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What are index-linked Guaranteed Investment Certificates (GIC)?

Index-linked GIC (also known as equity-linked, or market linked GICs) let investors participate in some of the gains of the stock market, but also preserve initial capital in the case that the markets fall. The more the stock index to which your GIC is linked increases, the more interest you are paid, within limits in some cases. If there is a major stock market crash, you at least salvage your principle. If that occurs, however, you would not be paid any interest over the term of the GIC.

Market growth GICs do have limitations and there may be subtle but important differences between the various versions so you would be well advised to shop around. Some have a rate of return cap, which prevents full participation in stock market gains. For example, total return might be capped at 30%. In comparison, the holder of an index mutual fund or exchange-traded fund would receive the full amount of the percentage increase in the benchmark index e.g. 100% if the index rose by 100%. Another draw back is that index-linked GICs do not pay dividends paid by mutual fund equity stocks. Moreover, unlike a regular GIC, you only receive interest if the underlying index rises. Unlike money market funds or Canada Savings Bonds, index-linked GICs are also illiquid because they require investors to lock in for several years. Since interest is only received at the end of the term, index-linked GICs are not ideal for RRIFs as the lack of interest until maturity may conflicts with the annual RRIF withdrawal rules.

Returns from index-linked GICs in unregistered accounts are taxed as if they were interest – rather than capital gains, which benefit mutual funds or stocks. Therefore, index-linked GICs are best held in an RRSP.