Higher rates for guaranteed investment certificates (GICs) have attracted investors seeking steady income, but GIC returns in non-registered accounts are taxed at the marginal rate, which is higher than for capital gains and dividends.Altayb/iStockPhoto / Getty Images
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Investors who stocked up on guaranteed investment certificates (GICs), lured by higher rates not seen in years, are now facing the aftereffects of higher income tax bills.
Advisors say retired seniors, many of whom are on a fixed income and have fewer write-offs and deferrals than working Canadians, have been hardest hit this tax season. Some owe a lot more taxes and face a clawback of their Old Age Security (OAS) benefits because of their GIC investment returns.
“Some of my clients who are seniors are shocked by their tax bills this year. They’re saying, ‘I can’t possibly have to pay that much.’ They just weren’t expecting it,” says Debbi-Jo Matias, a chartered professional accountant in Vancouver. “It was a tough tax season.”
GIC rates have hovered around 5 per cent since late 2022, attracting investors seeking steady, guaranteed income that’s more reliable than the stock market. However, advisors say some don’t realize that GIC returns in non-registered accounts are taxed at an investor’s marginal rate, which is higher than the tax rate for capital gains and Canadian dividends.
“There’s definitely a trade-off with GICs in terms of tax efficiency,” says Jason Heath, a certified financial planner and managing director at Objective Financial Partners Inc. in Markham, Ont. “Sometimes people think, ‘I’m getting 5-plus per cent on a GIC. That’s a good rate of return.’ But it’s also important to think of the after-tax return in a taxable account.”
The lure of GICs
Many seniors were comforted by higher GIC rates after years of relying on the volatility of stock and bond markets.
GICs are relatively simple to buy online or through a local bank branch. Some seniors were also grateful for the guaranteed returns as inflation drove up the price of groceries, gas and other living expenses.
“They were tired of watching their investments go up and down, and looked to GICs for the ease and security,” Ms. Matias says.
Still, the tax impact isn’t always considered when purchasing GICs.
Ms. Matias says some seniors have more income in retirement than when they were working, including pensions, investment income, registered retirement savings plans (later turned into registered retirement income funds with mandatory yearly withdrawals), Canada Pension Plan and OAS benefits. Retired seniors also don’t have as many tax deferral opportunities as people in their working years, such as contributing to an RRSP.
Being in a higher tax bracket and having fewer deductions and write-offs has resulted in many seniors paying more taxes than expected. Add the higher GIC returns and the taxes owed can add up greatly, Ms. Matias says. What’s more, those who owe more than $3,000 in taxes must also start paying instalments for the current tax year.
“I’m not against anyone buying GICs, but you have to plan to pay for the extra taxes,” Ms. Matias says.
Investment income also adds to tax bills
It’s not just GIC returns adding to higher tax returns, Mr. Heath says, but also unexpectedly high investment income from outperforming stock markets in 2023 – a year when many market watchers were predicting a recession.
“Some people are surprised to get a T3 [for investment income] because they didn’t sell any investments, but they might own a mutual fund, for example, that sold investments that, in turn, generated a capital gain,” he says.
Mike Preto, portfolio manager and insurance advisor with Hillside Wealth Management at iA Private Wealth Inc. in Vancouver, says seniors also need to consider the impact of inflation on their cost of living, and whether higher-taxed GICs are the best product to meet their longer-term financial goals.
“The big issue with GICs is they move higher with interest rates, and interest rates move higher with inflation,” Mr. Preto says. “We’re not saying never have GICs, but don’t get lured in by the higher rates. Think beyond that.”
His rule of thumb for clients is that all long-term assets should be invested in the market, while short-term money should be invested in cash, whether it’s a GIC or a more liquid high-interest savings account.
Tax as the ‘cost of doing business’
Mr. Heath notes that higher GIC rates may not last long, given expectations the Bank of Canada will start reducing interest rates, possibly starting as early as June.
“It’s important not to be blinded by the temporary high rates from GICs because they’re not likely to stay that high,” he says. “And GICs are likely to produce a lower long-run return than other investments such as stocks and bonds, not to mention the higher tax treatment compared with stocks.”
Still, Mr. Heath acknowledges that investing in stocks and bonds isn’t for everyone, particularly seniors who tend to be more focused on steady cash flow in their retirement years.
“If somebody is a conservative investor, or has to have the money for a specific short-term purpose, I might be inclined to say the tax is just the cost of doing business,” Mr. Heath says. “You should be careful about adjusting your investment strategy just to pay less income tax.”
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