A Guaranteed Income Contract (GIC) is a financial agreement between an insurance company and a corporate profit-sharing or pension plan. The insurance company guarantees a specific rate of return on the invested capital over the life of the contract, providing a stable income stream for the plan participants.
Structure and Features
Contract Components
- Parties Involved: The primary parties in a GIC are the insurance company (issuer) and the corporate profit-sharing or pension plan (investor).
- Guaranteed Return: The issuer guarantees a fixed rate of return on the capital invested by the corporate plan.
- Contract Duration: GICs have a predefined term, ranging from short-term (a few years) to long-term (several decades).
- Investment Capital: This is the amount of money invested by the corporate plan into the GIC.
Types of GICs
- Immediate GICs: These provide immediate periodic payments to the investor after the initial investment.
- Deferred GICs: Payments begin after a specified deferral period.
Special Considerations
- Credit Risk: The guarantee is subject to the insurer’s creditworthiness.
- Liquidity: Typically, GICs are not liquid investments, requiring capital to be tied up for the term of the contract.
- Tax Implications: Returns from GICs are generally taxed as ordinary income.
Examples and Applications
Pension Plans
GICs are often used by defined benefit pension plans to ensure a steady stream of income for retirees. They help in managing the risk associated with market fluctuations.
Corporate Profit-Sharing Plans
Corporations may use GICs to manage profit-sharing plans, offering employees a stable return on their investments, enhancing financial security.
Historical Context
GICs gained popularity in the 1970s and 1980s as companies looked for secure ways to manage pension funds. They have since evolved to include various forms tailored to different investment needs.
Applicability and Comparisons
GICs vs. Bonds
While both GICs and bonds offer fixed returns, GICs are typically issued by insurance companies, whereas bonds can be issued by governments or corporations.
GICs vs. Annuities
Both provide guaranteed returns, but annuities convert a lump sum into a stream of income payments, ideal for individual retirement, whereas GICs are more suited to institutional investments like pension plans.
Related Terms
- Yield to Call: The yield calculated assuming the bond issuer will repurchase the bond before its maturity date. This concept is important for comparing GICs and callable bonds.
- Annuity: A financial product that pays out a fixed stream of payments to an individual, primarily used as an income stream for retirees.
- Defined Benefit Plan: A type of pension plan where the employer guarantees a specified pension payment, lump-sum (or combination thereof) upon retirement.
FAQs
Q1: What happens if the insurance company defaults on a GIC?
Q2: Can individuals purchase GICs?
Q3: How are GIC returns taxed?
Q4: Are GICs suitable for all pension plans?
Q5: What is the typical duration of a GIC?
References
- Financial Industry Regulatory Authority (FINRA). “Guaranteed Investment Contracts.”
- U.S. Securities and Exchange Commission (SEC). “Information About Investing in Guaranteed Investment Contracts.”
- Insurance Information Institute (III). “Annuities and Guaranteed Income.”
Summary
A Guaranteed Income Contract (GIC) is a financial product providing a stable, guaranteed return over a specific period, ideal for corporate profit-sharing and pension plans. While offering security and predictability, GICs require careful consideration of the issuing insurer’s creditworthiness and tax implications. Comparing GICs to similar instruments, such as bonds and annuities, can help investors choose the best option for their specific needs.
