Written by Bolatito Laniyan
Tuesday, June 28th, 2022
If you've been on the news, on social media, or at a social gathering lately, you've most likely heard talk of rising interest rates. Coupled with inflation, it does feel like a season of leaps.
While rising interest rates can mean higher costs to pay off debts such as mortgages and lines of credit, the good news is that savings should earn more. And as returns on savings rise, they become a more attractive option, particularly at a time of market volatility. GICs are especially appealing, because you can lock in an attractive interest rate.
If you don't know a lot about GICs, or are curious about how GICs work, here's a guide to help you understand them.
What's a GIC?
A GIC is a Guaranteed Investment Certificate, (called “Guaranteed Investment" at Tangerine). It's called this because the money you put in a GIC is guaranteed - you can't lose your money. And in a fixed rate GIC, the interest rate at which you invest stays the same throughout the term. At maturity, you're guaranteed to get your principal sum plus the interest earned.
GIC terms can range from shorter terms like 30, 60 or 90 days, to a longer term like a year, or multiple years. Generally, the longer the term, the higher the interest rate.
How do GICs work in Canada?
In simple terms, you're basically lending the financial institution money, and they pay you back with interest at the end of the term. In addition to the financial institution's obligation to pay you back, Canada Deposit Insurance Corporation (CDIC) applies to GICs with Canadian banks that are members.
GIC interest rates are determined by the financial institution, influenced by the Bank of Canada interest rate policy and the rate environment. Each financial institution will have options for how interest is calculated and paid, based on the GIC you choose.
As an example, if you invest $1,000 in a GIC with a 3.00% annual interest rate for a 3 year term, at the end of the first year, it grows to $1,030, and at the end of the second year, $1,060.90. When the term is due, you would have earned $1,092.72.
Will I be taxed on my GIC earnings?
GIC earnings are considered to be a regular income. However, the earnings may not be taxable, depending on the type of GIC account you have.
For example, interest income earned in non-registered GICs is taxable. However, interest earned in TFSA and RSP GICs is tax-sheltered and tax-deferred respectively. So the interest earned on the principal is not taxable in a TFSA, and is only taxed when withdrawn from an RSP - assuming you don't contribute more than your limits for those plans.
Should I invest in GICs?
It depends on what your goals are. Here are some questions to consider:
- When do I need to have access to the money?
- What do I need the money for?
- What's my risk appetite?
When do you need access to the money you're investing? Will you need it in the near term, or can you put it away for longer?
Let's say you make a deposit in a regular, non-registered savings account. You earn a bit of interest, and you have the benefit of liquidity — meaning you can take out the money whenever you like. In the event of an emergency, you can make a withdrawal.
In another instance, let's say you're planning to buy a house, a car, or a boat in six months or a year. You decide you don't need this money for the next six or 12 months, and you invest it in GICs. It's a safe investment that guarantees your principal, so it's low risk. You've set aside money for the purchase, and have locked in an interest rate for your money to grow.
It always starts with what you're trying to achieve and how much risk you're willing to take on. As you consider other kinds of investments, for those that aren't guaranteed the way GICs are, the risk may be higher, but the potential return may also be higher. When you identify your goals, then you can determine what kind of savings or investment option is right for you.
A big thing to drive home is not: 'shall I invest in a GIC? Or should I invest in a mutual fund or the market?' It has to start with these questions: What are your goals? What is your risk tolerance? And what is the timeframe you're working with? So three things: goals, risk tolerance and timeframe.
How do I make the most of fixed GIC rates?
GIC laddering is often cited as a strategy to make the most of fixed rate GICs. It's a way of capturing the benefit of changing interest rates, even though each GIC locks in a particular rate. If you spread your investment over multiple GICs with different terms, you continually have a maturing investment, and you can decide how to reinvest to make the most of current rates. Staggering the maturity dates of your GICs is a good strategy to take advantage of a rising interest rate environment.
Again, answering the guiding questions above can help you decide if laddering makes sense for you.
And that's the tea on GICs!
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*TFSAs and RSPs have contribution limits per year, and you'll want to stay within your limits to fully experience the tax benefits.