As you’re getting closer to retirement, or if you’re saving money for a distant goal, you might want an investment that has no risk and a good interest rate.
That, in a nutshell, is what a guaranteed investment certificate (GIC) promises. These low-risk investments guarantee a modest return if you hold your money for a certain amount of time. How do they work and should you take one out? Let’s take a closer look at GICs and see.
What is a guaranteed investment certificate (GIC)?
A guaranteed investment certificate (GIC) is an investment that lets you earn interest on a lump sum for a specific period of time, while also guaranteeing you’ll get your initial deposit back.
GICs basically work like a savings account. You open one at a bank or credit union, deposit money, and let it grow. Unlike a savings account, however, GIC usually lock your money for a specific period of time, anywhere from a few months to several years. Withdrawing money during this time could lead to penalties or forfeited interest.
GICs are pretty simple to understand, but they do have some parts you should be aware of, most notably the principal, interest rate, and terms.
The principal is your initial deposit, which is guaranteed to come back to you, no matter what type of GIC you choose. Keep in mind: most banks and credit unions require a minimum initial deposit, such as $1,000 or even as large as $10,000, to open a GIC.
The interest rate is the rate at which your money will grow. For GICs, interest rates can be fixed or variable, depending on the type you choose.
Fixed interest rates are basically what GICs were designed for. At the offset, your GIC provider will give you a fixed rate, which won’t change, no matter what happens to the economy or the bank’s prime rate. If you lock into a 3% interest rate, for instance, and the prime rate falls to .50%, you’ll keep earning interest at the 3%.
Typically, the longer you keep your money in a GIC, the higher your fixed rate.
Variable interest rates, however, can fluctuate over your GIC’s terms. They’re determined by an underlying interest rate benchmark, usually the prime rate or an investment. If you expect the prime rate to increase during your GIC’s terms, a variable rate can help you capitalize on the higher rate.
The term is the amount of time you agree to keep your money invested in a GIC. Terms usually last from one to five years, though you can certainly find GICs with terms shorter or longer than that.
With terms, pay close attention to withdrawal restrictions. Depending on the type of GIC you get, you may have no or limited access to your GIC money during the term. Withdrawing money from your GIC before the term is up could result in penalties or forfeited interest.
What are the different types of GICs?
Fortunately, GICs come with different terms, interest rates, and withdrawal rules, which can help most investors find one that’s right for them. As you’re scanning the market, here are some of the most common GICs you’ll come across.
1. Non-redeemable GICs
A non-redeemable GICs is your standard GIC: you agree to keep your money in a GIC for a specific period of time, and, as long as you don’t withdraw money, your principal will grow at a hefty interest rate. If you do decide to withdraw money before your term ends, you’ll typically pay a penalty, which your GIC provider will specify in your contract.
2. Cashable GICs
Cashable guaranteed investment certificates (CGICs) are basically how they sound: a GIC that allows you to access your money during your term. Typically, CGICs have 1-year terms, and they’ll almost always come with a 30 to 90 day closed period during which you can’t cash out your investment. After this closed period ends, you can withdraw money without penalties.
Interest rates on CGICs are usually lower than non-cashable GICs, and though you can cash out your CGIC after your closed period, most financial institutions require you to keep a minimum amount in your account. So, in theory, if you’ve reached your minimum balance, you may no longer be able to cash out money.
3. Redeemable GICs
Redeemable GICs work similarly to cashable GICs: you can withdraw money from your GIC during your term without paying a penalty.
The difference between the two? Redeemable GICs typically don’t come with a waiting period: you can start withdrawing money the day after you sign your contract. But with greater flexibility also comes a bigger caveat: redeemable GICs often have an early redemption rate, which can be significantly lower than the GIC’s regular interest rate.
For instance, let’s say you take out a $5,000 1-year redeemable GIC with a .50% interest rate. A few months after you buy the GIC, you have a medical emergency that requires you to withdraw all of your money. In this case, your GIC provider probably won’t credit your initial $5,000 with the .50%. They’ll most likely credit it with the redemption rate, which can be as low as .05%, not much higher than the rate on a regular savings account.
4. Market- or equity-linked GICs
Market-linked GICs work a bit differently than the other types.Your GIC provider still guarantees you’ll get your initial deposit back, but instead of getting a fixed interest rate, your principal will be tied to the performance of an underlying equity market.
In general, as the underlying market performs well, your initial deposit will grow. If the underlying market does poorly, well—at the very least, you’ll get your principal back. The potential gains on a market-linked GIC could be much higher than the interest rates on normal GICs. But, of course, you’re not guaranteed to earn anything. Some market-linked GICs have participation rates, too, and maximum returns, so you always want to read the terms and conditions in your contract before signing the dotted line.
