Canadian investors are searching for ways to get better returns from their savings to help offset the steady rise in the cost of living. Ideally, the extra cash flow won’t trigger higher taxes.
One strategy to earn tax-free passive income involves owning investments inside a Tax-Free Savings Account (TFSA).
TFSA limit increase for 2024
The TFSA limit is $6,500 in 2023 and will increase to $7,000 next year. For investors who have already maxed out their TFSA space, the boost is good news. The government indexes the TFSA limit to inflation and raises the contribution limit in $500 increments.
Since the TFSA’s inception in 2009, the cumulative TFSA limit has grown to $88,000 in 2023. Not everyone is able to make the maximum contribution each year. Fortunately, unused space can be carried forward.
TFSA or RRSP
Everyone would love to maximize their TFSA and Registered Retirement Savings Plan (RRSP) contributions annually, but most people don’t have that much extra cash. Younger investors might choose to make TFSA contributions before putting savings in their RRSP if they think their income will be higher in future years. RRSP contributions reduce taxable income for the relevant year, so investors get a bigger tax savings when they are in a higher marginal tax bracket.
TFSA income is tax-free, and funds can be removed at any time. This provides flexibility in the event cash is needed for an emergency. Any funds withdrawn during the year will open equivalent new TFSA contribution space in the following calendar year.
RRSP withdrawals are subject to a withholding tax, and the money removed is counted as income. When possible, it makes sense to plan to withdraw RRSP money in retirement when a person is in a lower marginal tax bracket than when the funds were initially put into the RRSP.
GICs or dividend stocks for TFSA passive income
Rates on Guaranteed Investment Certificates (GICs) soared over the past two years in step with rising interest rates and a jump in bond yields. Recent strength in the bond market (reduced yields) suggests the top might be in for GIC rates. In fact, rates offered on no-cashable GICs for multiple-year terms have pulled back in recent weeks. That being said, investors can still get above 5% on a non-cashable GIC for terms of one to five years. It is important to remember that the funds are not available for the duration of the GIC term.
Dividend stocks are starting to rebound as bargain hunters search for deals before the next rally. Many top TSX dividend stocks remain discounted compared to their 2022 highs and currently offer attractive yields. Owning stocks comes with capital risks. Share prices can fall below the purchase price, and some stocks never recover.
High-quality dividend stocks that raise their payouts steadily, however, are usually solid buy-and-hold bets and can deliver attractive total returns when investors are able to buy during pullbacks.
Telus, for example, trades near $24 per share at the time of writing compared to $34 at the 2022 peak.
The core mobile and internet subscription businesses continue to perform well and should deliver reliable cash flow during tough economic times. Telus has increased the dividend annually for more than two decades. At the current share price, the dividend provides a 6.25% yield.
Other leading TSX dividend stocks, including Enbridge, TC Energy, and Bank of Nova Scotia have yields above 7.25% today.
The bottom line on TFSA passive income
A combination of top TSX dividend stocks and laddered GICs can quite easily yield an average of 6% in the current market. On a TFSA of $50,000, this would generate $3,000 per year. That’s an average of $250 per month in tax-free passive income!
