How to invest in RRSP GICs
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Guaranteed investment certificates (GICs) can be purchased and held in both registered and non-registered accounts. Non-registered accounts are similar to any regular bank account or investment you hold, where you are taxed on the interest you earn. Registered accounts, on the other hand, refer to special tax-sheltered savings plans that have been approved by the government.
One thing many first-time investors don’t realize is that they can purchase and hold GICs in their registered retirement savings plan (RRSP). Here’s a quick explanation of how it works.
What are RRSPs?
RRSPs are government-approved accounts intended to help Canadians save for retirement. Every year until you are 71, you can contribute a specified amount of money to your RRSP and deduct this contribution from your taxable income. Currently, the maximum contribution is 18% of your income or $30,780, whichever is lower. If you don’t max out your contribution room in a given year, it carries forward, meaning you can still use that room in the future.
RRSPs can be opened through most financial institutions, and can hold a wide range of investments, such as stocks, bonds, mutual funds and GICs.
There are a few different factors to consider when choosing an RRSP GIC. First, you’ll want to decide between choosing a redeemable or non-redeemable GIC. Non-redeemable GICs tend to pay higher interest rates than cashable ones, so this is something to keep in mind.
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- Ratehub tip: RRSPs are retirement investment accounts, so assets inside them are really not meant to be cashed out in the short term. Otherwise you will be charged tax for an early RRSP withdrawal. If you need the money for a medium or short-term goal like saving for a trip or paying tuition, consider holding a GIC in another type of account like a TFSA. If you hold the GIC in a non-registered account, on the other hand, you’ll be taxed on the interest earned.
Secondly, decide how long you want to lock in your RRSP GIC for. Most banks and financial institutions offer anywhere from one to five or even 10-year GIC terms.
Lastly, you’ll want to compare the GIC rates offered at different banks and financial institutions, and check whether they are CDIC-insured. That way you’ll know your money is safe when you lock in your desired rate. Keep in mind you’ll likely need at least $500 to invest in a GIC.
What are the disadvantages of GICs in RRSPs?
GICs are pretty safe investments, given they’re locked-in and sheltered from market volatility (unless you choose a market-linked GIC). If you’re looking for a very safe investment for your RRSP and don’t want to risk losing money, or you want to balance out your portfolio with a low-risk asset, they might make sense for you.
However, with this safety comes a disadvantage - you’re not likely to get as high earnings with a GIC as you would with other investments like ETFs or dividend stocks, for example. Plus, since the GIC is in your RRSP, even when it reaches the end of its term, you won't be able to withdraw it without paying withholding tax.
- Also read: When do GICs make sense for investors?
Benefits of investing in RRSP GICs
There are four key benefits of holding GICs in your RRSPs:
- Contributions are tax-deductible. The amount you fund into your RRSP is deducted from your gross income and therefore can result in a bigger tax refund.
- Your principal is guaranteed. Because it’s in a GIC, you know the principal will always be returned to you, which makes it a fairly safe investment. Bonus: The interest is also guaranteed, up to $100,000 (principal + interest).
- There’s a known rate of return. Unlike most other investments, which follow the stock market or a mix of stocks and bonds, an RRSP GIC will give you a set amount of interest over a specific period of time, i.e. 1.50% for three years. You can actually determine your return before you even invest your money.
- Your money can grow tax-free while in the RRSP. As long as it’s in the RRSP account, capital gains and interest income are not taxed by the government. You only pay tax on the money when you withdraw it from the RRSP.
- You can withdraw funds early in certain cases. Like with any RRSP, the funds in your GIC can also be withdrawn early with no tax penalty to help fund your first-time home purchase (Home Buyers' Plan) or an advanced degree (Lifelong Learning Plan). However, if you withdraw the funds from a non-redeemable GIC before it reaches maturity in the length of time you agreed to hold it for (i.e. 1 year or 5 years), you could pay a penalty or lose out on interest.
Case study: GIC in RRSP vs. non-registered account
Andre has saved $10,000 for his RRSP and is looking to buy a GIC. He settles on a 3-year term paying 1.50% compound interest. Andre lives in Nova Scotia and pays tax at a marginal rate of 35.00% (combined federal and provincial). How much will he save by buying the GIC in an RRSP where he can earn interest tax-free, versus a non-registered account where he would have to pay tax on the interest income?
| Year | Beginning Principal | Interest Earned | Ending Principal | Tax Saved on Interest |
|---|---|---|---|---|
| End of Year 1 | $10,000.00 | $150.00 | $10,150.00 | $52.50 |
| End of Year 2 | $10,150.00 | $152.25 | $10,302.25 | $53.28 |
| End of Year 3 | $10,302.25 | $154.53 | $10,456.78 | $54.08 |
| Total | $10,456.78 | $456.78 | $10,456.78 | $159.86 |
Andre earns an extra $296.92 ($456.78 - $159.86) by holding the GIC in his RRSP instead of in a non-registered account – and this doesn’t even include the tax savings of his initial investment. By contributing to his RRSP, he also will be able to claim a significant deduction on his income taxes.
RRSPs are a tax-friendly tool that should be part of all Canadian’s retirement savings strategies. Not only does investing in an RRSP allow you to deduct contributions from your taxable income, saving you in the short-term, they also allow you to earn interest income tax-free. For this reason, consider holding a GIC in your RRSP, as it will maximize your return and protect your principal.
What happens when a GIC RRSP term ends (matures)?
When a GIC held in an RRSP reaches the end of its term (aka its maturity date), in most cases, the bank or credit union will automatically move your funds from the GIC RRSP over to one of their RRSP savings accounts. This way, your cash will remain inside your RRSP at all times, ensuring your RRSP contribution room isn’t affected and you can continue to benefit from the tax-shelter advantages of a registered account. From there, you can choose to leave your funds in the RRSP savings account or invest the money in another RRSP account with the same bank. You can even transfer the funds in your RRSP from one bank to another and invest it elsewhere. Note: transferring the funds in your RRSP to another bank or credit union will have no impact on your contribution room because the money is continuously held in the RRSP the whole time and never cashed out. If you want to actively manage the GICs held in your account, one way to maximize your returns after maturity is by using GIC laddering.
In some cases, the bank or credit union may ask if you're interested in renewing the GIC once the term ends or will simply leave the funds in your RRSP as cash.
Rest assured, in all scenarios, the end of a registered GICs term won’t impact your RRSP contribution room or result in withholding tax since the cash will never be liquidated or withdrawn from your RRSP.
When does investing in a GIC RRSP make sense?
A GIC RRSP can be a great investment decision for a number of people.
For instance, if you’re a soon-to-be retiree with a short-time horizon (will need access to your cash relatively soon in under five years), an RRSP GIC can help you safely grow your nest egg with no risk.
Additionally, if you’re an aspiring home buyer with a plan to purchase your first-ever property in the near future, a GIC RRSP can be a great place to store your down payment and earn interest with no risk of losing the money you’ve worked so hard to save up. Under the Home Buyers' Plan, you’re allowed to borrow up to $35,000 from your RRSP to fund your first home purchase with no tax penalty. Note, while investing in the stock market can reap higher returns in the long-term, short-term market volatility can mean losing money when you need it most.
A GIC RRSP can also be an ideal savings vehicle for risk-averse investors or anyone looking to diversify their portfolio by allocating a set amount of money into low-risk assets.