Are GICs Worth It Inside of Your Tax-Free Savings Account?

WRITTEN BY Dan Kent | UPDATED ON: March 20, 2024

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Tax-Free Savings Accounts (TFSAs) afford Canadians a flexible investment option that is not subject to taxation on its profits. No taxes are levied on capital gains, dividends, or any accumulated interest.

Among the various investment vehicles that can be held inside a TFSA, a Guaranteed Investment Certificate (GIC) is an appealing choice for risk-averse investors who want a guaranteed rate of return.

A TFSA GIC ensures that the principal amount is shielded from market volatility while the interest earned is tax-free, making it a prudent option for long-term savings goals.

When it comes to investing in a GIC inside of your TFSA, one must be aware of the annual TFSA contribution limit and the variety of GIC terms available, which range from short to long-term. 

The best interest rates for GICs vary depending on the financial institution and the length of the term, which can significantly impact the potential growth of one's investment. 

By comparing the best GIC rates in Canada, savers can select an option that aligns with their financial objectives and risk tolerance.

What Is a GIC?

Guaranteed Investment Certificate (GIC) is an investment product where the principal is guaranteed, and a fixed interest rate is earned over a specified term, often between 1-7 years; however, lower terms are available. 

Some may feel that GICs are not worth it as the stock market has typically returned more. However, GICs offer security and predictability, which is ideal for risk-averse investors. In the current rate environment, they also offer high interest, something we haven't witnessed for decades.

Investors can also add more liquidity to their GIC holdings by utilizing a GIC laddering strategy, which I discuss in detail here.

What Is a TFSA?

A Tax-Free Savings Account (TFSA) is a versatile investment account with annual contribution limits that allows Canadians to earn tax-free investment income. 

A TFSA offers the flexibility to withdraw funds at any time, free of tax, making it an attractive option for both short-term savings and long-term investments.

The TFSA, along with the RRSP, RESP, LIF, LIRA, or FHSA, are what we would call registered accounts. Whereas a cash or margin account would be called an unregistered account.

Often, you'll see GICs distinguished as registered or non-registered. This simply means the account they're being held in.

Benefits of investing in GICs inside of your TFSA

Investing in Guaranteed Investment Certificates (GICs) inside your Tax-Free Savings Account (TFSA) provides Canadians with a secure and tax-efficient way to grow savings. They offer fixed returns and the peace of mind that comes with CDIC coverage.

Let's go over some of the core benefits of investing in GICs inside of your TFSA.

Tax advantages

Buying a GIC inside of your TFSA provides significant tax benefits. The interest accrued within a TFSA is entirely tax-free, meaning investors are not required to pay taxes on the gains, whether they are withdrawn or held in the account. 

This can lead to more effective compounding of interest, as the entire return is reinvested rather than being diminished by taxes.

GICs are very poor from a tax perspective. Their interest is taxed as ordinary income, unlike dividends received from a stock or mutual fund. Interest income is one of the worst forms of investment income, and if you can avoid it by tax-sheltering it, it can be extremely beneficial.

However, as we will go over soon with the downfalls of buying a GIC in your TFSA, in some cases it isn't work the tax benefits. More on that later.

They're a secured investment

A GIC is generally seen as a safe investment choice. In fact, outside of treasury bills and government bonds, they're arguably the safest investment out there.

Each investment is backed by The Canada Deposit Insurance Corporation (CDIC) up to certain limits, providing a safety net for investors. 

This insurance covers GICs for up to $100,000 per insured category, per institution, in case of the financial institution's failure, ensuring that Canadians' savings are protected.

Without the confidence that their deposits are safe, Canadians would never leave them in banks, and banks would never have the capital to loan out money. For this reason, the CDIC exists to give Canadians confidence.

Interest rates and returns

While interest rates on GICs may vary based on term lengths and market conditions, they usually offer higher rates compared to regular savings accounts. Your bank may offer you 0.5% on money held in a TFSA, and with a GIC, depending on the current rates, you could earn tenfold this.

