Every little bit counts when it comes to earning extra cash to help offset the impact of inflation. One way Canadian investors can get additional tax-free passive income is to invest funds inside a Tax-Free Savings Account (TFSA).
TFSA advantage
The TFSA limit is $6,500 in 2023. That brings the cumulative maximum contribution space to $88,000. In 2024 the TFSA limit will go up by at least another $6,500.
The great thing about the TFSA is that any unused contribution room carries forward indefinitely, so you can put savings into the account when they are available. Interest, capital gains, or dividends that are earned inside the TFSA can be taken out as tax-free income, and the amount withdrawn from the TFSA opens up equivalent new contribution space in the next calendar year.
Seniors get an additional benefit. The Canada Revenue Agency does not include TFSA earnings when calculating net world income that is used to determine the Old Age Security (OAS) clawback.
GICs or dividend stocks?
Guaranteed Investment Certificates (GICs) now offer rates in the 5-5.5% range, depending on the term. This is comfortably above the 2.8% rate of inflation reported for June, so savers can actually make some headway right now with the GIC investments.
GICs are attractive for people who don’t want to take on any risk and are comfortable locking up the fund for the term of the certificate. The downside is that the rate is fixed for the term, so you can miss out if rates go up as they have in the past couple of years. In addition, the principal is not accessible in the event there is an emergency need for the cash.
Dividend stocks give you more flexibility. The shares can be sold at any time to get the money. Buying dips is a good strategy, and the market correction that occurred over the past year has pushed some top dividend stocks down to the point where they now appear oversold and offer dividend yields that are higher than GIC rates.
Stock prices can be volatile and cheap stocks can get a lot cheaper. In addition, dividends sometimes get cut if a company runs into financial trouble. However, investors who can stomach risk can increase the return on their savings by owning dividend stocks, especially ones that raise their distributions on a regular basis. Over time, the share prices of top dividend stocks also tend to drift higher.
The bottom line on TFSA passive income
A mix of GICs and high-yield dividend stocks like BCE, Enbridge, or Bank of Nova Scotia could easily generate an average yield of 6% today.
On a $10,000 TFSA, this would provide $600 per year in tax-free income. That works out to $50 per month!
