Canadian retirees are searching for ways to get better returns on their savings without being bumped into a higher tax bracket or getting hit by the Canada Revenue Agency’s Old Age Security (OAS) clawback. Taking advantage of the full contribution limit of a Tax-Free Savings Account (TFSA) is one way to achieve this goal.
TFSA basics
A Canadian pensioner receiving OAS would have as much as $88,000 in TFSA contribution space in 2023. That means a retired couple can contribute and invest up to $176,000 to generate tax-free passive income.
The TFSA limit increase in 2023 is $6,500. In 2024, the TFSA limit contribution room will be at least that amount, giving investors even more space. Unused TFSA contribution room can be carried forward and used in the future. Funds removed from the TFSA open up equivalent new space in the following calendar year on top of the regular increase.
All TFSA profits can go right into an investor’s pocket. There is no tax on TFSA earnings, and seniors receiving OAS don’t have to worry about the extra income causing a clawback on their OAS payments in the next year.
This is very important to consider when retirees have decent pension income coming from a variety of sources. The combination of a company pension, Canada Pension Plan, OAS, and Registered Retirement Income Fund (RRIF) payments can quickly push taxable income to the OAS clawback threshold. In the 2023 income year, that number is $86,912. Every dollar of net world income above that amount triggers a 15% clawback on OAS payments, reducing the OAS a person receives in the next year.
For example, a senior with net world income of $96,912 in 2023 would see their OAS payments drop by a total of $1,500 in the July 2024 to June 2025 payment period.
TFSA Investments for passive income
Retirees can get rates on Guaranteed Investment Certificates (GICs) of up to 5.5% at the time of writing. As long as interest rates remain high, GIC rates should stay elevated. An investor might be tempted to put all their TFSA funds into GICs. The downside is that the rate is only good for the term of the GIC, and the renewal rate could be much lower when the GIC matures. In addition, non-cashable GICs offer the highest rates, but the funds are not available during the term of the GIC. Investors who think they might need access to their savings should keep this in mind before locking up the funds for multiple years.
Dividend stocks look cheap right now in many cases after the big drop in their share prices over the past year. Yields are now above 7% from top dividend-growth stocks. Enbridge (TSX:ENB), for example, has increased the dividend for 28 consecutive years and now offers a 7.6% dividend yield. BCE (TSX:BCE) raised its dividend by at least 5% annually for the past 15 years. At the time of writing, BCE stock offers a 7% dividend yield.
Stocks obviously come with risks as the share price can fall below the purchase price. Sometimes, dividend payments get trimmed or cut if a company runs into financial problems.
Top dividend-growth stocks, however, tend to recover from pullbacks and often maintain dividend growth during downturns.
The bottom line on TFSA passive income
Each person has to decide on the best TFSA mix for their particular situation. That being said, TFSA investors can quite easily put together a diversified portfolio of GICs and dividend stocks to get an average yield of 6.25% right now.
At this rate of return, a retired couple with combined TFSAs of $176,000 would be able to generate $11,000 per year in tax-free passive income that won’t put their OAS payments at risk of a clawback!
