There is definitely an advantage to holding GICs in your TFSA. Namely, as with all TFSA investments, any interest earned (and withdrawn) will not be subject to tax. This is particularly advantageous with GICs because the Canada Revenue Agency gives no favourable tax treatment to interest income. In other words, if you hold GICs in a non-registered account, expect the taxman to take his full share.
All that said, there’s also a very good reason NOT to hold your GIC in a TFSA…
Let’s assume that you have enough to both max out your TFSA room ($10,000 a year as of 2015) and have money left over to invest, either for a non-registered account or an RRSP. In other words, not all your money can go into the TFSA, so you have to choose which investments to purchase within the tax-free structure.
At this point, it’s worth keeping in mind that for all their benefits, GICs at the present time pay very low rates of interest. Even for longer maturities, such as 5 years, it’s very difficult to get much more than 2% on your money in a GIC.
With other investments, like ETFs, individual stocks or corporate bonds, it is definitely possible to earn more than the 2% you might make in a GIC. For this reason, you should put these products into your TFSA ahead of GICs. Because they offer the potential for the greatest gains, they also offer the possibility of saving you the most in taxes.
Imagine you have $20,000 to invest. You’ve already maxed out your RRSP, so $10,000 can go to your TFSA and the remaining $10,000 to a non-registered account. You’d like to put half of the money in 5-year GICs earning 2.00% and the other half in ETFs. You think the ETFs have the potential to earn 7% a year. How would your returns and taxes payable look, in the first year? (We’ll assume you live in Saskatchewan and are in the 41% marginal tax bracket. Also recall that taxes are only payable on 50% of capital gains.)
As you can see from the tables above, holding the GIC outside of the TFSA is the better move if your ETF manages to grow by 7%. Holding the ETF in a non-registered account would cost you $143.50 in taxes with a 7% gain, whereas the GIC at 2% only incurs $82.00 even with the more unfavourable tax treatment.
One final consideration: if you have speculative investments, there is definitely a temptation and incentive to put them into your TFSA, because if they do well you won’t pay any tax. Keep in mind, however, that if they don’t do well, you won’t be able to use the capital losses to offset any gains you might have.
Flickr: Kat R