Canadians are using their Tax-Free Savings Accounts (TFSAs) to build investment portfolios that can provide reliable streams of passive income in retirement to go along with pension income from work or government sources.
Self-directed pension
Canada launched the TFSA in 2009 to give people another savings tool to meet their financial goals in a world where the type of work people do is constantly evolving.
In the past, most people would get a job at a company, work there for 30 or 40 years and retire with a defined-benefit (DB) pension that guaranteed inflation-adjusted income for life. Today, businesses increasingly rely on contract workers to do jobs previously covered by full-time employees or have switched to defined-contribution (DC) pensions that shift the risk to the employee. In this case, the payout at retirement depends on how much the funds grow, rather than being guaranteed.
At the same time, people increasingly prefer the flexibility of being self-employed, but this means they are responsible for building their own pensions. The emergence of the gig economy and the era of making a living from a handful of “side hustles” is further changing the scope of retirement planning.
In short, most people in the early or middle parts of their careers are responsible for setting up all or part of their pension plan. The TFSA is part of that mix.
TFSA limit
The TFSA contribution limit is $6,500 in 2023. That brings the cumulative total since inception to $88,000 per person. This is large enough to get a decent personal pension in place to generate meaningful passive income.
GICs or dividend stocks
Guaranteed Investment Certificates (GICs) currently offer rates in the 5-5.5% range depending on the term of the certificate. Investors can usually choose to get the interest monthly, semi-annually, or annually. The safety of the principal investment makes the GIC appealing, especially at the current rates. Getting 5% guaranteed for the next five years is attractive right now, and GICs deserve to be part of the mix.
Stocks come with risks as prices can go down as well as go up, but many top TSX dividend stocks now look oversold and offer dividend yields above GIC rates. The best stocks to buy tend to have long track records of dividend growth.
TC Energy
TC Energy (TSX:TRP) is a good example of a great dividend stock that is currently out of favour. The energy infrastructure firm is wrapping up a major pipeline project that will now cost at least $14.5 billion, which is more than double the original budget. This has dragged down the share price along with a general pullback in the energy infrastructure sector.
TC Energy recently raised more than $5 billion through an asset sale to shore up the balance sheet. Management still expects the ongoing $34 billion capital program to support annual dividend growth of at least 3%.
The board has increased the payout annually for more than 20 years. At the time of writing, investors can get a 7.5% yield from TRP stock.
The bottom line on TFSA passive income
In the current environment, a combination of GICs and dividend stocks makes sense for investors seeking TFSA passive income. It is easy to put together a portfolio that would generate an average yield of at least 5.5% today without taking on a lot of risk. On a TFSA of $88,000, this would generate an annual income of $4,840.
That works out to an average of $403.33 per month!
