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TFSA Investors: How to Turn $6,000 Into a Tax-Free “Pension” to Supplement CPP!

Are you a TFSA account holder nearing retirement age?

If so, you’ve got one of the best retirement “secret weapons” at your disposal.

While most discussion about retirement saving in Canada centres on RRSPs, the truth is that the TFSA is arguably an even better retirement savings vehicle. While you can’t stash as much into a TFSA as you can in an RRSP, TFSAs give you the benefit of tax-free withdrawals. This means that the money you have in the account is the same amount of money you can withdraw.

In 2020, you can contribute $6,000 to your TFSA if your account was maxed out last year, and $69,500 if you haven’t contributed yet. That’s plenty of contribution space to build an income stream that will carry you through your golden years. At an average portfolio yield of 4%, you can generate $2,780 a year with $69,500 invested — a nice supplement to whatever benefits you’re getting from CPP and OAS. Even better, it’s all tax-free inside a TFSA.

Here’s how to get there.

Contribute every year until you’ve maxed out your account

If you invest $6,000 this year, your investments will double approximately every seven years at a 10% a year annual return. That alone could take you to $48,000 after 21 years. However, you’ll need more than that to generate $2,780 a year in tax-free income.

To do that, you’ll want to contribute at least $69,500, which is the total amount of accumulated contribution room this year. With that balance, you’ll earn $2,780 with a portfolio yield of 4%.

Of course, the maximum will be higher if you’re contributing over several years, but we’ll use this year’s number since the amounts for future years aren’t known.

Invest in dividend stocks

Once you’ve got some money in your TFSA, you’ll want to invest in dividend stocks or dividend-paying ETFs.

The reason that dividends are so important is because, as a retiree, you’ll depend on income to get by. You can generate income by periodically selling non-dividend-paying stocks, but a severe market downturn could put a damper on that plan. So, dividend stocks, along with interest-paying bonds, are the ideal for retirees.

One of the best dividend stocks in Canada right now is Toronto-Dominion Bank (TSX:TD)(NYSE:TD). TD is Canada’s second-largest bank. Over the past decade, it has also been the country’s fastest-growing bank thanks to strength in its U.S. retail business. Over the years, TD has delivered solid returns to investors while also paying a dividend that yields 4% at current prices.

A portfolio of stocks like TD, yielding 4% on average, would net you thousands of dollars a year in TFSA income. Not only that, but the income could rise over time. The best dividend stocks raise their payouts each and every year, which, over time, can lead to truly extraordinary yields on cost. TD, for example, recently increased its dividend by 10%.

With enough years of dividend increases, you could see a 4% yield stock turn into an 8% yield stock — and the income received would all be tax-free inside a TFSA.

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Fool contributor Andrew Button owns shares of TORONTO-DOMINION BANK.

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