Retirees are searching for ways to increase their income to help offset rising living costs. Canada Pension Plan (CPP) and Old Age Security (OAS) pensions are indexed to inflation, but these are also taxable sources of income, so the full value of the increase doesn’t go into your pocket.
Many of the expenses seniors pay on a monthly or annual basis are rising by more than the government’s official inflation rate. Retirees might decide to take on part-time work, but the added income could potentially lead to a cut in their OAS payments if their net world income tops the threshold for the OAS clawback.
Using a Tax-Free Savings Account to generate income on savings is one way to get earnings and not have to worry about being pushed into a higher marginal tax bracket or hit by the OAS pension recovery tax.
OAS clawback
The Canada Revenue Agency (CRA) implements a clawback on OAS payments if a person’s net world income is too high in a given year. The number to watch for the 2023 income year is $86,912. Every dollar above that amount triggers a 15-cent reduction in the OAS payments for next year. As an example, a senior with 2023 net world income of $106,912 would see their July 2024 to June 2025 OAS payment reduced by $3,000.
That’s a meaningful hit that should be avoided or reduced, if possible.
Income from most sources is taxable. CPP, OAS, company pensions, Registered Retirement Savings Plan (RRSP) withdrawals, and payments from a Registered Retirement Income Fund (RRIF) are all added to the net world income calculation. Earnings from investments held in taxable accounts also get included.
One way to reduce the tax hit is to make sure that TFSA contribution space is used up before making investments in taxable investing accounts.
TFSA limit
The TFSA limit in 2023 is $6,500. This brings the cumulative maximum TFSA contribution room to $88,000 per person. That means a retired couple would have as much as $176,000 in TFSA investment room that can generate tax-free passive income.
The contribution limit expands every year, with the size of the TFSA limit indexed to inflation and raised in increments of $500. The TFSA limit in 2024 will be at least $6,500.
Interest, taxes, and capital gains are all tax-free inside the TFSA and can be removed at any time. Money taken out of the TFSA during the year opens up equivalent new contribution room in the following calendar year.
Again, TFSA earnings are not used by the CRA for the net world income calculation used to determine the OAS clawback.
Best TFSA investments for passive income
Rates on Guaranteed Investment Certificates (GICs) issued by Canada Deposit Insurance Corporation (CDIC) members are above 5.5% right now for terms of one or two years. This is an attractive return for a risk-free investment. GICs are insured by the CDIC, as long as they are issued by member institutions, and the value is within the $100,000 limit.
For retirees who are happy with a return of 5% to 5.5% and do not need access to the invested funds before the GIC matures, this is an attractive option.
Seniors who are comfortable with the risks that come with owning stocks and are looking for higher yields might want to add some top TSX dividend stocks to their portfolio. Stock prices can be volatile, and dividends are not 100% guaranteed, but leading dividend-growth stocks typically increase their distributions every year, and their share prices usually recover from pullbacks.
At the time of writing, investors can get a yield of 7.5% from BCE (TSX:BCE). The communications firm increased its dividend by at least 5% in each of the past 15 years. Enbridge (TSX:ENB) has raised its dividend annually over the past 28 years and currently provides a dividend yield of 7.8%. These are just two examples of great Canadian dividend stocks that might be getting oversold and offer yields above the top GIC rates.
The best mix of GICs and dividend stocks is different for each person and should be decided based on comfort with risk, desired rate of return, and need for access to the invested funds.
The bottom line on TFSA passive income
Seniors can quite easily put together a diversified portfolio of GICs and high-yield dividend stocks to get an average yield of 6% today. On a TFSA of $80,000, this would generate $4,800 per year in tax-free income that won’t put OAS at risk of a clawback.
