What is a GIC?
A guaranteed investment certificate, known as a GIC, is an investment product offered by banks and trust companies that offer a fixed, low rate of return over a term of either one month or up to five years. though some GICs have a maximum term of ten years. Some GICs offer a variable rate of return (also called annual percentage yield or APY, for short) that is tied to the performance of an equities index and if no interest is generated, 100% of the principal invested is returned to you. These are market-linked GICs and they typically give a better rate of return than the traditional fixed-rate GIC. In the U.S., they offer a similar financial product called a CD, or certificate deposit.
How Do GICs Work?
When you buy a GIC, you are lending the bank your money for a stated term (or length) of deposit. This means you will not have access to the money you invested, and the interest it generates, for the length of the term.
In most cases, the longer the term, the more interest your money will generate. Though most GICs end at five years, terms can go up to a maximum of ten years. The minimum deposit for a GIC is typically $500 and GICs can be placed inside registered accounts, such as RRSPs, RESPs, RDSPs and TFSAs. These accounts have unique benefits, such as contribution matching by the government (with a RESP) or tax-deferrals with a RRSP where your contributions grow tax-free until withdrawal. Or, in the case of a TFSA, aren’t taxed at all up to a contribution limit. GIC deposits are also insured up to $100,000 by the Canada Deposit Insurance Corporation (CDIC).
How are GIC Rates Determined?
GIC rates are set like other banking rates. Banks and credit unions often use an index rate, typically the Bank of Canada overnight rate (also known as the policy interest rate), as a base to set rates for all interest-bearing accounts.
When the policy rate rises, banks and credit unions will generally increase the interest rates on accounts like savings and GICs. When the policy rate falls, banks will then lower their rates on those same accounts.
In addition to tracking current interest rates in the economy, banks and credit unions set rates based on a GIC’s term. Generally, the longer you keep your money in a GIC, the higher your interest rate. However, banks and credit unions may feature or promote individual terms at higher rates.
Types of GICs?
There are several types of GICs that all affect your investment in unique ways. Availability may vary between banks.
A traditional fixed-rate GIC features an interest rate or annual percentage yield (APY) that doesn’t change for the duration of the term. The interest is calculated at the end of the term at maturity.
Sometimes called step-rate GICs because they use stairs to tell you how the interest is calculated, an Escalator GIC is a GIC where the APY is guaranteed to go up every year.
Market-Linked GICs are hybrid GICs that mix the features of traditional GICs with stock-based investments. Though your principal investment is 100% guaranteed like a traditional GIC, the interest generated is based on the performance of the stock index that the GIC is linked to. This means the interest generated is variable and the maximum interest you can get is limited, but still potentially higher than traditional fixed-rate GICs.
Variable Rate GICs
Variable rate GICs will give you an APY that’s higher than the traditional fixed-rate as it’s tied to the prime interest rate. when interest rates go up, so does the APY. Conversely, when the prime rate goes down, so does the interest you can earn.