TFSA Passive Income: How to Earn $4,800 Per Year Without the CRA Taking a Cut

A good strategy to generate tax-free income while reducing portfolio risk.

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Retirees and other income investors are searching for ways to get better returns on their savings without taking on too much risk or getting hit by a higher tax bill. One popular strategy to generate tax-free passive income involves holding the investments inside a Tax-Free Savings Account (TFSA).

TFSA 101

The TFSA limit is likely to increase to $7,000 in 2024. This is an increase of $500 from 2023. The government indexes the TFSA limit to inflation, and the upward adjustments are done in $500 increments. In 2023, the maximum cumulative TFSA contribution space per person is $88,000.

Unused TFSA room can be carried forward, and funds removed from the TFSA during the year will open up equivalent new space in the following calendar year. This gives people a lot of flexibility when determining how they want to remove their passive income or take out some of the capital for spending needs.

Interest, dividends, and capital gains are tax-free when earned inside a TFSA and do not count toward net world income when removed from the account. This means the TFSA income doesn’t impact taxable income, and, in the case of seniors, won’t put Old Age Security (OAS) at risk of a clawback.

OAS pension recovery tax

Retirees who collect OAS need to keep an eye on their total taxable income. The Canada Revenue Agency implements a pension recovery tax on OAS when net world income tops a minimum threshold. That amount is $86,912 for the 2023 income year. Each dollar of income above this level will trigger a 15-cent reduction in the OAS that gets paid in the July 2024 to June 2025 timeframe.

As such, it makes sense for pensioners to hold income-generating investments inside a TFSA rather than in taxable trading accounts.

Good investments for passive income

Dividend stocks used to be the only game in town for getting decent yields on investments. In the past 18 months, however, the rise in interest rates in Canada and the United States caused a crash in bond prices, and a subsequent rise in bond yields. This has contributed to the jump in rates investors can get on Guaranteed Investment Certificates (GICs). Rates on GICs have started to fall along with the recent drop in bond yields, but investors can still get non-cashable insured GICs paying more than 5%. This is an attractive return, and it makes sense to have GICs as part of the portfolio to reduce risk.

That being said, top dividend stocks are still attractive. In fact, the pullback in the share prices of many great dividend-growth stocks has pushed yields to levels typically seen during a financial crisis. Owning stocks comes with risks. Share prices can fall below the purchase price, and sometimes, they don’t fully recover. However, top dividend stocks with long track records of distribution growth normally rebound from a market decline.

Enbridge (TSX:ENB), for example, just announced its 29th consecutive annual dividend increase. The company expects cash flow to grow next year, supported by capital projects and acquisitions. ENB stock trades near $47 per share at the time of writing compared to $59 at the peak last year.

At the current share price, investors can get a dividend yield of 7.8%.

BCE (TSX:BCE) is another great dividend-growth stock that looks oversold. The company is on track to deliver higher revenue and higher free cash flow in 2023 compared to last year. The stock, however, is currently trading below $54 compared to $65 earlier this year. Investors can get a dividend yield of 7.2% at the time of writing.

The bottom line on passive income

A combination of GICs and high-yield dividend stocks could easily produce an average yield of 6% right now. On a TFSA portfolio of $80,000, this would generate $4,800 per year in tax-free passive income that won’t bump you into a higher tax bracket or put OAS at risk of a clawback.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

The Motley Fool recommends Enbridge. The Motley Fool has a disclosure policy. Fool contributor Andrew Walker owns shares of BCE and Enbridge.

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