Canadians are wondering if they will be able to cover their monthly retirement expenses amid soaring living costs despite the inflation adjustments on their Canada Pension Plan (CPP) and Old Age Security (OAS) payments.
Why CPP and OAS might not be enough
People who live in Canada for most of their adult working lives and earn steady salaries every year for decades before retiring normally have access to full CPP and OAS pensions. This, however, is not the case for everyone.
Small business owners often pay themselves dividends instead of salaries. This keeps more money in their pocket during the working years, but the downside of that strategy is that they don’t make CPP contributions and need to create other pension income streams for retirement. Gig workers are in the same boat if they don’t make voluntary CPP contributions. Many just don’t have the cash-flow flexibility due to the nature of the work.
In addition, some people go overseas to work for several years. Depending on the duration of the time out of the country, the type of work, and the agreement between the other country and Canada, their CPP and OAS could be significantly reduced.
Finally, immigrants often arrive in the middle of their careers and don’t have enough time before retirement to contribute to CPP to get the full payout or meet the minimum residency qualifications for full OAS payments.
CPP amounts are determined by how much and for how long you contribute during your working years, along with your average earnings and when you decide to start taking the pension. For example, a person needs to contribute to CPP for at least 39 of the 47 years between the ages of 18 and 65 to potentially get full CPP payments at age 65.
OAS requires a person to be a qualifying Canadian resident after the age of 18 for a minimum of 10 years to get any benefit and a maximum of 40 years to get full OAS at age 65.
As such, government pensions might not be adequate to cover living costs for many people who are nearing their retirement age.
TFSA passive income
One strategy for creating a self-directed pension stream of tax-free passive income involves owning income-generating assets inside a Tax-Free Savings Account (TFSA). The government launched the TFSA in 2009 to give people another tool for setting money aside to meet financial goals. Since inception, the maximum cumulative TFSA contribution room per person has grown to $95,000, including the $7,000 TFSA limit for 2024.
The TFSA offers good flexibility. Any money that is removed during the year opens up equivalent new contribution space in the next calendar year in addition to the regular TFSA limit. All interest, dividends, and capital gains earned inside the TFSA are tax-free, so the full amount of the profits can go right into your pocket. TFSA income is not counted by the Canada Revenue Agency towards the net world income calculation that is used to determine the OAS pension recovery tax. This is important for seniors who have annual taxable retirement income that is near or above the OAS clawback threshold. That amount is $90,997 for the 2024 income year.
TFSA passive income investments
Investors who don’t like to take on any risk can simply own Guaranteed Investment Certificates (GICs) inside their TFSA. At the time of writing, it is possible to get a non-cashable GIC for one year that pays more than 5% interest. Rates in the two-year to five-year range are still above 4.5% from many issuers.
People who can handle some capital risk might decide to own quality dividend-growth stocks. Many top TSX dividend payers currently trade at discounted prices and offer attractive dividend yields. Enbridge (TSX:ENB), for example, has increased its dividend in each of the past 29 years.
The stock trades near $50 per share at the time of writing compared to $59 at the high point in 2022. Investors who buy ENB stock at the current level can get a dividend yield of 7.3%.
The bottom line on TFSA passive income
Investors can quite easily put together a diversified portfolio of GICs and dividend stocks to get an average yield of 5% right now. On a TFSA of $95,000, this would generate $4,750 per year in tax-free passive income that can help close the gap on a pension shortfall.
