Something a lot of first-time investors don’t know is that they can purchase and hold guaranteed investment certificates (GICs) in both non-registered and registered accounts. Non-registered accounts are regular savings accounts, where you’d have to pay tax on any interest income. Registered accounts, however, are tax-sheltered savings plans put in place by the government, and include RRSPs, TFSAs, RDSPs and registered education savings plans (RESPs).

RESPs are a tool used to save for future post-secondary education needs. Here’s a quick explanation of how RESPs work.

What are RESPs?

RESPs are government-approved savings accounts for post-secondary education. These accounts are typically opened by parents, in anticipation of their children’s future education expenses (most notably tuition fees). For the RESPs that have been opened since 2007, there is no annual limit but there is a lifetime total contribution limit of $50,000. The federal government and some provincial governments offer grants, to enhance RESP contributions; these are not included in the $50,000 limit so, with them, you could potentially have even more set aside for when your kids are ready to go to school.

RESPs can be opened through most financial institutions, and may hold a wide range of investments, such as stocks, bonds and GICs. Most RESPs may remain open for a maximum of 35 years.

Benefits of holding GICs in RESPs

There are two key benefits to holding GICs in your children’s RESPs:

  1. The principal is guaranteed. Because it’s in a GIC, you know the principal will be returned to you, which makes it a safe investment.
  2. The money grows tax-free while in the RESP. Similar to when you hold GICs in RRSPs or TFSAs, for as long as it stays in the RESP account, interest income is not taxed. And, even when money is withdrawn from the RESP, only the capital gains, interest income and government grants are taxed – not the original contribution amounts. One thing to keep in mind is that tax is payable by the beneficiary of the RESP when he or she receives the money for education expenses. Given that many students have little-to-no income, there may only be nominal (if any) tax payable on RESP payments.

In the early stages of an RESP, growth of contributed capital is likely going to be a priority, so investing the majority of the account in equities (like stocks) is logical. But as the expenses of post-secondary education near, capital preservation is likely to take precedent; this is an ideal time to buy GICs within RESPs.

Case study: When to invest GICs within RESPs

Jane and Doug opened an RESP for their son Matthew 10 years ago. Matthew is now 15 and will be attending university when he’s 18 years old. The total value of his RESP is $40,000 and Jane and Doug want to put half of that ($20,000) into a GIC. They are considering two options: either a 3-year non-redeemable GIC paying 1.50% with compound interest or a 3-year market-linked GIC tied to the Toronto Stock Exchange (TSX).

What will Matthew’s RESP earn in the following three scenarios?

  1. Jane and Doug choose the 3-year non-redeemable GIC at 1.50% (compounded)
  2. Jane and Doug choose the market-linked GIC and the TSX rises 20% over 3 years
  3. Jane and Doug choose the market-linked GIC and the TSX goes down 10% over 3 years

Scenario 1: 3-year non-redeemable GIC at 1.50%

Year Beginning Principal Interest Earned Ending Principal
1 $20,000.00 $300.00 $20,300.00
2 $20,300.00 $304.50 $20,604.50
3 $20,604.50 $309.06 $20,913.56
Totals $913.56 $20,913.56

Scenario 2: Market-linked GIC and the equity market rises 20% over 3 years

Year Beginning Principal Interest Earned Ending Principal
1 $20,000.00 $0.00 $20,000.00
2 $20,000.00 $0.00 $20,000.00
3 $20,000.00 $4,000.00* $24,000.00
Totals $4,000.00 $24,000.00

*The $4,000.00 is calculated by multiplying the principal ($20,000) by 20%.

Scenario 3: Market-linked GIC and the equity market declines 10% over 3 years

Year Beginning Principal Interest Earned Ending Principal
1 $20,000.00 $0.00 $20,000.00
2 $20,000.00 $0.00 $20,000.00
3 $20,000.00 $0.00 $20,000.00
Totals $0.00 $20,000.00

In Scenario 1, the non-redeemable GIC at 1.50% paid a total of $913.56 in interest. Scenario 2, when Matthew’s parents purchased a market-linked GIC and the market rose 20% over 3 years, returned $4,000 of interest. And, unfortunately, when the equity market declined in Scenario 3, no interest was earned.

Whether to add a market-linked GIC to an RESP depends on the risk profile of the investor. For those who are okay with the possibility of earning nothing over the GICs term, a market-linked GIC may be appropriate. However, if earning at least some interest is a top priority, a traditional GIC is a better option.

RESPs are a great way to save for your child’s future post-secondary needs. Not only does investing in a RESP-eligible GIC allow you to guarantee your principal, the money grows tax-free.