Canadian savers are taking advantage of the Tax-Free Savings Account (TFSA) to build portfolios of investments that can generate tax-free passive income to complement other pensions during retirement.
TFSA 101
Canada created the TFSA in 2009 as a new tool to help Canadians meet their financial goals. The TFSA limit is currently $6,500 per year. In 2024, the TFSA limit could jump to $7,000, depending on the inflation rate the government uses for 2023. TFSA limit increases are indexed to inflation and occur in $500 increments.
The maximum cumulative TFSA contribution room per person is $88,000 in 2023 for those who’ve never contributed. Retirees and late-career investors who aren’t battling high personal debt levels might have the funds available to maximize their TFSA investments.
Others who need to allocate excess cash to other priorities can carry forward any unused TFSA contribution space. In addition, pensioners and other investors who tap the TFSA earnings for passive income are able to make new TFSA contributions in the next calendar year that are equal to the amount of money taken out during the year.
However, people who have maximized their contributions just have to be careful they don’t remove cash and then put it back again in the same calendar year. Any contribution over the TFSA limit results in a fine of 1% per month.
Best TFSA investments to generate retirement income
A popular strategy for building TFSA wealth involves owning high-quality dividend-growth stocks and using the distributions to buy new shares. This sets off a powerful compounding process that can turn relatively modest initial investments into large savings over time.
Many top TSX dividend stocks give investors who enroll in their dividend-reinvestment plan (DRIP) a discount on the price of the shares purchased using the dividends. This increases the yield on the new shares and can help drive up long-term total returns.
During market pullbacks, the dividend payments can go a lot further to buy more shares as the share price drops. This, in turn, increases the size of the distribution on the next dividend date and can help to average down the capital cost of the holdings.
Fortis
Fortis (TSX:FTS) is a good example of a top TSX dividend stock that has helped make some patient investors quite rich. The utility operator has increased the dividend for 50 consecutive years and intends to boost the payout by at least 4% annually through 2028. Fortis provides a 2% discount on shares purchased using the DRIP.
The company has a $25 billion five-year capital program on the go that is expected to significantly increase the rate base to support the dividend growth target.
FTS stock trades near $54.50 at the time of writing. It was as high as $64 last year.
Long-term Fortis investors have done well buying Fortis on dips. A $10,000 investment in FTS stock just 20 years ago would be worth nearly $80,000 today with the dividends reinvested.
The bottom line on building TFSA wealth
Fortis is just one of the many top TSX dividend stocks that investors can own to build TFSA portfolios to provide retirement income. There is no guarantee the next 20 years will deliver the same returns, but the strategy of buying great dividend-growth stocks and using the distributions to acquire new shares is a proven one for building wealth.
Investors who simply want to pocket the tax-free dividend income have a great opportunity in the current market conditions. Retirees can easily put together a diversified portfolio of quality dividend stocks that would provide an average yield of 6%. On a TFSA of $80,000, this would generate $4,800 per year in tax-free passive income.
