What Are Guaranteed Investment Contracts?
Guaranteed investment contracts (GICs) are term deposits that are mainly sold by insurance companies. GICs come in many varieties, but this discussion will focus on traditional GICs. GICs work somewhat like a CD--you deposit a sum of money and, after a set time period, you receive your principal back plus interest. Individuals typically invest in GICs through retirement plans, such as a 401(k) plan. The insurer invests GIC deposits as it sees fit--typically in mortgages, real estate, and other fixed-income investments. GICs usually mature in one to five years.
GICs are "guaranteed" because the insurer promises to return principal and to pay a fixed rate of return at maturity. It's important to note that the "guarantee" is subject to the claims-paying ability of the insurer. GICs are not insured by the FDIC or otherwise as CDs are. Because of this increase in risk, GICs generally pay a higher rate of interest than CDs.
The issuing insurance company "guarantees" the preservation of your principal.
GICs offer a fixed rate of return, even if interest rates fluctuate.
Not FDIC Insured
Unlike some other types of cash alternatives, GICs are not insured by the Federal Deposit Insurance Corporation. The term "guaranteed" in guaranteed investment contract means only that the insurance company promises to pay a specific rate of return on the money you invest. Your money becomes part of the insurer's general assets. If the insurance company becomes insolvent, you become one of the claimants in bankruptcy court.
Tip: It is important to investigate the financial stability of the insurance company offering the contract. Ratings services such as A.
- Best, Moody's, Standard & Poor's, and Fitch publish ratings of insurance companies.
An opportunity cost is always involved when you invest in so-called safe vehicles. If you invested in long-term vehicles that are more risky, you could receive higher interest rates.
The interest you receive on a guaranteed investment contract is taxable income and must be reported on your federal income tax return unless you own GICs within a retirement plan in which taxes are deferred until money is withdrawn.
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