Registered vs Non-Registered GICs – What Should You Buy?
When Canadian investors are looking to secure their savings with a guaranteed return, they often turn to Guaranteed Investment Certificates (GICs) and the GICs that offer the highest rates.
What are GICs? These financial instruments can provide a safe haven for funds, guaranteeing both the principal amount and a fixed rate of interest.
However, choosing between a registered and a non-registered GIC can significantly impact one’s financial strategy. Understanding the distinctions between these two types is critical, as I have noticed a lot of misconceptions.
Registered vs non-registered GICs – What’s the difference?
There is actually next to no difference in the actual GIC, although some institutions will offer you better rates for registered and non-registered GICs. The only actual difference is the account you hold them in.
Registered GICs
Registered GICs are held within government-sponsored accounts such as RRSPs, TFSAs, or RESPs, which offer various tax advantages.
The growth within these accounts is usually tax-sheltered, allowing one’s investments to compound more over time. However, these accounts come with contribution limits and may have other rules regarding withdrawals and tax implications upon retirement.
Non-registered GICs
In contrast, non-registered GICs are held in non-registered accounts, like cash or margin accounts, and do not have the same tax benefits as their registered counterparts because they are not held in tax-sheltered accounts. However, they do provide more flexibility.
There are no contribution limits, making them an appealing option for investors looking to save beyond their registered plan contributions. The unlimited contributions also make GIC laddering a bit more effective, as you are not limited in your dollar values per GIC.
Nonetheless, the interest earned in a non-registered GIC is taxable at the individual’s marginal tax rate, which could affect the overall return on investment.
So, as you can see, it is more so the account the GIC is held in and not the actual GIC itself. This is a big distinction many need to understand.
The pros and cons of both registered and non-registered GICs
Benefits of registered GICs
The key advantage of registered GICs is the tax-deferred or tax-free growth potential.
For instance, GICs within a TFSA grow tax-free, meaning investors do not pay tax on the interest earned.
In contrast, GICs within an RRSP grow tax-deferred, with taxes payable upon withdrawal, which is often at a lower marginal rate during retirement.
Both accounts provide a way to save while utilizing available contribution room for efficient retirement savings or future spending.
It can be argued that these accounts, particularly the RRSP, should be invested in with a long-term mentality and as such, higher returning asset classes such as equities (stock market) should be utilized.
I tend to agree, but individual situations between investors can vary wildly, and GICs may make perfect sense for you in these accounts.
Disadvantages of registered GICs
Despite their benefits, registered GICs also come with limitations.
There are contribution limits depending on the account type—TFSA, RRSP, or RESP—which may restrict the amount an individual can invest annually.
Investments in these accounts (not the TFSA) are often locked in until certain conditions are met, such as retirement or educational expenses; early withdrawal may result in penalties or the forfeiture of the tax-advantaged status.
An additional disadvantage that has been mentioned above is opportunity cost. Yes, the GICs you hold in your tax-advantaged accounts allow interest to accrue tax-free and are some of the safest investments in the country. However, history has shown that riskier assets like stocks have outperformed the fixed-income element of a GIC.
As a result, lower returns on your capital could end up in you having less tax-free money in retirement.
Benefits of non-registered GICs
Non-registered GICs provide more flexibility than registered ones. This is because the capital is available to them freely after the GIC has matured, unlike an RRSP, where one would have to pay withdrawal penalties and income taxes on the money withdrawn.
Investors can add more liquidity by investing in redeemable or cashable GICs. These are typically short-term GICs, with a GIC term of 1-year or less.
Keep in mind, however, that these types of GICs typically only help the bank. You will earn a much higher interest rate on non-redeemable GICs, and they’re often the better choice for many.
Another added benefit of a non-registered GIC would be that it would allow you to hold a more diversified portfolio of stocks, ETFs, mutual funds, or any other equity investment you’d like in your tax-sheltered accounts.
Historically, equities have outperformed investments like GICs when held for the long term. So, it makes sense to hold these types of investments in tax-sheltered accounts, as returns can compound quickly.
