Tax-Free Savings Account GICs

This is how a tax-free savings account (TFSA) works: you deposit money, earn interest and, unlike a regular savings account, you never have to pay tax on your interest earnings. As an added bonus, you can choose to hold a number of different investments in your TFSA, including guaranteed investment certificates (GICs). If you’re unsure of how TFSA GICs work, or why you might want to open one, keep reading.

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What is a tax-free savings account GIC?

First, let’s review how GICs work. A GIC is an investment tool that lets Canadians save money and earn some guaranteed interest in the process. With a GIC, you invest money at a financial institution for a specific period of time (the “term) and they will guarantee the return of your principal (the amount you invested) plus interest. The interest is based on the length of time you save your money for, and typically the longer you invest, the higher interest rate you’ll get. For example, a 1-year GIC may only earn 1.00% interest while a 5-year GIC could earn 2.50%.

With a typical GIC, whenever you cash out your investment, you have to claim the interest as earnings on your personal income taxes. With a TFSA GIC, however, you don’t have to claim any earnings from your investment. So that’s all a TFSA GIC is: a GIC which you can earn interest on tax-free.

Note : The amount you can invest is still limited by your TFSA contribution room. So as long as you don’t over-contribute, all the interest you earn in a TFSA GIC will be tax-free.

What types of TFSA GICs exist?

Most lenders offer two types of TFSA GICs: cashable/redeemable and non-redeemable.

  • Cashable/Redeemable TFSA GICs are liquid assets that can be cashed out early (before the end of their term), without penalty. For this reason, though, they usually come with lower interest rates. Cashable TFSA GICs may be a good option, if you want some flexibility, and if you think there’s any chance you’ll want to take your money out to pay for emergencies or to invest in other opportunities.
  • Non-redeemable TFSA GICs, on the other hand, are locked in until they mature (at the end of their term). For this reason, they usually come with higher interest rates than cashable TFSA GICs. Non-redeemable TFSA GICs are ideal if you know you won’t need access to your money for a period of time, and want to save up for a specific goal, such as for school or a major purchase.

Case study: Regular GIC vs. TFSA GIC

Joe has $5,500 in a basic savings account, which also happens to be the maximum annual TFSA contribution he can make in 2014. He wants to invest in a GIC, but he’s unsure if he wants to max out his TFSA for the year or just invest in a regular GIC instead. After doing some research, Joe finds that his bank, CIBC, offers 3-year options for both that have the same interest rate of 1.60%. Since the interest rates are the same, how can Joe determine if one option is better than the other? Let’s take a look.

CIBC Bonus Rate GIC CIBC Bonus Rate TFSA GIC
Initial Investment $5,500.00 Initial Investment $5,500.00
Return After 3 Year (1.60%*) $264.00 Return After 3 Year (1.60%*) $264.00
Amount Taxed on Earnings (50%) $132.00 Amount Taxed on Earnings (0%) $0.00
Final Value of Investment $5,632.00 Final Value of Investment $5,764.00
Difference +$132.00

*Compounded annually, paid at maturity.

In doing further research, Joe discovered that the interest earnings from GICs (and bonds, for that matter) are taxed at a higher rate than other investments (mutual funds, stocks, ETFs, etc.). If he invested all his savings in a regular GIC, his total earnings would be taxed at a rate of 50% - that’s a huge loss! If he put the same amount of money into a TFSA GIC, instead, he wouldn’t be taxed at all and could walk away with 100% of his interest earnings. For obvious reasons, Joe opened a TFSA GIC instead of a regular GIC.

Why invest in a TFSA GIC?

Whether you choose to go with a cashable/redeemable TFSA GIC or a non-redeemable TFSA GIC, the main reason you might add a TFSA GIC to your investment portfolio is because your principal will be guaranteed. Unlike some more volatile investments, such as stocks and index funds, GIC investors are not exposed to the possibility of losing their initial investments due to fluctuations in the stock market. And then the bonus, of course, is that your interest earnings are tax-free. For all of these reasons, they are considered a safe investment.