How Does a GIC Work?

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by Ratehub.ca August 6, 2019 / No Comments

Guaranteed Investment Certificates (GICs) are fairly popular in Canada. As an investing method, they’re some of the lowest risk investments available. The principal amount invested in a GIC is insured, as is the interest that it earns. This makes the investment a suitable option for investors with lower risk-tolerance profiles that prefer conservative investing; but how does a GIC work exactly?

GICs work a kind of relationship between an investor and the financial institution that issues the GIC. This article focuses on how GICs work, from the point of purchase until maturity.

GIC Definition

GIC stands for Guaranteed Investment Certificate. It’s guaranteed because the interest it earns is guaranteed prior to the investment.

GICs are also guaranteed by insurance. In Canada, GICs are protected with insurance that is issued by the Canada Deposit Insurance Corporation (CDIC), so long as the term deposit length is under 5-years and $100,000.

GIC CDIC insurance protects investors in the event that a bank or credit union goes out of business.

How Do GICs Work?

When a customer of a bank or credit union purchases a GIC, they’re lending their money to the financial institution issuing the certificate. The bank or credit union then lends that money to other customers at a higher interest rate, usually in personal loans or mortgages.

Since the money invested in a GIC is lent out, the funds are inaccessible until the end of the GIC’s term. The end of an investment term is known as reaching maturity. GICs withdrawn before maturity are often subject to a GIC early withdrawal penalty. Terms on GICs range between 30 days and ten years.

Generally speaking, the longer the money stays in an investment, the more interest it’s capable of earning. At the end of the GIC’s term, the financial institution returns the customer’s funds with interest.

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Where Can GICs Be Purchased?

GICs are purchasable through online, in-branch, broker purchase. All are great ways of purchasing GICs but come with their own terms, conditions, and, sometimes, costs.

Online

Purchasing GICs online is an excellent way of purchasing GICs. In many cases, you can compare the best rates on GICs in Canada and ensure that you are getting the highest interest rate possible. Buying GICs online comes with no fees and can be done in the comfort of your own home. You can, of course, purchase GICs on this website as well.

Deposit Brokerage

GIC brokers, like stockbrokers, manage your GICs. Also known as deposit brokers, GIC brokers are able to get you better rates. Brokers, often but not always, charge management fees, which can add up after paying taxes on interest. 

How are GICs Taxed?

GIC taxation works in a similar way that income tax does. The percent in which you are taxed on your income also applies to the interest gained on your investment.

However, placing your GICs in a Tax-Free Savings Account (TFSA) or in a Registered Retirement Savings Account (RRSP) will keep your interest tax-free—just make sure you remain beneath your TFSA contribution and your RRSP contribution limit.

Are GICs Worth It?

Whether GICs are worth it depends on the person asking. Since everyone has a different attitude towards investing, financial health, and, specifically, risk tolerance, the way people invest their money depends on personal preference. 

Considering that GICs are inaccessible during the term deposit, the investments are ideal for investors who have a solid financial foundation.

For example, if you have access to an emergency fund, GICs might make sense for you. Should you experience an emergency, your funds are easily accessible in an emergency fund.

GIC Laddering

If you like GICs but aren’t too fond of keeping your funds in an inaccessible account, building a GIC ladder might be a suitable option for you.

GIC Laddering involves placing your funds in several GICs with different terms. Doing this allows your funds to mature at different times and different rates.

For example, if you have $20,000 you’re looking to invest, a GIC Laddering strategy would allow you to split your funds five ways at $4,000 across a 1-year, a 2-year, a 3-year, a 4-year, and a 5-year GIC term.

This allows the investor to reconsider whether or not they want to re-invest their money.

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