Canadians are searching for tax-free ways to get better returns on their savings to help offset the big jump in living costs that has occurred in the past few years. One strategy to generate tax-free passive income involves holding investments inside a Tax-Free Savings Account (TFSA).
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TFSA limit increase
Canada created the TFSA in 2009 to give people an extra tool for buildings savings to meet financial goals. The TFSA limit increase is $6,500 for 2023. This brings the maximum cumulative total TFSA contribution space to $88,000 for anyone who has qualified every year. In 2024, the TFSA contribution limit will be at least $6,500. The government raises the size of the TFSA limit in $500 increments. The timing is driven by inflation rates.
Unused TFSA room can be carried forward to future years. In addition, any money removed from the TFSA will open up equivalent new contribution space in the next calendar year. This gives people good flexibility to manage their cash flow needs.
TFSA investments to generate passive income
The big jump in interest rates over the past year has led to a sharp rise in the rates savers can get from Guaranteed Investment Certificates (GICs). At the time of writing, it is possible to get GIC rates in the 5% to 5.5% range from Canada Deposit Insurance Corporation (CDIC) members through most online brokerages. Interest can be paid monthly, semi-annually or annually, depending on the GIC.
Once the government decides it has raised interest rates high enough to get inflation under control, the surge in GIC rates will end, and there could be a quick reversal if the Bank of Canada has to reduce rates again to avoid a deep recession. For the moment, however, investors should take advantage of the risk-free returns above 5% as part of their TFSA investing strategy.
Dividend stocks should also be in the portfolio if you want to get higher yields and need the flexibility of having quick access to the principal investments. Stock prices can fall, as we witnessed in the past three years, but the shares of top TSX dividend stocks usually bounce back from big corrections. Dividends are typically paid four times per year, but some stocks pay monthly.
Right now, many great Canadian dividend stocks look undervalued and offer yields that are above the best GIC rates. The Bank of Canada is probably close to the end of its rate-hike cycle. As soon as the market senses a downward shift is on the way, dividend stocks should recover. As such, it makes sense to buy now while they are out of favour and offer great returns.
For example, stocks such as CIBC, BCE, and TC Energy have good track records of dividend growth and now offer yields of 6.4%, 6.9%, and 7.6%, respectively.
Investors have to decide the right mix for their personal situations, but some combination of top dividend stocks and GICs makes sense today.
The bottom line on TFSA passive income
In the current environment, it is quite easy for TFSA investors to put together a diversified portfolio of GICs and top dividend stocks to get an average yield of 6%. On a TFSA of $60,000, this would generate $3,600 per year in tax-free passive income.
That’s an average of $300 per month that can go straight into your pocket!
