GICs and Taxation

Before buying a guaranteed investment certificate (GIC), it’s important to understand the tax implications of having one or more in your investment portfolio. Actually, this is crucial, because not all investments are treated alike by the Canada Revenue Agency. As a result, savers need to compare the potential after-tax returns of various investment options.

How are GICs taxed?

In the case of a GIC, all the interest earned is taxed at a person’s so-called marginal rate. Your marginal rate is the tax bracket you fit into given your pre-tax annual income. Tax is payable to both the federal and provincial governments. For federal and provincial tax rates, see the CRA’s website here.

For tax purposes, interest income from a GIC is treated just like regular income. This differs from dividend income and capital gains income, both of which receive more favourable treatment. However, if you hold your GIC in a registered investment account, such as an RRSP or TFSA, you do not have to pay taxes on any interest earned.

In the following examples, let’s assume the GICs are held outside registered accounts, as the difference is pretty significant. For example, as this chart from KPMG explains, someone in the top tax bracket in Alberta in 2013 would pay 19.50% on capital gains income but 39.00% on interest income (that’s federal plus provincial tax). The numbers vary from province-to-province, but the story remains the same: interest income (which includes GICs) is not given any sort of tax break.

Example: Beth buys a 1-Year GIC

Beth puts $10,000 into a 1-year non-redeemable GIC paying 1.50% interest. She lives in Alberta and earns $52,000 a year, which qualifies her for the 32.00% tax bracket (combined federal and provincial). How much tax will she pay on her investment? And what’s her after-tax return?

To summarize, Beth’s 1.50% GIC earned $150 in interest of which $48 was paid in tax. She was left with an after-tax return of $102 or 1.02% on her original investment.

How are multi-year GICs taxed?

With GICs it is also possible you will have to pay tax on interest that has been earned but not yet received. For GICs with terms greater than one year that are automatically re-invested, you will have to pay tax on the interest earned at each anniversary date, regardless if you will not receive the actual payout until the end of the contract. From the CRA’s perspective, the interest counts as income once it is “earned”, not after it’s been physically paid out. (Another word for “earned” in this case is “accrued”.)

The exception to this is market-linked GICs. The return on these GICs is not normally taxed until maturity, when the exact return is known, at which point it is fully taxed as income (unless the GIC has a minimum interest guarantee which requires investors to report and pay tax on the minimum interest guarantee each year). This can create a financial burden: the investor owes tax on money that has not been received yet. Savers in this position need to be able to pay the tax while they wait for the GIC to mature.