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What is a GIC?

GIC stands for Guaranteed Investment Certificate. These differ from normal investments in one very specific way – your initial investment and the returns are guaranteed.

“Guaranteed?” You might ask.

Yes, guaranteed.

The way it works is simple. You agree to invest a certain amount of money for an agreed-upon length of time, ranging from 30 days to five years. At the end of the term, you receive your initial investment plus the interest accumulated at the rate you agreed to at the start of the term.

 

Shorter Lengths Means Lower Rates

While you can opt for a GIC for as little as 30 days, the interest rate will be quite small. On the low end, you’re looking at 0.2%, while at the high end, you’d net 1.15% (according to the best GIC rates on RateShop.ca right now).

Those rates are lower than some of the best high-interest savings accounts in Canada, which means you can earn more by saving the money in a bank or credit union instead of with a 30-day GIC.

Going from 30 days to 1 year, you’ll see rates rise from 1.15% to 2.9% - nearly three times as much! Finally, with a 5-year term you’d be earning 3.5% in interest.

 

How is interest calculated?

Interest is calculated as a percentage of the purchase value of the GIC. GICs are typically compounding assets, but some may be paid out annually instead of compounded. What does that mean?

When you compound interest, you take the amount you earned and put it back into the investment. So if you invested $10,000 and earned 1%, you would warn $100. The next year, you would earn 1% interest on $10,100, making you $101 – not a large increase, but significant.

If you were earning 3.5% on that $10,000 instead, you would earn this much per year:

 

Total Amount

Interest Earned That Year

1st year

$10,350.00

$350.00

2nd year

$10,712.25

$362.25

3rd year

$11,087.18

$374.93

4th year

$11,475.23

$388.05

5th year

$11,876.86

$401.63

 

As you can see, the longer you stay invested the more you earn in interest per year. That’s the power of compounding!

If the GIC paid out annually instead, you wouldn’t earn any additional interest. Your return would always be the same – the rate you got multiplied by the amount you invested.

 

Total Amount

Interest Earned That Year

1st year

$10,350.00

$350.00

2nd year

$10,700.00

$350.00

3rd year

$11,050.00

$350.00

4th year

$11,400.00

$350.00

5th year

$11,750.00

$350.00

 

If you chose to get paid out annually, you would earn $126.86 less than if you had chosen to compound.

 

So what’s the catch?

That depends on the type of GIC you purchase, and what your definition of a “catch” is. A fixed rate low interest GIC has no catch. You will get your money, absolutely guaranteed, at the end of the term: no ifs, ands, or buts. Even if the institution goes under you’ll still get your money, because GICs are insured by the Canadian Deposit Insurance Corporation (or provincial equivalent for credit unions). If you buy a variable rate GIC, you risk the interest rate dropping; your principal is still guaranteed, however.

The biggest downside with investing in a GIC is the opportunity cost of investing. A GIC has a low rate of return by design. You’re not taking a risk, so you don’t reap much of a reward. When you invest in a GIC, you’re not investing in something that could potentially have a substantially higher rate of return. This is good for when you can’t afford to lose money, but if you can, you’re potentially leaving money on the table.

Having a stable, guaranteed investment can offer peace of mind to risk-averse investors. GICs often offer higher interest rates than savings accounts, even if not by a large amount. So long as they outpace inflation, which is expected to be 1.79% this year, then they can be a great place to park your money safely.

The best way to offset the opportunity cost of GICs is to form a GIC ladder. Read more about GIC ladders here.

 

Redeemable vs. Non-redeemable

When you buy a GIC, you’ll have the option of deciding between a redeemable (or cashable) and non-redeemable (non-cashable) GIC.

A redeemable GIC allows you to withdraw your money at any time, while non-redeemable GICs do not. A redeemable GIC may function in one of two ways:

1.      Have a lower overall interest rate

2.      Have the same rate as a comparable non-redeemable GIC, but reduce the rate upon early withdrawal

It’s more common for redeemable GICs to simply have a lower overall rate.

Some non-redeemable GICs may allow for early withdrawal, but penalties range from a lower interest rate to forfeiture of interest earned up until that point. If you’re investing in a non-redeemable GIC, be sure you won’t need the money.

 

GICs and Taxes

It’s also important to remember that you’re taxed on the income earned in GICs if they’re kept in a non-registered account.

GICs pay interest income, which, unlike capital gains, are not tax-advantaged. You’re taxed on the interest at your marginal, or highest, tax bracket.

For example, let’s assume you invested $5,000 in a 5-year GIC with an interest rate of 3.5%. With compounding interest, you would earn a total of $938.43 in interest at the end of the term. Let’s see how different levels of income affect your real return after paying taxes. (Tax rates are based on Ontario tax brackets)

 

Taxes Owed on a 5-Year GIC

Income

Marginal Tax Rate

Tax Owed

Real Return

$30,000.00

20.05%

$188.16

$750.28

$50,000.00

29.65%

$278.24

$660.19

$80,000.00

31.48%

$295.42

$643.01

$100,000.00

43.41%

$407.37

$531.06

 

This tax could be avoided completely if you were to put your GIC in an RRSP or TFSA; however, you have a limited amount of contribution room. As riskier investments give better returns, they also have a higher tax burden on sale – keep that in mind when creating your financial portfolio.

 

 

 

 

Because you want as high an interest rate as possible, it’s a good idea to shop around for different GICs. Credit unions, often forgotten by consumers, are also insured by CDIC, so GICs from them are just as safe as GICs from banks.

 

 

 


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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