What is a GIC and is it Something I Want?

Posted on August 18th, 2009 by MillionDollarMan

I received this question from a reader. She is a teacher who makes just over 80K annually and has a fully indexed pension as well as a healthy amount of RRSPs. She is looking for a place for her short term savings.

What is a GIC and is it something I want to purchase? If so, how many? Why are they good and/or bad? My brother has them and claims I should too, but when I asked why all I heard was “blah, blah, blah”

A GIC is an acronym for “Guaranteed Investment Certificate”. It’s an investment, like a savings account where the bank says to you “If you put money into this account and don’t touch it for the time specified, we guarantee that we’ll pay you this percentage of interest.” It’s an amount of money you agree to loan to a financial institution and they agree to pay you a specified amount of interest in return.

So for example, let’s say if you had $1,000 and wanted to put it into a GIC with ING.

If you put in $1000 after one year you’d have $1012.50. They would pay you a guaranteed rate of 1.25% if you kept it in for the whole year.

If you put in $1000 for 5 years, at the end of 5 years you’d have $1159.27. You are keeping it in for 5 years so they are paying you 3%.

GICs are safe and secure investments that have very little risk. In the case of ING, if you do take out your money early, you still get all your money back. They just reduce the interest to 0.5%. Some banks don’t allow for early withdrawal. Some have penalties and others allow you to take your funds out at any time but don’t give any interest if you take it out early.

You don’t really buy them. You set up an account, deposit money into it and agree to keep it in there for a specified time depending on how long until you need the money and how much interest you’d like to make. After the term is over, the money gets put back into your regular account with the interest it made.

GICs are good because they are safe and secure and you never have to worry about losing money.

They aren’t good because they don’t make enough interest to keep up with inflation. They are a terrible savings plan for retirement but work well for shorter term savings goals (a down payment on a house, a car, a vacation) where you know you’re end goal date and you want a better savings rate than a regular savings account.

They are also not great for someone in a high tax bracket (like you) because you are taxed on every penny it earns which means in effect, you’d be making a lot less than 1.25%.

Now that Canada has the Tax Free Savings Account (at a current rate of 3% at ING) this would be a way better plan for your short term savings goal.

It gives the same great rate. It’s just as safe and secure. You’re not taxed on any money it makes in the account. You can take it out whenever you like. You don’t have to wait 5 years. The only glitch with the tax free savings account (TFSA) is that you can only deposit a maximum of $5000 a year. Not much of a glitch if you ask me! And if you take it out one year, you get to put it all back in the following year plus another $5000 if you like.

To summarize, a GIC is a safe secure investment with a guaranteed rate of interest but you’d be taxed on any earnings it makes and you’d have to keep it in for a specified period of time.

A TFSA (Tax Free Savings Account) is a safe secure investment with the same great interest rate but the interest earned is tax free and yours to keep. You can take it out whenever you need it! You can however hold your money in a GIC within the TFSA. This might be more attractive if the rate for the GIC was higher than the regular rate for the TFSA.

For your situation, I see no reason for a GIC at this time but I’d highly recommend the TFSA.

Do we have anyone out there that loves GICs as much as our reader’s brother? Can you give us any other advantages to a GIC that I might have missed?

Kathryn works in public relations and training for a non profit. In her off hours, she volunteers as a financial coach helping ordinary Canadians with the basics of money management. Her passions include personal finance and adult education. Kathryn, along with her husband and two children live in Ontario.