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GICs and Taxation

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Before buying a guaranteed investment certificate (GIC), it’s important to understand the tax implications of having one or more in your investment portfolio. Actually, this is crucial, because not all investments are treated alike by the Canada Revenue Agency. As a result, savers need to compare the potential after-tax returns of various investment options.


How are GICs taxed?

In the case of a GIC, all the interest earned is taxed at a person’s so-called marginal rate. Your marginal rate is the tax bracket you fit into given your pre-tax annual income. Tax is payable to both the federal and provincial governments. For federal and provincial tax rates, see the CRA’s website here.

For tax purposes, interest income from a GIC is treated just like regular income. This differs from dividend income and capital gains income, both of which receive more favourable treatment. However, if you hold your GIC in a registered investment account, such as an RRSP or TFSA, you do not have to pay taxes on any interest earned.

In the following examples, let’s assume the GICs are held outside registered accounts, as the difference is pretty significant. For example, as this chart from KPMG explains, someone in the top tax bracket in Alberta in 2013 would pay 19.50% on capital gains income but 39.00% on interest income (that’s federal plus provincial tax). The numbers vary from province-to-province, but the story remains the same: interest income (which includes GICs) is not given any sort of tax break.

Example: Beth buys a 1-Year GIC

Beth puts $10,000 into a 1-year non-redeemable GIC paying 1.50% interest. She lives in Alberta and earns $52,000 a year, which qualifies her for the 32.00% tax bracket (combined federal and provincial). How much tax will she pay on her investment? And what’s her after-tax return?

  • $10,000 GIC Value
  • 1.50% Interest Rate
  • $52,000 Yearly Salary
  • 32%Tax Rate
$10,000 principal x 1.50% interest rate = $150 interest income
$150 interest income x 32.00% tax rate = $48 tax payable
$150 interest income - $48 tax payable = $102 after-tax return
$102 after-tax return $10,000 principal =1.02% after-tax return in percentageterms

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To summarize, Beth’s 1.50% GIC earned $150 in interest of which $48 was paid in tax. She was left with an after-tax return of $102 or 1.02% on her original investment.


How are multi-year GICs taxed?

With GICs it is also possible you will have to pay tax on interest that has been earned but not yet received. For GICs with terms greater than one year that are automatically re-invested, you will have to pay tax on the interest earned at each anniversary date, regardless if you will not receive the actual payout until the end of the contract. From the CRA’s perspective, the interest counts as income once it is “earned”, not after it’s been physically paid out. (Another word for “earned” in this case is “accrued”.)

The exception to this is market-linked GICs. The return on these GICs is not normally taxed until maturity, when the exact return is known, at which point it is fully taxed as income (unless the GIC has a minimum interest guarantee which requires investors to report and pay tax on the minimum interest guarantee each year). This can create a financial burden: the investor owes tax on money that has not been received yet. Savers in this position need to be able to pay the tax while they wait for the GIC to mature.


Example: Jonathan buys a 5-year GIC

On January 1st, 2013, Jonathan bought a $100,000 5-year non-redeemable GIC paying 2.00% interest. He lives in the Yukon and pays tax at a marginal rate of 42.40% (combined federal and provincial). Assuming the interest is compounded annually and only paid out at maturity, how much tax will Jonathan owe before he can cash out his money?

  • $100,000 GIC Value
  • 2.00% Interest Rate
  • 42.40% Tax Rate
Year 1
$10,000 principal x 2.00% 
= $2,000 interest
$2,000 interest x 42.40% tax rate $848 tax payable
Year 2
$102,000 principal x 2.00% 
= $2,040 interest
$2,040 interest x 42.40% tax rate $864.96 tax payable
Year 3
$104,040 principal x 2.00% 
= $2,080.80 interest
$2,080.80 interest x 42.40% tax rate $882.25 tax payable
Year 4
$106,120 principal x 2.00% 
= $2,122.40 interest
$2,122.40 interest x 42.40% tax rate $899.90 tax payable
Year 5
$108,243.00 principal x 2.00% 
= $2,164.86 interest
$2,164.86 interest x 42.40% tax rate $917.90 tax payable

To calculate how much tax he will owe before he cashes out his GIC, we only need to add the tax payable for Years 1-4 (since he will be paid out before owing taxes in Year 5).

Example: Straddling tax brackets

Jason lives in Ontario and earns $87,000 a year. He recently inherited a substantial sum of money and decides to use some of it to purchase a $100,000 3-year non-redeemable GIC paying 1.75% interest. As a result of the GIC interest, his income is now $88,750. How much tax will he pay on the GIC interest after the first year?

To answer this question, it’s important to know that for incomes from $82,420 to $87,143, people in Ontario pay tax at a marginal rate of 39.41% (combined federal and provincial). After that, the marginal rate jumps to 43.41%. So, Jason will pay tax at a rate of 39.41% on the first $143 ($87,143 - $87,000) and 43.41% on the remaining $1,607 ($88,750 - $87,143).

In total, he will have to pay $753.94 of tax on his earnings.

When you review these examples, you can see why it’s so important to calculate your potential return on a GIC, before you open one. If you don’t want to pay tax on the money you invest, you should consider investing in TFSA GICs (interest is earned tax-free) or RRSP GICs (your interest isn’t taxed when you contribute, but you are taxed upon withdrawal).


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