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How To Decide If You Should Get a Registered GIC

If you asked any investor what the one thing they hated most was, I’d wager a good portion would say “taxes”. There’s a reason that so many rich people go to great lengths to hide their money from the government using things like off-shore bank accounts.

Canada has higher tax generally than the States, with the highest marginal rate sitting at 54% in Nova Scotia. This doesn’t mean that all your money is taxed at 54%, but rather any income you make past $206,000 per year.

While certain investments are tax advantaged, such as capital gains or eligible dividends, income earned from interest payments is taxed directly at your marginal rate. That can make your real returns quite small on interest-earning investments.

It’s especially painful when your interest-earning investment doesn’t earn much to begin with. Guaranteed Investment Certificates are some of the safest investments on the planet, with your principal and interest completely guaranteed, but as a result they also have very low interest rates. And when you finally do get your returns, you have to pay anywhere from 20.05% to 54% of that return to the government!

One way around this is to keep your GICs in a registered savings account like an RRSP, TFSA, or RRIF. Any income generated within a registered account, whether it’s capital gains or interest, are never taxed. Withdrawals from RRSPs and RRIFs are considered as income, and taxed accordingly, but they’re not all taxed at your marginal rate like interest is. Withdrawals from your TFSA are never taxed.

 

What is a registered GIC?

“Registered” accounts are accounts that are specifically registered with the Canadian government under a certain tax exemption plan. They’re all used for different purposes, but two things they have in common are their tax-exempt status (so long as you don’t withdraw) and the fact that there are rules about how much you can deposit and withdraw.

RRSPs, for example, reduce your taxable income whenever you make a contribution. But early withdrawal from an RRSP is met with a hefty tax bill. TFSAs are never taxed, but you don’t get a tax break when you deposit in one.

You can keep nearly any kind of investment inside of a registered account: cash, stocks, bonds, ETFs, and more. You open up a registered account and then use it to purchase whatever investment you’d like, including GICs.

You can’t first buy a GIC and then say afterwards that it’s intended for your RRSP. It must be designated as an RRSP GIC before you purchase it. You must also insure that you have enough contribution room in your RRSP or TFSA before you buy a registered GIC.

 

What’s the difference between a registered GIC and a non-registered GIC?

The main difference between registered and non-registered GICs is the tax burden. Registered GICs earn tax-free interest, so you get to keep 100% of the returns. Non-registered GICs are taxable, and any returns you get are taxed at your marginal tax rate.

But something else to keep in mind is that registered GICs also sometimes have lower interest rates than non-registered GICs. Some institutions won’t even offer registered GICs at all (and those institutions may have amazing GIC rates). However, lower rates are almost always made up for by the lack of taxation.

 

RRSP GICs

RRSP stands for Registered Retirement Savings Plan, and is the most well-known and most used registered account in Canada.

You can only contribute 18% of your income per year up to a cap. Any unused contribution room from previous years gets carried over indefinitely, so you can always save that room for later.

The fact that your contribution room is based on your income means that when you’re starting out in your career, you won’t get much contribution room every year. For example, if you made $20,000 working part-time then your contribution limit for that year would be just $3,600. However, if you make $60,000, you could contribute up to $10,800 for that year.

It’s not likely that you’ll be able to save 18% of your income every year, so the fact that you get to carry forward unused contribution room forever is useful. You can wait for a year that you have a lot of excess income and are in a higher tax bracket and greatly reduce the amount of tax you owe (usually resulting in a sizable refund).

If you withdraw from your RRSP before retirement, you face something called the withholding tax. Depending on how much you withdraw, you’ll immediately lose a percentage of it. Below is a table for your reference:

Amount Withdrawn

Withholding Tax Deducted

Up to $5,000

10%

$5,000 to $15,000

20%

Over $15,000

30%

 

But you don’t have to take out your RRSP GIC when it matures. You have a couple options. The first, and easiest, would be renewing your GIC with the same institution that you had the GIC with originally. There’s no fees or taxes for doing so, and you can go right back to earning interest.

The second option is to invest the money into a different account at the same institution, if they allow it. You don’t have to withdraw it, and you can put the money into riskier, but more rewarding, investments.

Finally, you can transfer it to another account at a different institution. Your current institution may charge you some fees for transferring out, but you aren’t taxed on the transfer.

 

TFSA GICs

There’s a lot of debate as to whether your Tax-Free Savings Accounts (TFSA) is a good place to hold your GICs. Since you never pay any tax on any investments in a TFSA, including interest, an argument could be made that GICs should definitely be held inside them, as you’ll reduce your tax burden the most.

On one hand, interest income is the most heavily-taxed form of investing. Other forms of investment income, like capital gains or dividends, are taxed more favourably. If you made $1,000 through interest and another $1,000 through selling stocks, you would keep more of the money you made from stocks after taxes every time.

One the other hand, GICs have very low interest rates, especially when compared to the possible returns on other, riskier investments. The argument that you should hold GICs in your TFSA assumes that you’ll earn an equal amount on GIC interest as you would with your other investments.

Let’s say you make $1,000 from a GIC and another $1,000 from selling stocks and your marginal tax rate is 29.65% - the rate for a single Ontarian making $50,000 a year. If neither of those accounts are registered, you’d have to pay the following taxes:

Account

Tax Owed

GIC

$296.50

Stocks

$148.25

 

Total tax owing = $444.75

By putting your GIC in a TFSA, you would save $296.50, which is double the tax owed on capital gains.

But in order to earn $1,000 in interest at the best TFSA GIC rate of 3.00% you’d have to invest $33,333 for 5 years. At the end of the 5-year term, you’d have earned $5,000 and saved $1,482.50 in taxes.

Instead, if your stocks increased in value by 6% per year, you’d only have to invest $16,667 to make $1,000 in one year. By investing $30,769 into stocks or ETFs, you take a higher risk, but could earn nearly $800 more!

Unless you’re completely terrified of losing money, or you are nearing retirement age, more of your portfolio should be in equities than in fixed income because of the potential for growth.

 

RRIF GICs

Registered Retirement Income Funds (RRIFs) are converted from RRSPs whenever you want, otherwise automatically at 71. One key difference between an RRIF and an RRSP is that you can’t make any additional contributions to an RRIF after it’s been made. You can hold multiple RRIFs, but can’t contribute money to any others. In addition, since you can’t open an RRSP after 71, it effectively means you can’t make any more contributions to any of your RRIFs after 71.

RRIFs require you to withdraw a certain amount of money annually, which increases every year. There are no maximum withdrawal limits. Like RRSPs, you don’t pay any tax on the gains, just on your withdrawals, which are considered income.

When a GIC matures while inside an RRIF, you can reinvest it however you like, whether that’s in equities, another GIC, or even just leaving it as cash. You can’t make any more contributions to an RRIF but you can invest the money within like you would with any other account.

 

Should I get a registered GIC?

If you have a lot of money to invest, it can often be better to use your TFSA to invest in riskier investments than GICs because of the growth potential. If your portfolio has a reason to have large amounts of fixed-income assets like GICs, such as you’re nearing or over retirement age, it makes more sense to have GICs in your registered accounts.

Whatever your decision, be sure to check the best GIC rates before you purchase a GIC so you know you’re getting the most money.


Chris Chris 01/26/2019
Canadian personal finance buff and all-around writing enthusiast, Chris loves breaking down complicated money ideas to show that they're really not so complex. 
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