What choices do I have when it comes to GICs? What are the basic features of a traditional GIC? These and others are some of the questions we will help you answer.

What choices do I have when it comes to GICs?

There are two types of GICs: traditional GICsand market-indexed GICs, each of which is outlined below.

Traditional GICs: Traditional GICs are classified as Fixed Income investments because they possess a fixed maturity date and a fixed interest rate or rate of return. When you invest in a traditional GIC, you know what your investment will earn in each period and you know that your capital will be returned on a certain date in the future.

Market-indexed GICs: A market-indexed GIC is issued with a guarantee for the repayment of the invested capital, but the interest earned is dependant on the performance of an underlying index or benchmark over the term to maturity. This type of GIC is similar to principal protected notes (PPN) issued by Canadian chartered banks.

What are the basic features of a traditional GIC?

The basic features of a traditional GIC include the following:

  • Term to Maturity:  A GIC term to maturity can range from 30 days to as long as 10 years. GICs with a term to maturity of five years or less qualify for CDIC insurance.
  • Minimum Investments:  Most GIC issuers require a minimum initial investment of $500.00 for GIC purchases. There may also be different minimum investment levels for a registered account and GICs with different interest payment options. GICs denominated in a currency other than Canadian dollars, for example U.S. dollars, may require a minimum initial investment of $5,000.00. Investors should verify purchase minimums with their financial institutions.

What are the options when buying a traditional GIC?

Investors can select from a number of the following options that will dictate their access to the GIC capital between the initial purchase date and the final maturity date:

  • Fixed or non-redeemable GICs:  With this type of GIC the investor is not able to access the GIC principal until the maturity date.
  • Redeemable GICs:  This type of GIC provides an investor with access to the principal of a fixed rate GIC, but with severe penalties.
  • Flexible or cashable GICs:  With this type of GIC the investor will have access to the GIC principal prior to the maturity date. They may be able to cash-in a portion or all of the GIC prior to the maturity date. There may be restrictions and penalties that apply to early withdrawals, so investors should understand the GIC’s structure. Typically, investors accept a lower interest rate for flexible/cashable GICs than for non-redeemable GICs.
  • Laddered GIC:  This is a type of non-redeemable GIC that is structured such that a portion of the principal matures and becomes accessible on the annual anniversary. So for example, if a $20,000.00 laddered GIC is purchased with a five-year maturity date, then on each of the five annual anniversary dates 20%, or $4,000.00, matures and becomes available for reinvestment or other uses. Typically, if the investor does not indicate otherwise, the maturing portion would be rolled-over and reinvested for another 5-year term.

What are the income payment options available for traditional GICs?

Investors have a number of the following options for the calculation and payment of the interest income they earn on their GICs:

  • Annual interest:  Here the GIC’s interest income is calculated as simple interest and paid once a year on the annual anniversary date of the GIC. Simple interest is calculated by taking the principal amount of the GIC and multiplying it by the GIC’s stated interest rate.
  • Annual compound interest:  With this option, the GIC’s interest income is calculated as simple interest on the annual anniversary date and the interest amount is added to the GIC’s principal amount. In the following 12 months, the GIC principal and accumulated interest to date, will earn the GICs stated annual interest return. No annual interest payments are made to the investor. On the GIC’s maturity date, the investor will receive their original principal plus all calculated compounded interest income.
  • Monthly/quarterly/semi-annual interest payments:  With this option investors can receive their earned interest in periodic installments. This is an attractive option for investors that wish to use the interest income to help support their lifestyles or match interest payments with regular expenses.

What are the interest rate options available for traditional GICS?

There are number of interest rate options available to investors:

  • Fixed rate:  The interest rate is set at the time of purchase and does not change during the GIC’s term to maturity.
  • Variable rate: The GIC’s interest rate is set and changes according to a published interest rate – Bank Prime Rate, for example. The GIC’s interest rate is variable and it would change, up or down, depending on the underlying rate.
  • Escalating or Step-up rate:  The GIC’s interest rate will increase from the initial rate on each annual anniversary. For example, if the GIC is set to mature in 5 years, then the first year’s interest rate might be 1.50% in the first year, 2.00% in the second year, 2.50% in the third year, 3.00% in the fourth year and 5.0% in the fifth year. This structure would provide an average annual interest return of 2.80%.
  • Currency:  GICs are available in currencies other than those denominated in Canadian dollars. Foreign currency GICs will have different features and details. Investors should check with their respective financial institutions for full details. Because foreign currency GICs are issued by Canadian institutions, there is no withholding income tax applicable for Canadian residents and non-residents. In addition, accounts and investments denominated in currencies other than the Canadian dollar are not eligible for insurance from CDIC.
  • Registered Account Eligible:  Yes.
  • Transferable:  Some GIC issuers permit the transfer of ownership from one entity to another. Investors should check with the financial institution.
  • CDIC insurance coverage:  For Canadian dollar denominated GICs with terms to maturity of five years or less, CDIC insurance is available. CDIC will insure up to $100,000 of principal and interest, for all deposits with any one member financial institution.  (See the section on CDIC for a more information on CDIC coverage.)
  • Taxation:  Interest earned, but not received, and interest paid to investors, in any calendar year, is reported on a T5 Income Tax Information Slip issued by the financial institution at the end of each calendar year. Typically, financial institutions only issue a T5 Income Tax Slip, if the interest earned exceeds $50.00, however, the interest must still be reported on your annual income return.

