Canadian seniors are looking for ways to get better returns on their savings to help offset soaring living costs while avoiding being hit by higher taxes.
TFSA benefits
Government pensions like the Canada Pension Plan (CPP) and Old Age Security (OAS) are adjusted for inflation, but the increase in these pension payments can also push retirees into higher marginal tax brackets. In addition, as soon as a person’s net world income hits a minimum threshold, the Canada Revenue Agency implements its OAS pension recovery tax, otherwise known as the OAS clawback. The number to watch for the 2023 income year is $86,912. Every dollar in net world income above that amount triggers a 15-cent clawback on the OAS payments next year.
One way to earn investment income and avoid the tax implications is to hold the investments inside a Tax-Free Savings Account (TFSA). In 2023 the TFSA contribution limit increased by $6,500. This brings the cumulative maximum TFSA space to $88,000 per person. That’s large enough to build a meaningful portfolio of investments to generate tax-free income.
The contribution space grows every year. The TFSA limit increase in 2024 will be at least another $6,500. In addition, any earnings that are removed from the TFSA open up equivalent contribution space in the following calendar year.
TFSA contribution sources can be from existing savings or cash flow from pensions and other investments.
For example, seniors often convert RRSPs to a self-directed Registered Retirement Income Fund (RRIF) once they turn 71 due to the RRSP rules. Once the RRIF is created, the person has to remove a minimum amount each year and the payment is taxable as income. If you don’t need the after-tax money right away, you can put the cash in a TFSA to earn tax-free income.
RRIF payments are taxable similar to income from company pensions, CPP, and OAS.
Good TFSA investments for passive income
Retirees can finally get good rates on Guaranteed Investment Certificates (GICs). At the time of writing, it is possible to get 5.5% on a one-year GIC and above 5% for terms of two to five years. GICs normally offer the option to take the interest payments monthly, semi-annually, or annually, although the rate might be different for each option.
Dividend stocks still deserve to be part of the portfolio, especially for investors who want to get higher yields, need access to the funds quickly, and are comfortable riding out market volatility. The market correction is now giving investors a chance to buy some top TSX dividend stocks at discounted prices. Pullbacks increase the dividend yield and could potentially set a new investor in the stock up for decent capital gains on the rebound.
Energy infrastructure stocks, including TC Energy and Enbridge, are good examples of top dividend stocks that look cheap today. These companies have increased their dividends annually for more than 20 years and currently offer dividend yields of 7.6% and 7.4%, respectively.
Some Canadian telecoms and banks also look undervalued and offer high dividend yields.
The bottom line on TFSA passive income
A retiree can quite easily put together a diversified portfolio of GICs and top Canadian dividend stocks that would provide an average yield of 6% right now. On a TFSA of just $75,000, this would generate $4,500 per year in tax-free passive income.
That works out to an average of $375 per month that won’t bump you into a higher tax bracket or put OAS at risk of a clawback.
