GIC (Guaranteed Investment Certificate) is similar to a savings account since deposits earn interest income. Most GICs can only be withdrawn after the term length while funds on a savings account can be withdrawn anytime. GIC term lengths typically varies from 3 months to 10 years.
Interest income are commonly received either every year or on the maturity date. Also, the initial capital are paid back on the maturity date after the term length of a GIC.
Generally, long term GICs (more than 1 year) earn higher rates than short term GICs (less than 1 year).
After the term length (maturity date), funds on a GIC can be withdrawn or reinvested to a new GIC with a different rate and term length.
2 Main Kinds of GICs
- Redeemable GIC
- Non-redeemable GIC
Redeemable GIC is also called a cashable GIC. Funds inside a redeemable GIC can be withdrawn anytime. Because of this, rates are a lot lower on a redeemable GIC. Rates on a redeemable GIC are similar to a savings account since funds on both accounts can be withdrawn anytime.
Funds on non-redeemable GICs can only be withdrawn after the term length of a GIC. For the most part, rates are higher for long term GICs (more than 1 year) compared to short term GICs (shorter than 1 year).
Rates are higher in a non-redeemable GIC. Most GICs are non-redeemable.
Key Summary about GICs
- Investments on a GIC earns a fixed rate of interest for a period amount of time which varies from 3 months to 10 years. After the term length, full amount of capital is paid back.
- Generally, long term GICs pays higher interest rates than short term GICs. Should rates rise in the future, GIC rates are fixed until a GIC matures.
- Earnings on an Individual GIC accounts are taxable while income from TFSA GIC accounts are tax free.
GIC Taxes
Interest income on a GIC account are taxable at your marginal tax rate, similar to employment income. However, income from GICs inside a TFSA and RRSP accounts are not taxable and exempt to taxes. RRSP withdrawals are taxable while TFSA withdrawals are not taxable.
Outside of TFSA and RRSP accounts, financial institutions may give a T5 statement (Statement of Investment Income) every year which includes the amount of taxable interest income received from a GIC. T5 statement is used to file tax returns on investment income.
Most financial institutions pay the same rates on a regular GIC accounts, TFSA GIC, and RRSP GIC accounts.
Deposits to an RRSP and TFSA accounts are limited up to a certain contribution limit. TFSA has a contribution limit of $6,000 on 2021. Visit this article I made for full comparison between TFSA, RRSP, and Personal (Individual) accounts.
Aside from GICs, stocks and mutual funds can also be invested inside TFSA and RRSP accounts.
GIC Real Life Examples
Assume I have purchased a 2 year GIC worth $15,000 that pays 1.00% interest rate on November 2021. On November 2022, I can receive $150 (1.00% of $15,000) interest income. When the GIC matures on November 2023, I will receive another $150 and the initial $15,000 capital is paid back.
Alternatively, I can choose to wait to receive the total interest income on the maturity date. After 1 year, the $150 interest income would be added to capital. The total interest income for Year 2 would be the 1.00% of $15,150. The total interests and capital would be received after 2 years on this second option.
Next, let us say I purchased a 6 month GIC worth $15,000 that pays 1.00%. The yearly interest income would be $150 (1.00% of $15,000). Since 6 months is half of a year, interest would also be in half.
In this case, $15,075 of interest and capital is paid back after 6 months.
Can you lose money in a GIC?
GICs are CDIC insured (Canada Deposit Insurance Corporation) as long as the financial institution is a CDIC member. In case of bankruptcy of a CDIC member firm, clients will not lose money up to a certain limit. CDIC insures up to $100,000 per account category per member firm.
GICs (Guaranteed Insurance Certificates) have fixed rates and the initial capital are fully paid back on the maturity date. Returns on other investments like stocks, mutual funds, and ETFs are unpredictable. Stock market can crash 20% or more in a year. (cdic.ca)
The worst case scenario for a stock is when a company goes bankrupt. Stock price becomes near $0 when a company go bankrupt. Sears stock and Hertz stock are a few examples of companies that have gone bankrupt in recent years.
CDIC Insurance
CDIC covers deposits in savings, chequing, and GIC accounts and term deposits. CDIC does not insure stocks, bonds, mutual funds, ETFs and cryptocurrencies.
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Some of the account categories covered are Individual, Joint, TFSA, and RRSP accounts. CDIC insures deposits up to $100,000 per each account category for each CDIC member firm.
GIC Accounts (Funding, How it Works)
Financial Institutions in Canada typically require a savings or a chequing account before opening a GIC account. A GIC account is opened after choosing a term length and funds are transferred from a savings or chequing account to purchase a GIC.
Multiple GICs with different term lengths can be invested at any one time. Interest income are paid out to a chequing or savings account every year or at the time of maturity. After the term length, funds can be transferred from a GIC account to a savings/chequing account.
Also, TFSA and individual accounts can have multiple GICs with different term lengths. For example, a 2 year GIC and a 3 month GIC can be held at the same time.
Most financial institutions require at least $100 or $500 minimum to invest in a GIC.
Disadvantages of a GIC
- Since GICs have little to no risk, GIC rates are lower compared to other investments like stocks, mutual funds, etc.
- Non-redeemable GICs can only be withdrawn at the maturity date while stocks and savings account can be withdrawn in a couple of days.
- Since rates on long term GICs are fixed, interest income will remain the same (even if inflation rise) until the GIC matures.
- Interest rates (on everything) in the past decade have been historically low compared in the past.
Generally, high risk assets have higher upside while low risk assets have lower upside potential. GICs, savings accounts, and bonds are commonly considered as low risk assets while stocks and mutual funds have higher risk and higher upside potential.
How Banks make Money on GICs
Banks make money by lending loans at a higher interest rate than the rates the bank paid for the money. For example, a bank may charge 5% for a car loan and only pay 2% on funds received from a GIC. In this scenario, the bank earns 3% interest.
Is a GIC better than a TFSA?
GICs, stocks, bonds, mutual funds, and other assets can be invested in a TFSA account. Most financial institutions offer TFSA GIC accounts where interest income in a TFSA GIC account is tax free. However, deposits to a TFSA account is limited up to a contribution limit ($6,000 on 2021).