The big increase in living costs is pushing retirees to find ways to get better returns on their savings without getting bumped into a higher marginal tax bracket. Seniors who received Old Age Security (OAS) pensions also need to watch out for the OAS clawback.
Fortunately, Canadians can take advantage of their Tax-Free Savings Account (TFSA) contribution space to hold investments that will generate tax-free income.
The TFSA limit is $6,500 in 2023. This brings the maximum total contribution space to $88,000 per person. Each year, the government expands the TFSA contribution space with the TFSA limit indexed to inflation and adjusted upward in $500 increments. The TFSA limit for 2024 will be at least $6,500.
Any money removed from the TFSA during the year opens up equivalent new contribution space in the following calendar year. This is in addition to the regular TFSA limit amount.
The Canada Revenue Agency implements a 15% OAS pension recovery tax on net world income that tops a minimum threshold. The number to keep an eye on in the 2023 income year is $86,912. For example, a person with a 2023 net world income of $96,912 would see their OAS reduced by $1,500 in the July 2024 to June 2025 payment period.
Earnings from a company pension, OAS, Canada Pension Plan, Registered Retirement Savings Plan withdrawals, or payments from a Registered Retirement Income Fund (RRIF) all get taxed as income. Profits from investments held in taxable accounts also go into the calculation.
Fortunately, all interest, dividends, and capital gains generated inside the TFSA are tax-free and can be pulled out as earnings that won’t count toward the net world income total. As such, it makes sense to maximize TFSA contributions before holding investments in taxable savings and investing accounts.
GICs and dividend stocks
Guaranteed Investment Certificates (GICs) now pay attractive rates and deserve to be part of the portfolio. Retirees can now get rates above 5% for terms of one to five years from issuers that are Canada Deposit Insurance Corporation (CDIC) members. That’s pretty good for a zero-risk investment.
The downside of the GIC is that the rate of return is fixed, and the money is locked up for the term of the certificate.
Dividend stocks come with risks, as investors have witnessed over the past 18 months. The surge in interest rates that pushed up GIC rates has led to a pullback in the share prices of many top TSX dividend stocks. Share prices can be volatile, and dividends sometimes get cut. However, great dividend-growth stocks typically increase their dividends every year, and their share prices normally rebound from market corrections. Shares can be sold at any time, so the funds are always available in the case of a financial emergency.
In the current environment, stocks such as Enbridge, Telus, and CIBC, for example, offer dividend yields of 7.5%, 6.4%, and 6.3%, respectively.
The right mix between GICs and dividend stocks is different for every investor depending on the required return, appetite for risk, and the need for access to the invested funds.
The bottom line on TFSA passive income
Investors can quite easily put together a diversified portfolio of GICs and top dividend stocks today to get an average yield of at least 6%. On a TFSA of just $40,000, this would generate $2,400 in tax-free passive income per year that won’t put OAS payments at risk of a clawback.