Use Your TFSA or RRSP to Maximize GIC Returns

Andrew Hepburn
by Andrew Hepburn May 10, 2016 / No Comments

If you’re looking to buy a GIC, you’ll have to first figure out what kind you’d like. You can choose between long-term or short-term GICs and redeemable or non-redeemable ones. Most GICs are Canadian dollar-denominated but there are U.S. dollar ones as well.

Once you’ve made the decision about what product you’re going to buy, you’ll need to give some thought to where to put your GIC. Given that tax season has just ended, it seems appropriate to discuss the issue of GICs and taxation.

Simply put, you have two options: You can either place your GIC in a non-registered account or you can put it in a registered account such as a TFSA or RRSP. What you choose will have implications for when you (or your accountant) do your taxes in the future.

If you choose to own a GIC in a non-registered account, you’ll have to pay tax on all interest income at your marginal tax rate for the year in which the interest was earned. In contrast, if you own a GIC in a TFSA or RRSP, the interest earned can accumulate on a tax-free basis.

The obvious benefit to putting a GIC in a registered account is that the interest won’t be subject to tax. Moreover, many experts will tell you that because interest income is taxed at your marginal rate, it can be especially beneficial to shield it from the Canada Revenue Agency (CRA). Unlike capital gains, which receive favourable tax treatment from the CRA, interest income is given no such break.

For example, if you live in Nova Scotia and make $60,000 in 2016, your marginal tax rate is 37.17%. This is the tax rate you’ll pay on any GIC income in a non-registered account. Let’s say you earn $100 in income on your GIC. You’ll pay $37.17 to the CRA, leaving you with a net return of $62.83. The higher your marginal tax rate, the more you’ll pay, percentage-wise. Someone living in Nova Scotia earning more than $93,000 will pay 43.50% on any interest income.

Non-registered account Registered account
Interest income $100 $100
Marginal tax rate 37.17% 37.17%
Taxes owing $37.17 $0

 

So if you have room in a registered account, it’s a good idea to give serious thought to putting your GIC in it. You’ll avoid paying a fair chunk of interest income to the CRA when your taxes are due.

The situation becomes more complicated if you’re able to max out your RRSP or TFSA and have room left over for investments in a non-registered account. If this is the case, you’ll have to decide whether you want the GIC inside or outside a non-registered account.

On the one hand, placing a GIC inside a TFSA or RRSP will allow you to avoid paying the full marginal tax rate on your GIC income. But if that means you’re then placing an equity investment in a non-registered account, you’ll want to give some thought to the relative tax implications.

Mutual funds, index funds, or individual stocks are typically more tax-efficient because only 50% of a capital gain is taxable compared to 100% of interest income. On the surface, this would seem to make the case for putting these vehicles in a non-registered account and placing the GIC in the registered account.

However, you’ll probably make more money on something like an index fund compared to a GIC over the long run, especially in a low-interest rate environment. There are exceptions, of course. And there have been periods in history where the stock market has gone down or stayed flat for a decade.

But if you think your equity investments are going to outpace your GIC returns, you may want to put those products in your RRSP or TFSA. That way, if you end up having a substantial capital gain at some point, you won’t have to pay any tax on it yet (with an RRSP your taxes are deferred until you begin making withdrawals in your golden years).

Taxes aren’t a flashy topic, but it’s important when you’re managing your investments. So if you do have room in a registered account for a GIC, that’s definitely something to consider.

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Flickr: Alex Vakulenko


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