TFSA Investors: Earn $500 in Tax-Free Income Each Year With Less Than $10K in Savings

The Tax-Free Savings Account, or TFSA, can be used to create a passive-income stream for life. You can use the benefits of this popular registered account to generate recurring income by either investing in high-yield bonds or quality dividend stocks.

The rising interest rates have increased yields significantly, making bonds attractive for income-seeking investors. However, investing in undervalued dividend stocks can help you earn regular income as well as derive capital gains over time.

Here are three TSX dividend stocks that can help TFSA investors earn over $500 in tax-free income each year with less than $10,000 in savings.

Bank of Nova Scotia stock

The Canadian banking sector is heavily regulated, and a conservative approach has allowed the big banks to enjoy a wide economic moat. This has enabled the Bank of Nova Scotia (TSX:BNS) to pay investors an annual dividend of $4.24 per share, indicating a tasty yield of 6.7%.

Unlike its TSX peers, Bank of Nova Scotia is looking to gain traction in emerging markets in Latin America. While expansion in South America might be considered risky, it provides BNS an opportunity to benefit from higher earnings over the long term.

While several U.S. banks were forced to cut and suspend dividends during the financial crash of 2008, BNS could maintain these payments due to its robust financials. In the last 20 years, BNS has raised dividends by 8.2%, which is exceptional for a cyclical stock.

Priced at nine times forward earnings, BNS stock is very cheap and trades at a discount of 10% to consensus price target estimates.

Sun Life Financial stock

One of the largest insurance companies in Canada, Sun Life Financial (TSX:SLF) is valued at a market cap of $39 billion. Sun Life has over 85 million clients with $1.37 trillion in assets under management (AUM). It has a well-diversified business that includes wealth and asset management, group health and protection, and individual protection.

Sun Life currently offers shareholders a dividend yield of 4.5%. As part of a recession-resistant industry, Sun Life has increased these payouts by 9.6% annually in the past five years. With a payout ratio of 56%, the company has enough room to keep increasing its dividends, given earnings are forecast to rise by 8.6% annually in the next five years.

Priced at 10.5 times forward earnings, SLF stock currently trades at a discount of 10.6% to consensus price target estimates.

Allied Properties REIT stock

The final dividend stock on my list is Allied Properties (TSX:AP.UN), a real estate investment trust, or REIT. Similar to other real estate companies, Allied Properties is feeling the heat of higher interest rates. In the second quarter (Q2) of 2023, higher interest expenses and extended lease-up timeframes resulted in a 3% decline in adjusted funds from operations compared to the year-ago period.

However, Allied Properties ended Q2 with a payout ratio of 84.2%, which is quite sustainable. Allied Properties pays shareholders an annual dividend of $1.80, indicating a yield of 9.2%.

Moreover, Allied Properties emphasized that interest expenses will decline in the second half of 2023 due to debt-repayment initiatives, which should improve earnings growth in the near term.

The Foolish takeaway

If you want to earn $500 in annual dividends, you need to invest $2,500 in each of these three TSX stocks. Investors can double their payouts in the next decade if these companies increase dividends by 7% annually.