option.

"We surveyed 1500 brokers. Of the ones that sold TIPS, 70 percent said they'd like other inflation-protected products," says Tom Ricketts, CEO of Chicago-based Incapital. "The number one problem with TIPS is they're too complicated because of the tax issues. Also, the yields are low. Corporate bonds will have a higher yield because of the risk. We've redesigned the process."

I bonds
I bonds are a U.S. Treasury product. The earnings rate is a combination of two separate rates -- a fixed rate of return that is good for the life of the bond and a semiannual inflation adjustment. The Treasury announces the fixed rate of return and the semiannual inflation adjustment every May and November. The fixed rate you receive depends on when you buy the bond. The inflation adjustment you receive when purchasing the bond is good for six months and may change every six months afterward.

Be aware that you must hold an I bond for at least 12 months, and if you cash out in less than five years, you'll forfeit three months' interest.

For more on I bonds, click here.

Which option to use?
So, how can you determine which of these investments might be best for you? Bankrate.com's senior financial analyst, Greg McBride, says they're all good options, so you should decide based upon your needs.

"InterNotes are good for someone who's a little more cash-flow dependent; perhaps a retiree who depends upon regular interest income to meet expenses. But they'd have to be comfortable with the added risk of relying on unsecured corporate debt that's subject to the credit risk of the company.

"CDIPs and TIPS might appeal to someone who wants to put a down payment on a house in three years. They want to preserve the principal and its purchasing power. They're not dependent on the coupon payments to meet expense. They're content to wait until maturity to realize the full value."

McBride says the differences as to how inflation is accounted for shouldn't be the primary consideration for investors who are weighing their inflation-protected options.

"If the CDIPS pay enough of a premium over TIPS or the I bond to compensate for having to pay state and local taxes, and the InterNotes offer a high enough return that you can take on the credit risk that doesn't exist with TIPS, the I bond or the FDIC-insured CDIPs, then the decision is largely one of liquidity preference."

McBride says the I bond is a good consideration in the same scenarios as CDIPs and TIPS, but he cautions that the fixed rate of return is the only guarantee. Consumers who purchase an I bond for the long haul should focus on that number rather than the variable inflation adjustment.