5. Registered GICs
With a registered GIC, you can store your GIC inside a registered retirement account, such as a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP). A registered GIC allows money earned on interest to grow tax-free, which can help you earn even more, as GIC earnings are typically subject to capital gains taxes.
6. Escalator GICs
Escalator GICs give you a fixed interest rate that rises every year. For instance, you may get a 2% interest rate the first year, a 3% interest rate the second year, and a 4% interest the third year. In general, the longer you keep your money in an escalator GIC, the more interest you’ll ultimately earn.
What are the benefits of a GIC?
If you’re looking for a safe, no-risk investment that will also help you earn some interest, a GIC may be right for you. Here are a few of the main advantages to taking one out.
1. Your principal is protection
When you buy a GIC through a bank, your GIC is protected through the Canadian Deposit Insurance Corporation (CDIC). That means, if your bank defaults or fails to pay back what you put in, you’re guaranteed to receive at least $100,000 (this guarantee only applies to GIC with terms of five years or less).
If, instead, you buy your GIC through a credit union or other provincial financial institution, your GIC provider will have a provincial guarantee, which, as you can guess, varies by province:
- For Alberta, British Columbia, Manitoba, and Saskatchewan, all deposits are guaranteed with no maximums.
- For Quebec, deposits up to $100,000 are guaranteed.
- For Ontario, deposits up to $250,000 are guaranteed, though if your GIC is in a registered retirement account, your entire deposit is guaranteed.
- For New Brunswick, Nova Scotia, Newfoundland, and Labrador, deposits up to $250,000 are guaranteed.
- For Prince Edward Island, deposits up to $125,000 are guaranteed, with unlimited RRSP deposits.
Even if your bank doesn’t go under, your bank or credit union is legally obligated to return at least your principal. It doesn’t matter how the market swings or what happens in the larger economy. They will always return your initial deposit.
2. You can secure a fixed interest rate
Perhaps the most unique benefit of GICs is their ability to lock you into a favorable interest rate. If interest rates are unusually high, you can take out a GIC and secure the rate before it changes. High-interest savings account cannot offer you this luxury.
3. GICs have no or low fees
Typically you can take out a GIC at no cost to you. As long as you have the minimum deposit, and as long as you stay within the terms specified in your contract, you won’t pay anything to store money in your GIC.
What are the disadvantages of a GIC?
A guaranteed return of principal and a fixed interest rate may sound great, but they come with several caveats. Before you store a wad of cash in a guaranteed investment certificate, consider the following risks.
1. They may not pace with inflation
Most GICs have low interest rates — at least, low compared to other investments. If your interest rate is barely keeping pace with the inflationary rate (historically around 2%), you won’t earn anything: the principal plus earnings will be relatively equal to your initial deposit.
2. You could pay taxes
Unless you hold your GIC in a tax-sheltered retirement account (such as a TFSA, RRSP, or RIFF), you’ll pay taxes on your GIC’s earnings. Any interest you earn on a GIC will be taxed as ordinary income, and you’ll report it on your tax filing.
3. You can’t easily cash it out
For non-redeemable GICs, you will have a hard time liquidating your investment before your term is up. In order to break your contract, you have to prove to your bank that you’re in dire need of the money, and even then it’s still up to your bank to allow you to cash out the GIC.
If your bank or credit union does agree to return your principal before the term is up, you’ll most likely pay a penalty or forfeit any interest earned.
Is a GIC the right investment for you?
A guaranteed investment certificate is a smart choice if you have a lump sum that you don’t expect to use in the next few months or years. GICs can be especially useful for long-term savings goals, such as saving for a down payment, planning a major expense (wedding or vacation, for instance), or even storing money to use later in retirement. And, because you can hold a GIC within a Registered Education Savings Plan (RESP), they could also be instrumental in helping you save for your kids’ college.
A GIC isn’t a good place for an emergency fund, however, since it restricts access to your money. GICs are also poor investment vehicles if your goal is to save money for retirement. Compared with other investments, such as stocks, the return on GIC is extremely low, meaning you won’t build retirement wealth with GICs alone.
If you’re young and you have several years before retirement, you should consider investing in something that has more growth potential, such as stocks, ETFs, or mutual funds. Though GICs can give you a guaranteed return of principal, the interest rate won’t outpace inflation, and you’ll lose out on earning more on compound growth. You can use a GIC to supplement your investments, but be wary of allocating too much to one.