What is a GIC?

Why a GIC?

Diversifying a liquid investment portfolio to include safer securities is always wise. With a GIC, you lock your investment in for a period, whatever you find acceptable. You can lock in your guaranteed investment certificate for as little as a few months to as long as 10 years, depending on the financial institution you buy it from. Note also that interest rates can vary a great deal, currently reaching as high as a little over 5%, depending on the institution and the duration of the term. Usually, the longer the term, the higher the interest rate you can get on a GIC.

Guaranteed investment certificates come in different types, including cashable, redeemable and non-cashable options. Cashable GICs allow customers to withdraw their money before the end of the term in case of an urgent need. These typically have a short locked-in period of about 30 to 90 days, after which users can access their funds without any penalties. Redeemable GICs, on the other hand, do not have a waiting period, allowing people to access their money at any time.

Not all GICs are cashable or redeemable; non-cashable GICs require investors to keep their money locked in for the entire term without the option for early withdrawal. So, if you might need to access your funds before your GIC comes due, it's wise to ensure you get a cashable GIC. Non-cashable GICs also tend to have higher interest rates than cashable ones to compensate for locking in your money. Always check each guaranteed investment certificate's specific terms and conditions before investing.

Here are some key facts about GICs.

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Registered GICs

You can invest in registered GICs as part of one of Canada’s various registered savings plans, such as the Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA). The federal government regulates a registered guaranteed investment certificate and allows users to grow their savings without applying taxes on the money earned through interest rates upon maturity. However, with an RRSP, you’ll have to pay taxes when you cash your GIC in.

Also, note that there is a maximum allowable contribution within these registered accounts. Depending on the account, there may be hefty fees if people need to withdraw some of their money. For instance, a TFSA can hold different investment vehicles, including GICs or mutual funds. The amount you can put into a TFSA every year is limited, with a limit of $7,000 for 2024. However, the contribution room accumulates over your lifetime, starting at age 18. Online calculators can help determine how much you can invest in your TFSA.

Non-Registered GICs

As the name suggests, non-registered GICs are not held in a registered account and don’t come with tax breaks or incentives. However, users don’t have to worry about age or contribution limits. You can invest as much as you’d like in a non-registered GIC.

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What types of GICs are there?

A guaranteed return or fixed-rate GIC

Think of fixed-rate GICs as the classic, most well-known guaranteed investment certificate product. When investors choose a fixed GIC, they expect to receive a defined amount of interest payable at specified periods during the term that they choose. So, if someone has invested $1,000 in a one-year fixed-rate GIC at 1%, they will receive $1,010 on the maturity date.

Floating or variable-rate GICs

A floating guaranteed investment certificate is when your GIC saving is linked to the financial institution’s prime rate. So if that rate goes up, you make more money. However, the opposite is also true.

Market- or equity-linked GICs

This type of GIC is linked to the performance of an underlying stock market index. Market-linked GICs bring greater returns if the market performs well. With these GICs, the rate of return is not determined until maturity. So if your GIC is linked to the S&P/TSX 60 index and goes up over the three-year contract period you chose, the GIC’s return will reflect the exchange’s performance, up or down.

Market-linked GICs are locked, meaning you won’t be able to access your money before the term ends. But your principal remains guaranteed. However, taxation applies to these types of GICs. Money made through interest is taxed at a higher rate than capital gains. And no dividends are earned through market-linked GICs, an entitlement you would have if you had invested directly in the stock market.

Foreign exchange GICs

US dollar-denominated GICs are the most common foreign currency-guaranteed investment certificates in Canada. If you're interested in profiting from foreign currency fluctuations, opting for a foreign exchange GIC might be a good choice.

This option is great if you visit a foreign country associated with the currency while earning interest. For example, if you are planning to visit the US and stay there for a couple of months and want to cut your inflation losses, then this could be a good option.

WARNING: Foreign currency GICs are not covered by CDIC insurance. There is no guarantee you will get your money back in case the bank or credit union fails. Also, with this type of investment, the bank will buy slightly below the market rate and sell slightly above. This is how banks make money on this type of investment — through what's known as a "spread." And there is the possibility that the currency the GIC is in can fall, leaving you with less money in Canadian dollars. All of this makes this type of GIC riskier than other types.

Disadvantages of GICs

We’ve talked a lot about the benefits of GICs but here are some of the downsides of this financial product.

1. Your money is tied up for the term you chose, meaning if you want to reap the full interest benefits, you can’t tap into it until the end of the term.
2. What if inflation is higher than the interest rate on the GIC you chose? In that instance, your money will lose purchasing power over the GIC’s term.
3. Like all investments, the riskier the investment is, the higher the rewards. And remember, the foreign currency exchange GIC has no guarantee that your principal is covered.
4. Your interest earnings on a GIC will be taxed if it’s not in a registered investment vehicle such as a TFSA.
5. Usually, there’s a stipulated minimum amount to invest in a GIC, which can be a challenge for someone with limited savings.

GICs might sound like a straightforward concept; however, there are many nuances. As with any type of investment, do your homework.

The formulas financial institutions use to determine your final investment value may be complex. So you need to know the details of how you get paid on your GIC.

For example, a market-linked GIC is promised a maximum return of 9% over a three-year term. But this could mean that the maximum of 3% a year is made only if the market performs well, so 9% isn’t fully guaranteed. Be sure to read the fine print and ask if you have questions.

A major tip on how to be a smart GIC investor

Some veteran investors use a strategy called the “GIC ladder” with GICs.

You divide a lump sum of money into, let’s say, five GIC accounts with different maturity rates for each year.

For example, the money in “rung one” would be invested in a GIC for one year, the second rung for two years, until the fifth rung is invested in a five-year GIC, which would most likely have the highest interest rate.

This gives you more flexibility to access your money than with just one GIC.

With files from Sandra MacGregor