Tax-Free Savings Accounts (TFSAs) and Guaranteed Investment Certificates (GICs) are both valuable financial tools to consider having in your portfolio. They serve very different purposes, but can also work together. Though they are very different, people may ask is a TFSA or a GIC better?
GICs and TFSAs are not inheritently better than one another, but rather fulfill different roles in your portfolio. TFSAs serve as a container for various investment vehicles, which can include GICs, allowing them to grow tax-free. Whereas GICs are an investment instrument to grow your money.
Both TFSAs and GICs can have a place in a strong financial portfolio. Let’s dive into what purpose each tool can serve.
What is a TFSA?
A Tax-Free Savings Account is a type of Canadian registered account that allows you to grow your investments tax-free.
TFSAs can be thought of containers to store your assets. They can hold numerous asset types, including (but not limited to):
- Cash
- Stocks & Bonds
- Mutual Funds & Exchange Traded Funds
- GICs
- Real Estate Investment Trusts (REITs)
And any growth or distributions (e.g. dividends) held in TFSAs are non-taxable. This means that if your investment rises by 20%, you get to keep the entirety of that growth. Contrast this with non-registered accounts where you would be taxed for capital gains, dividends, or interest income.
Now like any good thing, there’s a limit to the amount you can contribute to your TFSA. Each year after the year you turn 18, you start to accrue contribution room. Your contribution room typically increases by about $6,500 per year (see here for annual amounts), and the penalties for over-contributing are severe.
You can withdraw freely from a TFSA, but it does impact your contribution room for that year. TFSAs are a fantastic tool for growing your wealth tax-free, but it’s important to understand the rules to avoid any adverse consequences.
What is a GIC?
Guaranteed Investment Certificates (GICs) are an investment tool in which you deposit money with a bank or other financial institution for a specified term, in return for a guaranteed interest rate.
So for example, you could have a 1-year GIC at 3%. This means that for every dollar you deposit at the outset, you would get back $1.03 at the end of the year. So a $10,000 deposit would turn into $10,300.
As suggested by the name, the return for GICs is guaranteed. You’re guaranteed to get the return specified in the terms of the GIC contract. Now in exchange for this guaranteed increase in your funds, you lose access to this money for the duration of the term. As well, the returns are typically lower than those of other investments.
Now though they have downsides, GICs can make sense when you’re saving for a specific expense in the future.
Can I Have a GIC in a TFSA?
GICs can be held in a TFSA. As mentioned above, TFSAs act as containers to hold various investments, which can include GICs.
Holding a GIC in a TFSA means that any returns made are not taxed. That may sound great, but you must also consider the best use for the limited contribution room in a TFSA.
Due to it’s tax advantages, the government only allows a limited contribution to your TFSAs. As such, you want to maximize the tax advantages of your TFSAs by using them for the highest return assets you can. So though it may sound great to not pay tax on the interest on a GIC, if you’re preventing yourself from using that contribution room for a higher return asset (e.g. index funds), you may be costing yourself in overall wealth built.
If you’re choosing between holding a GIC with a 3% return or an index fund with a 10% return, the tax savings will be much greater if you hold the index fund in your TFSA.
GICs are better suited for non-registered accounts.
What are the Pros and Cons of TFSAs?
TFSAs are a fantastic tool to accelerate your wealth growth, but as with everything, there are disadvantages as well:
| Pros | Cons |
| Tax-Free Growth – There is no tax on the growth of your investments at the time of sale, or at withdrawal. | Contributions are not tax-deductible – Unlike RRSPs or FHSAs, contributions to your TFSA cannot be deducted from your employment income. |
| No limits to withdrawals – Unlike other registered accounts, funds can be withdrawn from your TFSAs at any time, for any reason. | Contribution room only resets at year-end – If you withdraw from your TFSA, you can’t use that contribution room again until the following calendar year. |
| No limit to account growth – Though there is a limit to the contribution room, there’s no limit to how much your investments can grow. | Contribution limits – Relatively low annual limits that limit the base capital you have to grow. |
| Diverse assets can be held in TFSAs – TFSAs can hold assets such as stocks, bonds, GICs, mutual funds, index funds, and more. | Cannot be used for active investing (e.g. day trading) – TFSAs cannot be used to make an active income, and the tax penalties can be severe for activities like day-trading. |
What are the Pros and Cons of GICs?
GICs are not as useful as TFSAs, but they can have a place in your financial life. Here are the pros and cons of GICs (read more here)
| Pros | Cons |
| Guaranteed Returns – You are guaranteed to grow your capital as per the interest rate promised. | Money is locked up for duration of term – Depending on the terms, you may not be able to withdraw your funds until the term is complete. In other cases, you can withdraw, but you will be penalized. |
| Safe investment – GICs are guaranteed and insured up to $100,000 under the CDIC. | Lower Returns – GIC returns range from 1% to 5%, compared to an average stock market return of 10%. |
| Options for interest rates and terms – GICs are offered at terms of 6 months to 5 years, and you can compare interest rates from various banks and financial institutions. | Taxed as active income – GICs are taxed at the same rate as your employement income, unlike dividends and capital gains which can have more favourable tax treatment. |
| Simple and easy to understand – GICs have a defined term and return, unlike more complex financial instruments that can have intricacies that aren’t clear to new investors. | Minimum investment amount – GICs have a higher barrier to entry (typically $500 to $1,000 minimum investment) compared to other investment types. |