Because GICs are often fixed-rate products, they can provide predictable and stable returns. When held within a TFSA, these returns are not only guaranteed but also grow tax-free, maximizing the investor's overall savings potential.

Disadvantages of investing in GICs inside of your Tax-Free Savings Account

GICs inside of your TFSA look like a foolproof way to invest at first, but investors should be aware of certain drawbacks. The primary disadvantages centre around interest rates, liquidity, and the potential opportunity cost associated with these instruments.

Your returns will be lower than other high-risk yet proven investment vehicles

Firstly, TFSA GICs typically offer lower interest rates compared to other investment vehicles. This lower rate can result in a modest annual return on one's savings, particularly in a high-inflation environment, eroding the real purchasing power of those funds over time.

For example, the stock market has continually proven to outperform fixed-income investments like GICs over the long term. When you factor in the tax-free element of the TFSA, it may become more beneficial for investors to take more risks to accumulate more tax-free capital if they can withstand the swings.

Lack of liquidity

Liquidity is another concern. Money invested in GICs is locked in for a specified term. If an investor needs to access their funds before the maturity date, they might face fees or lose the accrued interest, making it less flexible than other savings options.

If one ties up their TFSA with GICs and down the line wants to pull that money out to either utilize or put it in higher earning investment vehicles like stocks, ETFs, or mutual funds, they will not be able to do so until maturity.

Maximum contribution amounts

One also must consider that investments in your TFSA are not infinite. There is a TFSA contribution limit, which restricts how much can be contributed annually. Exceeding this limit could have you paying interest to the government.

With all this said, should you be investing in GICs in your TFSA?

The flexibility of a TFSA allows for tax-free withdrawals, making a GIC within a TFSA an attractive choice for both short-term savings and long-term financial planning. For risk-averse investors, it's a great way to earn a fixed rate of return, especially now that rates are high.

However, for those who have longer time horizons, GICs inside of a tax-free vehicle like the TFSA can end up costing you in the long run due to lower returns. You'd be surprised at how quickly tax-free returns can compound, and you want to take advantage of as much as you can to retire earlier.

If you're going to buy one, however, selecting the right GIC for your Tax-Free Savings Account requires understanding the features of this investment product and considering factors like the duration of the investment and whether the interest is compounded annually or at maturity. 

Let's go over that and some common questions next.

Choosing the Right GIC for your TFSA

Let's go over some of the important elements you need to take into account when looking to buy a GIC inside of your TFSA>

Find the best rates possible

Financial institutions frequently adjust their GIC rates, making it crucial for investors to compare the latest offerings. 

Typically, online banks are able to provide higher rates than traditional brokerages due to the fact they can operate on tighter spreads because of their low overhead nature. However, it is not out of the question for traditional banks to have promotional rates.

In addition to this, make sure that you negotiate your rates with your institution. Reaching out and asking for a better/more competitive rate can end up with you earning more on your savings. Will it always work? Of course not. But emailing the bank doesn't take long, and you could be pleasantly surprised.

Understand your term

The term of a GIC can vary from short-term (30 days) to long-term (5 years or more), influencing the interest rate of the product. 

Typically, a longer term has higher rates due to the increased length of the investment. However, this isn't always a guarantee. If the institutions believe that policy rates could be headed lower, they could easily offer more attractive rates to incentivize people to lock into shorter terms.

One very important thing for investors to consider is their timeline and how the terms offered will interact with that. If you may need the money in a couple of years to buy a car or fund a down payment, it makes little sense to lock the money into a long-term GIC with a maturity longer than that.

Understand the minimum deposit and minimum balance

Sometimes, institutions will have high minimum deposits for their GIC products and may require you to maintain a particular balance in your account. 

It's important you understand how much you have to invest and choose a financial institution that fits your needs. Often, you can earn higher GIC interest rates if you have larger minimum deposits. But it's not always a guarantee.

Redeemable vs non-redeemable GIC for your TFSA

A redeemable GIC allows investors to access their money before the end of the term, typically with lower interest rates as a trade-off for flexibility. 

