Canadian income investors are searching for ways to get better returns on their savings without being pushed into a higher marginal tax bracket or, in the case of seniors, being hit with a clawback on their Old Age Security (OAS) pension payments. Using a Tax-Free Savings Account (TFSA) to hold income-generating investments is one way to achieve this goal.
TFSA limit and increases
Every qualifying Canadian resident gets more TFSA contribution space each year. The TFSA limit in 2023 is $6,500. This brings the total maximum cumulative space to $88,000 since the launch of the TFSA in 2009. The government indexes the TFSA limit to inflation and increases the size of the limit in increments of $500.
Contribution room can be carried forward to future years. In addition, any cash removed from the TFSA during the year opens up new contribution room in the following calendar year.
Profits on investments are all tax-free inside the TFSA and are not counted towards personal income when withdrawn. This means the full value of interest, dividends, or capital gains can go right into the investor’s pocket.
OAS pension recovery tax
Seniors who receive OAS pensions get an additional benefit. The Canada Revenue Agency does not use TFSA earnings when calculating net world income used to determine the OAS clawback. In the 2023 income year, the earnings number to watch is $86,912. Every dollar of net world income earned above that amount triggers a 15-cent reduction in the OAS payment in the following year.
For example, a senior with a 2023 net world income of $101,912 would see their OAS paid from July 2024 to June 2025 reduced by $2,250. That’s a big hit, even if a person is fortunate enough to receive retirement income at this level.
A company pension, Canada Pension Plan, OAS, Registered Retirement Savings Plan (RRSP) withdrawals, and Registered Retirement Income Fund (RRIF) payments are all taxable income. Earnings from investments in taxable accounts, rental income, and earnings from a part-time job also get taxed.
As such, it makes sense to use up the full available TFSA space before holding investments in taxable accounts.
TFSA passive income
In the current market environment, there is an opportunity to get attractive yields from Guaranteed Investment Certificates (GICs) and top TSX dividend stocks.
Non-cashable GIC rates from Canadian Deposit Insurance Corporation members are in the range of 5.1% for a five-year GIC to more than 5.6% for a one-year GIC at the time of writing. That’s a decent return on a safe investment.
Over the past year, the share prices of good dividend-growth stocks have pulled back to the point where many now appear undervalued and offer great yields. BCE (TSX:BCE) has a dividend yield of 7% at the time of writing. Another industry leader, Enbridge (TSX:ENB), now provides a yield of 7.7%.
BCE and Enbridge have long track records of annual dividend growth, and investors should see the trend continue. At the very least, the existing distributions should be safe.
As soon as the Bank of Canada signals it is done raising interest rates, there will likely be a drop in the rates offered on GICs, and the share prices of dividend stocks should rebound, so it would make sense to consider a combination of GICs and high-yield dividend stocks right now for a TFSA focused on passive income.
Investors can quite easily get an average yield of 6.25% from a diversified portfolio of GICs and dividend stocks. On a TFSA of $60,000, for example, this would generate $3,750 per year in tax-free income that wouldn’t put OAS payments at risk of a clawback.
