GICs get a bit of a bad rap in the investment world. They’re not as flashy or as exciting as equities or stocks — nor do they come with the same kind of volatility — so some may label them as a boring, steady eddy kind of investment. Let’s face it; everyone needs a bit of that to build a balanced portfolio.
There are two main types of Guaranteed Investment Certificates (GICs), registered and non-registered. Registered GICs are meant to be invested in a registered account such as a Registered Retirement Savings Plan (RRSP), a Tax-Free Savings Account (TFSA), a Registered Education Savings Plan (RESP), or a Registered Retirement Income Fund (RRIF).
Registered GICs will grow tax-free in these types of accounts. But the income gained will be taxed at the holder’s marginal tax rate when they withdraw the funds (normally this occurs when your RRSP reaches maturity, on the last day of the calendar year you turn 71). However, if you withdraw funds from an RRSP prior to maturity, the money will also be subject to a withholding tax of 10% to 30% depending on how much you take out. Funds from a TSFA don’t have a withholding tax, as they are tax-free in the account and upon withdrawal.
Non-registered GICs are invested outside of those kinds of registered accounts and instead in a regular unregistered investment account. The income from these GICs will be taxed at the holder’s marginal tax rate (a person’s combined federal and provincial tax rate, which ranges depending on the province you live in, from about 20% to 50% depending on your overall level of income).
So, which is the right type of GIC for you? That depends on your investment goals, what you are earmarking that money for, and when you need the money.
- What Are the Pros and Cons of GICs?
- What Kinds of GICs Are There?
- How Long Do You Have to Hold a GIC?
- Tax Implications
What Are the Pros and Cons of GICs?
Before we compare the types of GICs, let’s take a look at the basic features all GICs incorporate.
The pros of GICs include:
- They have a guaranteed or predictable return.
- They are a low risk and less volatile investment.
- Your principal is protected.
- A low initial investment is required as you can open one with as little as $100.
- GICs are protected by the Canada Deposit Insurance Corp. (CDIC), which protects an investor’s deposits in savings and chequing accounts and GICs up to $100,000.
The cons of GICs include:
- Lower rates of return compared to investments such as stocks as GIC rates of return range from 1.3% to about 3%. RateSupermarket.ca can help investors search for the best rates based on the type of GIC.
- Your money may be locked in for a certain amount of time, or you face penalties to withdraw earlier.
- Over a longer-term (5 years or more), the inflation-adjusted return of your investment may decline due to a rising rate of inflation. In other words, the purchasing power of your money may not keep up with inflation.
What Kinds of GICs Are There?
There are a slew of different kinds of GICs. Some non-registered GICs are more flexible than others, so you can take your money out when you need it, while others require you to keep it locked in to earn the interest promised. Registered GICs are less flexible and are most advantageous when the funds remain in the registered account without being withdrawn.
Here are some of the different types of GICs you can invest in:
- Cashable GICs: These are GICs that don’t lock in your money and let you take it out when you want to without penalty.
- Non-cashable GICs: These are GICs that cannot be redeemed until the term expires or a penalty applies.
- Redeemable GICs: These GICs allow you to redeem them early at various rates.
- Fixed-rate GICs: These GICs have a fixed investment return over a certain period.
- Variable-rate GICs: These GICs are tied to a bank’s prime rate and may fluctuate depending on changes to the bank’s rate.
- Rising rate GICs: These are GICs that have a rate that increases over time, such as a rise in the rate every year it’s held.
- Market linked GICs: The performance of these GICs is tied or linked to the equity market or certain stock or bond indexes. If the market rises, the GIC earns more, but if it falls or stays flat, there is a chance the GIC won’t rise in value.
How Long Do You Have to Hold a GIC?
That depends. Short-term GICs can be as short as three months or six months.
Longer-term GICs are for one, three, five or even as long as 10 years.
Usually, the longer you hold the GIC, and the more restrictive the rules to get your money out, the better the interest rate you’ll receive.
Ratesupermarket.ca can help you find out the best rates for various GICs, both registered and non-registered.
The key issue to look at is the tax implications of each kind of GIC.
A registered GIC will be sheltered from tax as it grows in an RRSP, RESP, or RRIF. However, it will be taxed when you withdraw that cash from the registered account. Hopefully, that isn’t for a long time as an RRSP is meant to hold retirement funds until retirement.
At that point, the strategy is that your income level is lower in retirement, and therefore, so is your tax rate. When you do withdraw funds from your RRSP (or RRIF after age 71), you will pay tax at your highest marginal rate because a GIC earns interest income, and the Canada Revenue Agency (CRA) taxes interest income at your current marginal tax rate.
If you need the money soon, then putting it in your RRSP is not the best option for you. In your RRSP, you can purchase a longer-term GIC, which can earn you more income that’s sheltered until withdrawal.
In a TFSA, you can withdraw the money from at GIC upon maturity, tax-free. The growth of investments in your TFSA is not taxed upon withdrawal like an RRSP.
In an RESP, it’s best to leave the money in this account until you withdraw funds to finance your child’s education, or there are penalties involved. However, you can plan the length of time before the start of school for your child to determine the best amount of time to hold a GIC in that account.
You should not withdraw the fund from an RESP until a child is at a post-secondary education institution. At which time, the student’s income will determine the tax on the funds, which should be a low tax bracket.
In an unregistered account, the interest income earned by a GIC is taxed when it’s received, at your highest marginal rate. Again, which depending on your overall level of annual income, can be anywhere from 20 to 50%.
Interest income is best earned within a registered account due to the more favourable tax treatment until withdrawal.
The Final Word
GICs are a great part of an overall investment portfolio as they are a less volatile investment and can be part of the fixed income portion. They help reduce volatility and provide income when equity investments may decline. They are a secure way to invest funds but do your research, so you choose the right kind of GIC, whether registered or non-registered, to help you meet your financial goals.