Conversely, non-redeemable GICs lock in funds for the entire term but offer higher interest rates, rewarding investors for their commitment. Deciding between redeemable or non-redeemable should reflect the investor's need for liquidity and return preferences.

However, the one thing I would caution about is the fact that you should be attempting to earn the highest possible rates from your fixed-income investments.

The attractiveness in terms of being able to access the money in an emergency with a cashable GIC is nice. However, you'll pay for the ability with a much lower interest rate.

Instead, one should look to invest money they have zero plans touching in non-redeemable GICs to take advantage of much higher rates.

This is obviously just my opinion, but I'm a firm believer that these specialized products really only benefit the bank in the long run.

Be aware of the TFSA contribution limits

When managing a Tax-Free Savings Account (TFSA), it is crucial to understand the contribution rules set by the Canada Revenue Agency (CRA) to maximize benefits while avoiding over-contribution.

It seems great to purchase a GIC inside of a TFSA and earn a tax-free, guaranteed rate of return. However, if you don't pay attention to your annual contribution limit, your gains can be quickly eroded by fees.

Contribution limits

Each year, individuals are granted an annual TFSA contribution limit, which the CRA determines. An unused contribution room can be carried forward indefinitely, allowing the potential accumulation of significant contribution space. Individuals can find their current limit by logging into 'My Account' on the CRA website.

However, one important caveat with this number. It is not updated frequently, so it's important to cross reference this contribution limit room with how much you've contributed recently.

Over contribution penalties

Contributing more than the allowable TFSA limit results in excess contributions, which are subject to a penalty tax. The CRA imposes a tax of 1% per month on any amount that exceeds the contribution room.

You can see how this can be devastating in terms of your overall returns. If you purchase a GIC that pays a 5% annual rate of interest, every month, 20% of your overall returns from that GIC would simply go to fees if you over-contribute.

So, it's very important to keep this in mind.

Impacts of withdrawals

Withdrawals from a TFSA, including from GIC investments, do not reduce the total amount of contribution room available. 

In fact, the amount withdrawn in one year is added back to the individual's contribution room at the beginning of the following year. Therefore, they can effectively replace the withdrawn funds in the TFSA.

Just know that you must wait until the next year to recontribute the money. Let's go over a very simple example.

If your TFSA is maxed out and you choose to withdraw $10,000 in June, you will not be able to re-contribute that $10,000 until January 1st in the next calendar year, having to wait half the year to re-contribute. If you withdraw the money on December 31st, however, you'd only have to wait a day before you could re-contribute.

Common questions when it comes to TFSAs and GICs

Does a maturing GIC affect TFSA contribution room?

A maturing GIC within a TFSA does not impact an individual's contribution room. As gains from a TFSA GIC are tax-free, they do not count towards the contribution limit. 

This would be much the same as if you earned money investing in a stock, ETF, or mutual fund. the gains are considered tax-free and do not impact your contribution room. Only money that you deposit in your TFSA impacts your room.

Can I move a GIC into my TFSA?

It is possible to transfer a GIC into a TFSA, provided there is an available contribution room. This is a very important element to consider, as if you do not have the room and move a GIC inside of your TFSA, you could face heavy penalties that quickly erode the interest earned on your GIC.

When considering a transfer, the GIC must be deemed eligible for a TFSA, and one should be aware that transferring a non-registered GIC may have tax implications.

Can I withdraw money from a GIC inside my TFSA?

Withdrawals depend on the terms of the GIC—some are non-redeemable, meaning funds cannot be withdrawn until maturity. Conversely, some GICs offer the flexibility of early withdrawals, but there could be penalties or lost interest. Always check the GIC's conditions before assuming funds can be accessed.

What happens when a GIC matures inside my TFSA?

Upon maturity, financial institutions usually notify you and may provide options, such as reinvesting in a new GIC, transferring to a different investment, or withdrawing the funds. 

With a TFSA, once a GIC matures, you'll often find your principal amount inside your account, along with any accrued interest, depending on how you've selected to be paid.