The CRA is paying $2,000 per month in CERB payments to eligible Canadians during this COVID-19 crisis. CERB payments are taxable as ordinary income. Therefore, the amount taxed will depend on your total income and marginal tax rate for the year.
There’s a way to get 100% of BIG tax-free income — using your Tax-Free Savings Account (TFSA) to its fullest!
How to get BIG tax-free income from your TFSA
Interest rates are low. As a result, most interest-bearing investments are uncompelling. To get BIG tax-free income from your TFSA, you’ve got to look towards big dividend stocks.
In any market, it’s risky to chase yields. It’s even riskier to do so in today’s stressful environment. Even blue-chip names like Suncor and Wells Fargo have fallen into the dividend-cut bucket this year.
That said, sometimes it could be a rare buying opportunity to buy stocks in anticipation of partial dividend cuts. However, it’s a risky business. Oftentimes, long before a stock actually cuts its dividend, the market would have sensed something and sold it off.
For example, H&R REIT stock fell as much as 60% before it cut its dividend. I picked up some shares in April before it announced a 50% dividend cut in May.
Buyers of H&R REIT today can get a 7% yield that’s an attractive income. Additionally, its dividend (and stock price) is likely recover to higher places, as the economy normalizes over the next few years.
Investors need to research high-yield stocks carefully and decide on a case-by-case basis if they’re worth investing in from an income and total return perspective.
Some places you can explore for relatively big dividends are real estate investment trusts (REITs), banks, and utilities.
Be careful to avoid BIG withholding taxes on foreign dividends
If you’re earning dividends from a company that’s domiciled in another country, there’s a good chance that there will be foreign withholding taxes on those dividends. The TFSA cannot prevent the foreign country from taking that tax. In that sense, the TFSA is not entirely tax free.
To make sure your TFSA stays 100% tax free, avoid foreign dividend stocks.
That said, sometimes the foreign income portion may be so small that the withholding tax is negligible in comparison to your total returns.
For example, I took the 2020 market crash as an opportunity to buy Brookfield Property Partners shares in my TFSA. Some people may have avoided the stock, because they’re unsure of how its fat dividend yield would be taxed. I just received my first cash distribution from the stock.
Less than 0.15% of that quarterly cash distribution was taxed. That’s a negligible expense for a stock that’s still paying more than 11% per year today. Moreover, I expect great long-term price appreciation from it at the current dirt-cheap levels.
In summary, be careful to avoid BIG withholding taxes on foreign dividends in your TFSA. However, you might choose to invest in foreign stocks with low yields or small overall withholding taxes if their total return profiles are attractive.
The Foolish takeaway
I could have simply recommended a few high-yield stocks for this article. However, I hope I showed that investing is actually not that simple. Behind each stock is a real business. Each business faces unique challenges and opportunities every day. Additionally, investors’ risk tolerance, knowledge in investing, and investment horizon are different.
If you’re only getting high yields from your TFSA, you need to be careful of concentration risk. REITs, banks, and utilities are still great places to earn big income from. However, you should also consider diversifying your portfolio into, say, technology, healthcare, and consumer staples to spread your risk around and to avoid huge drawdowns of your portfolio for an extended time.