Retirees and other investors interested in passive income are wondering how they can boost cash flow to help offset the higher cost of living without getting hit with a higher tax bill. One popular strategy to generate tax-free passive income involves holding investments inside a Tax-Free Savings Account (TFSA).
TFSA limit in 2024
The Canadian government created the TFSA in 2009 as a new tool to help people set aside cash to meet a variety of financial goals. The TFSA limit is indexed to inflation and increases by jumps of $500. In 2024, the TFSA limit is likely to rise to $7,000. This will bring the cumulative maximum TFSA contribution space per person to $95,000 from the current level of $88,000.
Unused contribution room can be carried forward. In addition, any funds taken out of the TFSA during the year will open equivalent new contribution space in the following calendar year. This is in addition to the regular TFSA limit.
Income generated inside the TFSA is tax-free. In addition, the CRA does not count TFSA earnings towards the net world income calculation used to determine the Old Age Security (OAS) clawback. This is important for seniors who have high retirement income. In the 2023 income year, the threshold is $86,912. Every dollar of income above that amount triggers a 15-cent reduction in OAS paid next year.
Good investments for TFSA passive income
Investors have an opportunity today to get decent rates on Guaranteed Investment Certificates (GICs) and high yields from top Canadian dividend stocks. As soon as interest rates begin to fall again, this situation could change quickly.
GICs
A GIC is a risk-free investment as long as the provider is a Canada Deposit Insurance Corporation (CDIC) member and the GIC value is within the $100,000 limit. In the event the financial institution that issued the GIC goes bust, the CDIC covers the GIC.
Investors can easily get non-cashable GICs paying better than 5% right now for terms of one year through five years. It makes sense to ladder the investments so that the GICs mature on a steady basis. The downside is that the rate is fixed for the term, and rates on renewal could be much lower. In addition, the invested capital is locked up for the term of the GIC.
Dividend stocks
Investors got a brutal reminder in the past few years that stock prices can be volatile. Even the shares of some top-quality Canadian dividend stocks have pulled back considerably in the past 12-18 months. This is hard to watch if the stocks are already in your portfolio, but the drop is also providing an opportunity to get great yields from good companies that have long track records of dividend growth.
Stocks can be sold at any time to access the funds if needed. Dividend growth increases the return on the initial investment. This can be a huge deal over the course of several years and is one reason stocks are attractive despite the risks.
For example, Enbridge (TSX:ENB) has increased its dividend annually for 29 consecutive years.
The stock is likely oversold at this point and now provides a 7.7% dividend yield.
TC Energy (TSX:TRP) has increased its dividend annually for more than two decades. Management expects the capital program to support ongoing dividend growth of 3% to 5% per year over the medium term. At the current share price, TRP stock offers a yield of 7.5%.
Fortis (TSX:FTS) has a yield of 4.25% today. That’s lower than other options, but the company has increased the payout annually for the last 50 years and intends to boost the distribution by 4-6% annually through at least 2028.
The bottom line on TFSA passive income
Investors can quite easily put together a diversified TFSA of GICs and top dividend stocks to get an average return of 6% today. On a TFSA of just $40,000, this would generate $2,400 per year in tax-free passive income that won’t put OAS at risk of a clawback.
