How a Guaranteed Investment Contract (GIC) Works - SmartAsset

There’s a wide range financial instruments available to investors. While many of us know the most popular asset classes and investment vehicles, the guaranteed investment contract (GIC) is fairly uncommon. In short, it’s a financial instrument, typically issued by an insurance company, that comes with some unique characteristics. Not to be confused with guaranteed investment certificates, these contracts share some similarities with certificates of deposit (CDs) and bonds. They offer relatively little risk, but for a slightly higher return. Consider working with a financial advisor as you create and update your investment plan for the future.

What Is a Guaranteed Investment Contract (GIC)?

A guaranteed investment contract (GIC), also known as a funding agreement, is an agreement between two parties, an insurance company and a contract purchaser. The contract requires that the purchaser, or investor, provides the insurance company with a deposit that it then keeps for a fixed period. In turn, the insurance company repays the investor the original deposit amount, along with extra interest.

The insurance company also pays interest on the original amount at a guaranteed rate. This come in both fixed and variable variations. The terms of the contract determine the exact repayment schedule and the amount of each repayment.

So, in terms of function, they work much like a certificate of deposit. However, only insurance companies, or non-bank financial institutions, market them. In addition, the returns on a GIC are usually higher than you would find with a bank CD, although not necessarily by much.

Understanding How GICs Work

Oftentimes, employers offer GICS as an option for employees to invest their pension or 401(k) contributions. Companies also offer three other investment choices, which typically include the company’s common stock options, equity mutual funds and money market mutual funds.

A GIC functions most similarly to a normal bond with varying maturity. Employers may offer them with a maturity period as short as a year and up to 20 years. At the point of maturity, the investor receives both their principal investment and any interest that has accrued. There are also some GICs that offer periodic disbursements of the built-up interest over the contract’s life. However, these are few and far between.

There are two main types of guaranteed investment contracts: participating guaranteed investment contracts and non-participating guaranteed investment contracts. Participating GICs come with a variable rate of return, allowing investors to capitalize on changing interest rates over time. In contrast, non-participating GICs offer fixed rates of return.

When deciding between the above options, an investor will want to rely on current and projected market rates. For instance, if analysis predicts interest rates to skyrocket in the next few years, the purchaser may want to consider a participating GIC. In general, though, investors purchasing GICs aren’t looking for high returns. GICs are a conservative option with short-term maturity periods and reliable earnings.

Example of a Guaranteed Investment Contract

Let’s say that there is a company called ABC Company. ABC Company decides to purchase a GIC from an insurance provider, XYZ Insurance, for the employees in its pension plan. In return, XYZ Insurance guarantees the company a return on the investment. In addition to repaying the original amount ABC Company purchased the contract for, XYZ Insurance also pays interest. This may be at a fixed or variable rate until the end of the contract.

This GIC will likely be a general account, so XYZ Insurance pools money from its GIC accounts and manages the funds accordingly. If it does so poorly or declares bankruptcy, ABC Company potentially loses its principal and/or returns. Alternatively, the GIC might be organized into separate accounts, which the issuer manages individually.

GICs target specific audiences, though. In particular, insurers market GICs to groups that qualify for favorable tax status. That includes nonprofit organizations and churches that fall under the tax code section 501(c)(3), making them exempt from taxes. Usually, the insurer manages a pension or retirement plan and offers these groups the GIC as a low-risk investment.

What Are Some of the Risks of GICs?

While GICs are safer than many alternative investment options, they are not completely free of risk. As with any investment, there’s the chance an investor may lose money when they put funds into a GIC.

The GIC’s return depends on the term and size of the investment. So, the larger the investment on a general account GIC, the greater the return. However, a general account GIC that comes with a fixed interest rate is vulnerable to inflation.

For example, say an investor purchases a 10-year general account GIC at a fixed interest rate. During the time the investor owns this investment, known as the holding period, inflation may rise. At some point the rate of inflation may outpace the investment’s interest rate because GICs are usually low-interest. As a result, the investor not only misses out on higher returns but loses money as well.

In the past, GICs were actually common investments for 401(k) retirement funds. However, their popularity dropped after the junk-bond market took a downturn in the early 1990s. In particular, the failures of two insurance companies, Executive Life and Mutual Benefit Life, resulted in a sharp decline of investor faith. Newer versions of the GIC carry additional protections against potential issuer default, though.

Bottom Line

Forming the perfect investment requires research. You need a solid mix of investments in your portfolio to benefit from diversification and protect your assets. Because of this, it’s worthwhile to explore investments with various risk levels and return rates. A guaranteed investment contract offers very little risk and a modest interest rate. But it promises somewhat higher rates than other similarly low-risk alternatives. If that works well with your investment strategy, you might want to consider the opportunity to invest in a GIC.

Tips on Saving for Retirement

Guaranteed investment contracts are a conservative way to invest for retirement. But they are not suited for all retirement savers. A local financial advisor can help you understand whether a GIC is right for you. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Pensions are less common these days. But most employees have access to a 401(k) retirement plan through their workplace. Using a 401(k), you can stash away pre-tax dollars and allow to grow tax-free. Additionally, you can bump up your savings with an employer matching program.
Planning for retirement outside workplace plans is often difficult, especially if you are self-employed. But there is an option for saving without depending on an employer: the individual retirement account (IRA). You can enjoy the same tax benefits with an IRA as a 401(k), although with lower contribution limits.