Canadian savers are taking advantage of their growing Tax-Free Savings Account (TFSA) contribution limits to build self-directed portfolios of investments that will generate reliable tax-free passive income.
Seniors benefit from not putting their Old Age Security (OAS) pensions at risk of a clawback, and other investors who need to earn more to cover rising living costs don’t have to worry about potentially being bumped into a higher marginal tax bracket.
TFSA limit
The TFSA limit in 2023 is $6,500. This brings the maximum cumulation TFSA contribution space to $88,000 for anyone who has qualified since the TFSA launched in 2009. Each year, the government gives investors new contribution room with limit increases indexed to inflation in increments of $500. The TFSA limit in 2024 will be at least $6,500.
Unused TFSA contribution space can be carried forward. Money removed from the TFSA during the year opens up equivalent new contribution space in the next calendar year, along with the regular TFSA limit allowance.
Income generated inside the TFSA is not taxed and can be removed at any time. Popular TFSA investments for producing tax-free passive income include Guaranteed Investment Certificates (GICs) and high-yield dividend stocks.
Are GICs or dividend stocks better for a TFSA?
GICs currently offer attractive rates above 5% for terms of one year to five years. Investors who don’t want to take on any risk and are comfortable locking up their money during the GIC term should consider making GICs a significant part of their portfolios.
Investors who require higher yields, need immediate access to their investments and can handle taking on capital risks might want to focus more on top dividend stocks that raise their distributions on a regular basis. Each time the company increases the distribution, the yield on the initial investment rises.
Stock prices can fall below the purchase price, so investors need to be comfortable riding out volatility. Sometimes, dividends get cut. However, great dividend-growth stocks tend to boost the payout steadily and usually rebound from market pullbacks.
BCE (TSX:BCE) is a good example to consider today. The stock looks oversold after the latest correction and now offers a 6.7% dividend yield.
BCE has raised the dividend by at least 5% in each of the past 15 years.
The bottom line on TFSA passive income
Investors can quite easily get an average return of 6.25% right now from a portfolio of GICs and top TSX dividend-growth stocks. On a $6,500 TFSA, this would generate $406.25 per year.
Retirees and other investors who can take advantage of the full $88,000 TFSA contribution space could get $5,500 per year in tax-free passive income at a 6.25% yield.