What are the basic features of a market-indexed GIC?

The basic features of a stock market-indexed GIC include the following:

  • Term to maturity: A stock market-based GIC has a term to maturity of 3 or 5 years.
  • Minimum investments: Most GIC issuers require a minimum initial investment of $500.00 to $1,000.00. Check with your financial institutions.

What are the basic features of a market-indexed GIC?

The basic features of a stock market-indexed GIC include the following:

  • Term to maturity: A stock market-based GIC has a term to maturity of 3 or 5 years.
  • Minimum investments: Most GIC issuers require a minimum initial investment of $500.00 to $1,000.00. Check with your financial institutions.

What are the options when buying a market-indexed GIC?

Due to the complicated structure of stock market-indexed (or market-linked) GICs, investors do no have much flexibility, as outlined below:

  • Non-Redeemable:  These types of GICs are non-redeemable. The investor must hold them to the date of maturity. 
  • Flexible or cashable:  Stock market-linked GICs are not cashable. 
  • Participation rate:   Each GIC issue has a complicated structure that will detail the specific underlying index or benchmark to be used in calculating the investment’s rate of return. In addition, the GIC may or may not earn a return equivalent to a percentage of the performance of the underling benchmark (for example, if the GIC has a maximum participation rate in the performance of the underlying benchmark). If the benchmark increased in value by 10%, then the rate of return for this GIC would 3.5% or 35%. Participation rates can also be restricted to maximums. For example, if the same benchmark increases in value by 15% in a single quarter, the GIC participation rate may be restricted to 10% in any quarter. In this case, the GIC owner does not participate at a 35% rate but rather 23.33% rate (3.5% divided by 15%). Investors should fully understand the description of the GIC’s participation rate. 
  • Maximum and minimum rates:  Many market-linked GICs have set maximum and minimum rates of return that the investor can earn. For example, if the maximum return for a 3-year market-linked GIC is set at 12.0%, the investor can earn no more than 12.0% in the 3-year period, or 4.0% per year. Even if the underlying index increased in value by 25% during the 3-year period, the investor’s maximum return is capped at 12.0%. Investors should ensure they understand the market-linked GIC’s terms and features before investing. 
  • Income payment options : Market-linked GICs do not provide any return or income stream prior to maturity. A return, if any, is tied to the performance of the underlying benchmark. There is no assurance that the underlying benchmark will appreciate over the term to maturity and, therefore, no assurance that investors will receive any amount at maturity other than repayment of principal.  The return on the market-linked GIC will be determined in accordance with the calculation method as described on the GIC’s Information Statement.  Some market-linked GIC calculations of final investment returns exclude dividends earned and paid by the underlying benchmark indices. Some of the market-linked GICs have a prescribed minimum interest rate that would be calculated annually.
  • Currency:  These GICs are Canadian dollar denominated. The underlying growth benchmark can be an international index.
  • Transferable:  Non-Transferable.
  • CDIC insurance coverage:   According to The CDIC, market-linked or index-linked GICs are term deposits whose returns are linked to a variation in a stock exchange index. They are neither an insurance contract nor security. They are deposits redeemable at maturity. An index-linked deposit would be insurable if it meets the CDIC’s eligibility criteria.
  • Taxation:   Returns from a market-linked GIC held inside a tax-free or tax-deferred account are not subject to income tax. If the market-linked GIC has a guaranteed minimum interest rate, the interest income from the minimum rate will be calculated and reported annually in a T5 Income Tax Information Slip. The market-linked calculated return, if any, will be reported in a T5 Income Tax Slip for the year of maturity. This income will be taxed as interest income, not capital gains, and all of it will be taxed in the year the GIC matures.

