Canadian investors are taking advantage of their Tax-Free Saving Account (TFSA) contribution space to build self-directed retirement portfolios. One popular investing strategy involves buying top TSX dividend stocks and using the distributions to acquire new shares.
TFSA limit increase
The TFSA limit will increase from $6,500 in 2023 to $7,000 in 2024. This will boost the cumulative maximum contribution room from $88,000 today to $95,000.
All interest, dividends, and capital gains earned inside the TFSA are tax-free and can be fully reinvested or removed as income without a tax hit.
This is important to consider when planning the timing of retirement income. Seniors who receive Old Age Security (OAS) have to watch out for the OAS pension recovery tax. This is a 15% clawback the Canada Revenue Agency implements when net world income tops a minimum threshold. That amount in the 2023 income year is $86,912. For example, a senior with a 2023 net world income of $96,912 would take a $1,500 OAS hit in the July 2024 to June 2025 payment period.
Since TFSA income doesn’t count toward the clawback calculation, it makes sense to build TFSA savings to use as income after starting to receive OAS. If possible, investors should try to withdraw funds from their Registered Retirement Savings Plan (RRSP) in the early years of retirement before OAS payments begin, especially if a person’s combined income from a company pension, Canada Pension Plan, OAS, and other taxable sources will put them over the minimum net world income threshold.
Power of compounding
Time is your friend when it comes to building a retirement fund. Taking advantage of the power of compounding can grow relatively modest initial investments into meaningful portfolios. The idea is to buy top Canadian dividend-growth stocks and use the distributions to acquire new shares. The snowball effect is slow at the beginning but can really have an impact on personal wealth over the course of two or three decades. This is particularly true when the dividend increases annually and the stock price drifts higher over time.
Using a dividend-reinvestment plan (DRIP)
Companies encourage investors to use dividends to buy more shares instead of taking the cash. Many even offer a discount on the share price as an incentive. Investors can normally direct their online brokerage service provider to automatically enroll in the DRIP for a stock. In this case, only whole shares are usually purchased, so some of the cash from the dividends would still go into the account.
There isn’t a fee for buying shares through the DRIP, and the strategy helps investors take advantage of market pullbacks by acquiring new shares at a lower price.
The strategy requires patience and the discipline to ride out downturns to let the process work. The best stocks to buy tend to be ones with long histories of dividend growth.
Fortis
Fortis (TSX:FTS) is a good example of a top TSX dividend stock that has delivered great returns for patient investors who reinvest their distributions. The board has increased the dividend annually for 50 years and intends to boost the payout by 4-6% per year through at least 2028.
Fortis grows through capital projects and acquisitions. The current $25 billion capital program will significantly increase the rate base over the next five years. Fortis gets nearly all of its revenue from rate-regulated assets, including power-generation facilities, electric transmission networks, and natural gas distribution utilities.
Fortis stock trades near $56.50 at the time of writing. It was as high as $65 last year.
Investors who buy at the current level can get a 4.2% yield. Fortis offers a 2% discount on stock purchased under the DRIP.
Long-term investors have done well with Fortis. A $10,000 investment in FTS stock 25 years ago would be worth more than $140,000 today with the dividends reinvested.
The bottom line on building TFSA wealth
The strategy of owning top dividend-growth stocks and using the distributions to buy new shares is a proven one for building wealth. There is no guarantee that Fortis will deliver the same returns over the next 25 years, but the stock still deserves to be part of a diversified retirement portfolio.
