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 as allowed GICs to offer better earnings to customers, even for short-term investments. Fixed-rate GICs insure 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 other financial institution for an agreed-upon term and interest rate. It's name refers to the fact that your principle investment is guaranteed to be returned to you at the end of the term, and in the case of fixed-rate GICs, with the prescribed 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 do this 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, whereas those with provincial insurance can vary depending on the province.
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 GICs withdrawn before maturity are often subject to a GIC early withdrawal penalty.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.
Purchasing GICs online is a smart method, as you'll be able to compare the best rates in Canada and ensure that you'll be getting the highest yield possible. Buying GICs online comes with no fees and can be done in the comfort of your own home.
If you'd rather have an experienced professional find you the best rate on a GIC, you can hire a deposit broker to help you get the best interest and term length for your money. Also, because brokers work for your bank, you could end up getting a better rate than someone purchasing a GIC on their own.
The only caveat? Some brokers may charge management fees for their services, which could eat into your earnings.
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 and won't need access to the money until its term is up.
For example, if you have an emergency fund held in a high-interest savings account, GICs might make sense for you. Should you need to access that money immediately, you can easily withdraw it from your HISA while keeping the funds in your GIC untouched.
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 money in several GICs with different terms. Doing this allows it 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 one-year, a two-year, a three-year, a four-year, and a five-year GIC term.
At the end of the first year, the the one-year GIC will reach maturity. Now the remaining GICs will mature in one, two, three, and four years. Providing you won't need to cash out your earnings from the one-year GIC that just matured, you can now reinvest that principle (plus its interest) in a new five-year GIC. This not only allows you to keep your maturity profile consistent, but it gives you the freedom each year to gauge market conditions and reassess whether you want to cash out of your matured GIC or reinvest in a new one.
The bottom line
While GICs have always been popular with older and more conservative investors, they can be a useful product for those of any age, depending on their financial goals and current situation. Before purchasing a GIC, speak to a financial advisor and find out if they're a good match for you.