The U.S. Treasury is offering a reissue of CUSIP 912828QV5, which originally auctioned on July 21, 2011, with a yield to maturity of 0.639%. This TIPS has a coupon rate of  0.625% and will mature on July 15, 2021. The auction will close Sept. 22 at 1 p.m.

If you are looking to buy this Treasury Inflation-Protected Security, remember that the yield to maturity is set at the auction. It is likely to be well below the coupon rate of 0.625%, meaning that you will pay more than $1,000 for $1,000 of this reissue. In addition to base yield, the principal of a TIPS continues to rise with inflation until maturity.

What is the likely yield to maturity? Because this TIPS was first issued in July and trades on the open market, you can get a good idea of the likely yield. As of Monday, that yield was 0.047%. You can use this chart to check the yield daily (look for the issue with a maturity of 2021 Jul 15).

Is that an attractive yield? No. It will be a record low yield – by a wide margin – for any 9- to 10- year TIPS ever auctioned. The current record low is 0.409%, set in July 2010 just before the Fed launched QE2. (I posted a chart recently showing all 10-year auctions in history, check it out.)

Will yields keep falling? They certainly won’t keep falling. They will rise, but the question is: When? And what is the lowest they can go? Some experts say that the 10-year TIPS base yield rises along with the U.S. Gross National Product. A yield near zero seems to indicate investors are very pessimistic about the U.S. economy.

To get an idea of the decline, look at this TIPS being reissued Sept. 22. It was first issued two months ago, on July 21, and it went off at a rate of 0.639%. In two months, that rate has fallen to 0.047%, a drop of 59 basis points. In January 2011, 9 months ago, a 10-year TIPS was auctioned at 1.170%. That is 112 basis points higher than this week’s likely yield.

Incredible. But the near-term history shows that TIPS rates could turn around very quickly, rising to ‘more-normal’ rates of 1% to 2% for a 10-year TIPS. When that happens, TIPS will be much more attractive.

Nevertheless, the rate trend is currently down and has been for all of 2011.

The tax issue. Since this TIPS will pay almost zero as its base interest rate, investors will get very little cash flow from it. The principal does rise with inflation, but it is taxed as income in the year it was added. So that means this 10-year TIPS will have negative cash flow (near-zero base interest minus taxes owed) until maturity.

This wouldn’t be an issue for a TIPS held in a tax-deferred account.

Are there better alternatives? One investment stands out for the small investor: I Bonds. If you haven’t bought I Bonds this year, you can still buy $5,000 in Treasury Direct and $5,000 in paper bonds. A couple can buy twice that. (Paper bonds will no longer be issued after Dec. 31, except as a tax refund.)

1. I Bonds currently pay a base rate of zero percent, plus a second rate based on inflation. The current inflation-adjusted rate is 4.6% for half a year, which guarantees that an investor will earn 2.3% (probably more) for the required 1-year holding period. (That 4.6% rate will change on Oct. 31, and probably fall a bit. If you buy before Oct. 31, you will get the 4.6% for six months.)
2. I Bonds can be sold after one year with a three-month interest penalty, and after five years with no penalty.
3. Interest payments on I Bonds are not taxed until the bond is redeemed, which can be 30 years from when they are purchased. That is a huge advantage over TIPS.
4. Because of that tax advantage, I Bonds traditionally offer a base interest rate about 1% lower than a 10-year TIPS. But since I Bonds cannot go below a zero interest rate, the advantage shifts powerfully to I Bonds when TIPS are paying near zero.
5. I Bonds are a much easier investment to keep track of. There are no yearly taxes due, and you can track your investments with the Savings Bond Wizard.

I Bonds versus TIPS. I have been a frequent buyer of TIPS in the last 12 months. The strategy was to move money out of a higher stock market and into the super-safe portion of my portfolio. Since July, the stock market has corrected somewhat and TIPS yields have fallen sharply.

TIPS have lost some of their appeal at these rates.

I Bonds are the clear choice for the first $10,000 to $20,000 you are seeking to place in a super-safe investment.