Retirees and other self-directed Tax-Free Savings Account (TFSA) investors who want steady passive income have an opportunity in the current market conditions to get good returns while reducing portfolio risk.
TFSA limit increase
The TFSA limit is likely to increase to $7,000 in 2024 from $6,500 in 2023. This will bring the cumulative maximum contribution space per person to $95,000, compared to $88,000 this year.
All interest, dividends, and capital gains earned inside a TFSA are tax-free and the full value of the profits can go straight into your pocket. Any funds removed from the TFSA during the year opens up equivalent new contribution space in the next calendar year in addition to the regular TFSA limit.
OAS clawback threshold
Pensioners with TFSA room should consider maximizing their TFSA contributions before holding income-generating investments in taxable accounts. Everyone benefits from getting tax-free income from a TFSA, but people who collect Old Age Security (OAS) have a particular incentive to reduce taxable income.
The Canada Revenue Agency implements an OAS pension recovery tax on net world earnings that come in above a certain level. In the 2023 income year, the threshold is $86,912. Every dollar of net world income above the annual threshold amount triggers a 15-cent reduction in the OAS that gets paid in the following year. For example, a senior with net world income of $106,912 in 2023 would see their OAS cut by a total of $3,000 for the July 2024 to June 2025 payment period. This is a big hit that should be avoided when possible.
GICs or dividend stocks for passive income
Investors can finally get decent rates on Guaranteed Investment Certificates (GICs) thanks to the big surge in interest rates over the past 18 months. This might not last long. In fact, GIC rates are already falling from their recent highs, but investors can still get more than 5% on a multi-year, non-cashable GIC.
A GIC is a risk-free investment as long as it is from a provider that is a Canada Deposit Insurance Corporation (CDIC) member and the value is within the $100,000 limit. The downside of a non-cashable GIC is that the funds are locked up for the term of the certificate, and the rate is fixed.
Dividend stocks took a beating this year, largely as a result of rising interest rates. Several top TSX dividend stocks now trade at cheap prices and offer high yields. TC Energy (TSX:TRP), for example, has increased its dividend annually for more than two decades and currently provides a 7.3% yield.
Stocks come with risks. The share price can fall below the purchase price, and dividends sometimes get cut if a company gets into financial trouble. Top dividend-growth stocks, however, tend to boost their payouts through all economic conditions. This increases the yield on the initial investment each year. Stocks also offer investors more flexibility as the shares can be sold to access the invested funds.
The best mix of GICs and dividend stocks depends on a person’s risk tolerance, desired returns, and need for access to the savings.
The bottom line
Not everyone has $88,000 to put into a TFSA with that contribution room available today, but even smaller contribution amounts can generate attractive passive income.
Investors can quite easily put together a diversified portfolio of GICs and top TSX dividend stocks to get an average yield of at least 6% in the current market. On a TFSA of just $40,000, this would generate $2,400 in tax-free income per year. That averages out to an extra $200 per month that can go right into your pocket without pushing you into a higher tax bracket or putting OAS at risk of a clawback.
