The principal of TIPS adjusts with inflation and interest is paid on that inflation adjusted amount. You are correct.
However, TIP is not TIPS. TIP is a bond fund that holds TIPS. It is not the same thing.
From the Prospectus:
"Adjustments for inflation to the principal amount of a U.S. inflation-protected U.S. Treasury bond held by the Fund may be included for tax purposes in the Fund's gross income, even though no cash attributable to such gross income has been received by the Fund. In such event, the Fund may be required to make annual distributions to shareholders that exceed the cash it has otherwise received. In order to pay such a distributions, the fund may be required to raise cash by selling portfolio investments."
Taxes are owed on the inflationary gains of TIPS bonds each and every year. In order for TIP shareholders to pay the tax on the inflationary gains, the gains must be distributed. That's how I read it anyway.
One need only look back through the distribution history to see verification of this. TIP made large payments when the CPI was running very hot (inflationary) and zero payments when the CPI was running very cold (deflationary).
Here's another way to look at it. If interest was the only thing distributed by TIP then there would be virtually no distributions. The real yield of the fund (0.21%) minus the fund's expenses (0.20%) is just 0.01%. 0.01% of today's $101.78 is $0.01. Clearly TIP pays more than a penny in distributions each year. The only way this makes sense at all is if the distributions are almost entirely inflationary gains.
I have a decent understanding of how the TIPS are supposed to work...
My understanding is that the underlying securities' principal goes up in lock-step with the CPI; in other words, let's say a bond is worth 100 and the rate on it is 2%. If CPI goes up 2.5%, the bond's "worth" increases to 102.50 and it is upon that principal that the 2% is multiplied against. You can see where this doesn't really mean that the return on the TIPS is "additive" - that is, the rate doesn't suddenly become 4.5%... Can you verify that this is actually how the individual TIPS making up the TIP fund work?
Two dividends over 50 cents in April and May and now this jump over a dollar.....what is driving this?? Not that I am complaining mind you.....but are we looking at going back to something more like 25 cents in the months ahead???