Disadvantages of non-registered GICs
The interest income earned by a GIC is taxed. Non-registered GICs require individuals to pay taxes on the earned interest at their marginal tax rate, which can reduce the overall profitability.
Interest income is one of the worst forms of investment income you can have from a tax perspective. Capital gains and dividend income are often taxed at a much friendlier rate.
Interest Rates and returns of registered and non-registered GICs
Although the main difference between these two GICs is the accounts they’re held in, some institutions often offer more attractive rates for the two different GICs.
In some instances, a bank may give you a boost in interest if you purchase a registered GIC versus a non-registered GIC, for example. It’s important to keep an eye on the highest GIC rates currently and make a decision from there.
How interest rates impact GICs
Interest rates play a pivotal role in defining the earning potential of GICs. Sometimes times of low interest rates can have some people asking: are GICs are worth it or not?
Redeemable GICs offer the flexibility to cash in before the maturity date but typically come with lower interest rates compared to non-redeemable GICs, which lock in funds for a set term but usually provide higher returns.
The Bank of Canada’s decisions can substantially influence GIC interest rates, and when rates rise, newly issued GICs become more attractive investments in comparison to older, lower-yielding ones.
Conversely, when rates drop, existing GICs at higher rates become more valuable. Unless, of course, you have a variable rate GIC. These types of GICs are rarer but do exist. They offer a variable interest rate instead of a guaranteed rate, one that will fluctuate with policy rates set by the Bank of Canada.
Banks will typically offer you a more attractive rate of interest when locking in long-term. This is because fixed-rate GICs with long periods to maturity are subject to more interest rate risk.
Overall, banks will plan our their GICs rates by how they project future movements in policy rates. If they believe rates may be heading down, they may encourage investors to lock into shorter terms so that when those mature, lower policy rates will allow them to issue new GICs at lower rates.
However, if the bank believes rates will rise, they may offer you more attractive long-term rates. That way, when rates go up, your GIC will be at a lower rate than they’d have to offer you if it matured at that time.
Choosing the right GIC for your goals
When selecting a Guaranteed Investment Certificate (GIC), pinpointing the exact financial targets one aims to achieve is crucial. Although I am a fan of allowing my tax-sheltered accounts to grow with equity investments over GICs, that isn’t to say your situation is completely different.
Aligning GICs with financial goals
One’s financial goal can drastically influence the type of GIC that is most suitable.
For those looking at savings goals, such as setting aside money for an emergency fund, a non-registered GIC might be preferable for its ease of access and lack of contribution limits. Yes, you’ll pay taxes on the earnings. But, the added liquidity and flexibility may be what you need in your particular situation.
Conversely, for individuals with investment goals centred around long-term growth or saving for a down payment on a home, a registered GIC could help.
Let’s say you want to utilize the Home Buyers Plan, which is a plan that allows someone to pull money out of their RRSP tax-free to use for a down payment on a home.
In this situation, you may find you don’t want to invest your RRSP into the stock market as its value may be much lower at the time you need to pull the money out simply due to the market volatility. In this situation, a registered GIC makes perfect sense.
There are hundreds of situations that can change the goals of any single investor. So, although I’ve highlighted just a couple here, don’t discount your own current situation.
Comparing GIC providers
Once the alignment with financial goals is clear, the next step involves comparing various GIC providers.
As I mentioned above, you may get banks that offer more attractive rates for particular registered accounts, or they may offer better rates for holding the GICs in unregistered accounts.
Factors like interest rates, terms, the option for a market-linked GIC, and account fees should all be evaluated.
You will typically find more attractive rates at online banks, as they have less overhead and expenses than traditional major banks, which allows them to have tighter “spreads” on their loans.
However, this isn’t always the case, and GIC rates are often negotiable at major institutions that are trying to keep up with the wave of online banks.
The account limitations of registered GICs
Canada offers a variety of registered accounts tailored for different life stages and financial goals. The TFSA allows individuals 18 and older to contribute up to a specified limit each year, with the flexibility to withdraw funds without losing contribution room.
