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How Does a GIC Work?

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As inflation continues and market conditions remain turbulent, some Canadians are expressing a renewed interest in Guaranteed Investment Certificates (GICs). While they may have previously been thought of as a low-risk but low-payoff investment option, the recent hike to interest rates nationwide has allowed GICs to offer better earnings to customers, even for short-term investments. Fixed-rate GICs ensure the principal amount as well as the interest that it earns, making them a great option for investors with lower risk-tolerance profiles that prefer conservative investing, but how does a GIC work exactly?

 

What is a GIC?

A GIC (or Guaranteed Investment Certificate) is an investment product that can be purchased from a bank or another financial institution for an agreed-upon term and interest rate. The name "GIC" signifies that your principal investment is guaranteed to be returned to you at the end of the term, along with the specified interest rate, regardless of market conditions. This means that even in the unlikely event of your financial institution going out of business, your money will still be protected.

Providers are able to offer this guarantee because GICs are insured by either the CDIC (Canada Deposit Insurance Corporation) or the province where the GIC was purchased. GICs covered by the CDIC are insured for up to $100,000, while the coverage for GICs with provincial insurance can vary depending on the province.

 

How Do GICs Work?

When a customer buys a GIC from a bank or credit union, they are essentially lending their money to the financial institution that issues the certificate. The bank or credit union then lends that money to other customers at a higher interest rate, typically through personal loans or mortgages.

Since the funds invested in a GIC are used for lending purposes, they cannot be accessed until the GIC reached maturity, which marks the end of the investment term. Withdrawing money from a GIC before it matures often incurs an early withdrawal penalty. GIC terms on GICs range from 30 days to ten years.

In general, the longer the money remains invested, the more interest it can earn. At the end of the GIC term, the financial institution returns the customer’s funds along with the accrued interest.

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Where Can GICs Be Purchased?

GICs can be purchased online, in a branch or through a broker. Each option has its own terms, conditions, and sometimes costs. 

  1. Online: Buying GICs online is a smart method because it allows you to compare the best rates in Canada and ensure you get the highest yield possible. There are no fees associated with buying GICs online, and you can do it from the comfort of your own home.
  2. Deposit Brokerage: If you prefer to have an experienced professional find you the best rate and term length for your GIC, you can hire a deposit broker. Brokers work for your bank and may be able to secure a better rate than if you purchased a GIC on your own. However, keep in mind that some brokers may charge management fees that can reduce your earnings. 

 

How are GICs Taxed?

GIC taxation is similar to income tax. The interest gained on your GIC investment is taxed based on your income tax rate. However, if you hold your GICs in a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Account (RRSP), your interest will remain tax-free. Just make sure you stay within your TFSA contribution and your RRSP contribution limits.

 

Are GICs Worth It?

The worth of GICs depends on the individual. People's attitudes towards investing, financial health, and risk tolerance vary, so the way they invest their money is a personal preference. GICs are ideal for investors with a solid financial foundation who don't need immediate access to their funds until the GIC term is up. 

For example, if you have an emergency fund held in a high-interest savings account, GICs might be a good fit. If you ever need to access the money immediately, you can withdraw it from your savings account while leaving the funds in your GIC untouched.

 

GIC Laddering

If you like GICs but prefer to have more flexibility, you can consider GIC laddering. This strategy involves investing in multiple GICs with different terms. By doing this your GICs will mature at different times and rates. 

For example, if you have $20,000 to invest, you can split it into five GICs at $4,000 each with terms of one-year, two-years, three-years, four-years, and five-years. After the first year, the one-year GIC will mature, while the others will continue to mature in subsequent years. If you don't need to cash out the earnings from the one-year GIC, you can reinvest the principal and interest in a new five-year GIC. This allows you to maintain a consistent maturity profile and give you the flexibility to reassess and adjust your investments each year. 

 

The bottom line

While GICs have traditionally been popular among older and more conservative investors, they are useful for those of any age. Before purchasing a GIC, it's recommended to speak to a financial advisor to determine if they are a good fit for you.

 

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