GICs in RRSPs
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 $23,820, 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 are permitted to hold a wide range of investments, such as stocks, bonds, mutual funds and GICs.
Benefits of holding GICs in RRSPs
There are four key benefits of holding GICs in your RRSPs:
- It lowers the amount of income tax you pay. Being able to deduct 18% of your earnings from your taxable income can save you a significant amount of tax.
- 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 3 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.
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.