On the other hand, the RRSP is designed primarily for retirement savings, providing tax breaks on contributions and deferring taxes until funds are withdrawn, hopefully at a lower tax bracket.
An RESP is intended to support post-secondary education, allowing earnings to grow tax-deferred while the government contributes a certain percentage in the form of education savings grants.
Each registered account type has distinct rules about contributions, taxes, and withdrawals, which are important for investors to understand before making investment decisions.
Strategic use of registered and non-registered GICs
Many investors have different tax situations that can impact the decision to invest in a registered or non-registered GIC.
Tax mitigation
For a Non-Registered GIC, the interest income is taxable. Investors pay taxes at their marginal income tax rate. However, with a Registered GIC held within a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP), the earnings accumulate tax-free, and in the case of a TFSA, withdrawals are not taxed.
In an RRSP, you’re deferring taxes until retirement, where you may be in a lower tax bracket.
Suppose a specific individual is in a situation where it may be more beneficial from a tax perspective to claim capital gains or dividend income from their taxable accounts. In that case, they may consider buying a registered GIC inside one of their tax-sheltered accounts despite the lower flexibility and opportunity cost.
Building a diversified portfolio
Incorporating GICs into a diversified portfolio can mitigate risk while providing stable investment income.
As investors get older, they tend to move more of their investments into fixed-income properties that generate stable income. So, someone who is 75 years old may value the tax-free income of a GIC inside of their TFSA despite the fact they’re likely sacrificing returns over the long term.
The opportunity cost to a 75-year-old isn’t nearly as impactful as it is to a 25-year-old. GICs can act as a buffer against the volatility of assets like stocks or bonds. Their inclusion is particularly strategic for those nearing retirement, complementing other retirement funds, such as RRIFs and annuities.
Investment in GICs should align with an individual’s risk tolerance, financial goals, and the constraints of contribution limits to registered plans.
Safety and insurance on GICs
Regardless of whether or not you’re choosing a registered or non-registered GIC, they still come with the same security and protection.
I’m highlighting this because I have had some investors who believe GICs that are held in accounts like Registered Education Savings Plans (RESP), Registered Retirement Income Funds (RRIF), Tax-Free Savings Accounts (TFSA), and Registered Retirement Savings Plans (RRSP) are somehow safer. This isn’t the case.
CDIC protection
In the event a financial institution fails, the Canada Deposit Insurance Corporation (CDIC) ensures that GICs and other eligible deposits are safe, up to a limit of $100,000 per depositor, per insured category, at each member institution. This deposit insurance is automatic and charges no fees to depositors.
If you are looking to invest more than $100,000 into a GIC, many investors will look to spread their money out over several institutions so that they have full coverage.
Make sure your bank has CDIC coverage
When investing in GICs with any bank in Canada, it’s important to ensure that your financial institution is a member of the CDIC. Members of CDIC provide additional security for your investment, even in the event of bankruptcy.
The vast majority of banks you are looking at GICs with will be members of the CDIC. However, before committing to a GIC, confirming that the product is insured can help investors make a decision with greater confidence.
Calculating your GIC returns
Although there are many different types of GICs outside of market-linked GICs, the calculations in terms of your returns will be very simple.
To calculate the return on a GIC, one must consider the annual interest rate and how often interest payments are made, which can impact the compounding effect.
In some instances, you can take the interest you earn in cash at specific intervals. Alternatively, the bank would allow you to compound your interest and pay it all back at maturity.
Let’s look at an example of that:
- A non-redeemable GIC with a 5.25% annual interest rate and a 3-year term, compounded yearly on a $10,000 investment, would yield:
- Year 1: $10,525
- Year 2: $11,076.63
- Year 3: $11,655.68
These returns are compounded annually and show how the initial investment grows due to the effect of compounding interest.
When you look at the total returns on this GIC, they sit at $1,655.68, which is a total of 16.55%. This is higher than the 5.25% x 3 years = 15.75% you’d earn had the money not compounded.