Remember:  In the investment industry, an accepted rule of thumb is that a risk-free investment rate of return should be equal to the rate of return from a government guaranteed bond. So if an investor purchases a market-linked GIC that has no risk of principal loss, in theory then, the investment’s annual rate of return should be equal to that from a government bond with the same term to maturity, before fees. After fees, however, the investor’s return would be less. Market-linked GICs have fees and costs that an investor does not see. It is difficult to know if market-linked GICs actually earn investors a return that is higher than a regular GIC with the same term to maturity. Because of the individual nature of market-linked GICs, no actual performance details are ever published. The marketing literature for market-linked GICs relies heavily on back-testing historical data, which can be misleading and potentially meaningless.

When should I use GICs?

Anytime an investor has designated a portion of their savings to be invested in the Fixed Income asset category, GICs should be considered an option. Their features, interest rate, term to maturity, access to principal before maturity, should be compared with the same features inherent in bonds and preferred shares.

When comparing Fixed Income options, investors should consider the market price fluctuations between the date of purchase and the date of maturity. Remember that a GIC does not trade in an active secondary market as a bond does, and therefore its monthly statement price will remain stable at $100.00 for simple annual GICs and $100.00 plus accrued interest for compounding GICs.

Does it really matter which financial institution I buy the GIC from if it is a member of CDIC?

Ultimately it does not matter which institution you buy the GIC from if it is a CDIC member and the GIC meets their insurance criteria. If the member institution fails, then you can rely on CDIC to repay your principal and interest within their limits.

How do I decide on the right GIC?

The GIC you select should have a specific job to perform within your investment portfolio. The GIC’s job description should be specified within the Investment Policy Statement (IPS) that governs your portfolio. For example, if the job you are filling is described as “to safeguard capital and to provide a consistent reliable annual income,” then you can rule out stock market-linked GICs and variable-rate GICs. Looking at your current Fixed Income maturities, you can identify the year with the lowest dollar amount of maturities that should be reinforced.

Example: If your portfolio has $10,000 maturing in one year, $12,000 maturing in two years, $0.00 in three years, $15,000 in four years, and $10,000 in five years, then you know that the weakest year for maturities is the three-year category. Therefore, you should be looking at Fixed Income options that mature in three years, regardless of the interest rates offered in other maturities.

Likewise, if the specific job is to fill a hole in the funds held for future expenses or investment opportunities, then you should not be looking at non-redeemable longer-term GICs or market-linked GICs. You should narrow your search to flexible, cashable options.

How important is the current direction of interest rates to my GIC decision?

Current interest rates and the shape of the current yield curve are certainly important considerations, but basing your investment decision on the forecast of the unknowable direction of interest rates is not a very structured, nor effective investment approach. It is much more important to maintain a well-balanced, laddered Fixed Income maturity schedule, governed by a well-written Investment Policy Statement (IPS).

If your Fixed Income investments are balanced as to maturity dates and credit quality, then you have the luxury of not worrying about interest rate changes.

Are market-linked GICs a good option for investors?

This is difficult to answer for two basic reasons. First of all, there is no published performance history making it difficult to know if the structure works. You may have to ask friends and associates if they have ever had any experience with market-linked GICs to help gauge their success or failure. The marketing of market-linked GICs tends to rely upon back-testing historical data rather than actual results. Secondly, no one knows how well or poorly future markets will perform.

Note: Market-linked GICs are considered to be a type of hybrid investment: it looks like a Fixed Income investment, but has the personality of a stock market investment.

Are there other options or products similar to market-linked GICs?

Yes. The chartered banks also issue principal protected notes (PPNs). These are not CDIC insured and have a limited secondary market for trading. (See our section PPNs  for additional details.)

Another option for investors is to create their own market-linked GIC. The market-linked GIC can be somewhat replicated by buying a discounted (Residual, Coupon, Compounding Bond/GIC) and then accompanying this with an investment in an exchange traded fund (ETF), which can be accomplished as follows:

If you have $10,000.00 to invest, but you do not want to risk any of your principal, then you could invest a portion in a compounding Fixed Income investment and the balanced in a market-linked ETF.

Example: Let’s say you buy a compounding bond/GIC that matures in 5 years at a value of $10,000.00. This bond/GIC, if it compounds at 4.05% annually, will cost approximately $8,066.00 to purchase and it will mature in 5 years at $10,000.00. This is the guarantee of your principal. With the difference of approximately $1,934.00 ($10,000 – $8,066), you buy units in a stock market ETF.

Keeping with this example, in five years, your compounding bond/GIC will mature at $10,000.00 and you can sell or keep the units of the ETF. Just like a market-linked GIC, the interest earned by the compounding investment will be taxed as interest income in the year of maturity and any capital gains or losses incurred by the ETFs will be taxed accordingly at the time of disposition. If the investments are held within a tax-free or tax-deferred account, then the income tax effects are identical to a market-linked GIC held in the same account.

Note: The above example achieves the same financial result as a market-linked GIC, but with greater control, understanding and lower costs for the investor.