How to Make $2,850 a Year Tax-Free With Index Funds

By investing in index funds like the iShares S&P/TSX Capped Composite Index Fund (TSX:XIC), you can make thousands in passive income.

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TFSA investing is one of the most powerful wealth hacks available to Canadians. By holding your investments in a TFSA, you shelter them from taxation. The end result is a greater take-home return than would otherwise be possible.

TFSAs are uniquely well suited to holding assets that produce cash income, such as dividend stocks and interest-bearing bonds. Such assets produce income that is almost always taxable. By contrast, non-dividend stocks are in many cases not taxed even when held in taxable accounts. If you hold non-dividend shares for your entire lifetime, you pay no taxes on them.

While many investors invest aggressively in their TFSAs, it isn’t necessary to do so. Even with simple index funds you can get thousands of dollars per year in tax-free TFSA income. In this article, I will explore how to get $2,850 in annual passive income through TFSA investing.

The typical TSX index fund yield

You don’t need to invest in risky penny stocks to profit from TFSA investing. All it takes is a plain old boring index fund. In 2024, the typical TSX index fund yields 2.85%. By investing in such funds diligently over a period of many decades, you can end up with a decent amount of passive income.

Consider the iShares S&P/TSX Capped Composite Index Fund (TSX:XIC), for example. XIC is a Canadian index fund consisting of 240 Canadian stocks. It invests in a pretty broad swath of Canada’s public equity market: banks, energy companies, utility companies, and more. It boasts a tiny 0.06% management fee – so small you probably won’t even notice it – and has excellent liquidity.

Index funds like XIC are often considered ideal for new investors because they have lower risk than individual stock positions. All stocks have two types of risk: specific risk (the risk inherent to the company) and market risk (the risk inherent in the markets). With an extremely diversified portfolio, you neutralize the effects of specific risk, leaving you exposed to only market risk.

Also, index fund investments do not require as much research as individual stock investments do. One of the benefits of diversification is that it means you are essentially buying “the market,” not a particular stock. You don’t need to know much about the stocks in the index to invest profitably in the index. So, index funds are suitable for TFSA investing.

How much you’d have to invest

To get to $2,850 in passive income with TSX index funds, you would need to invest $100,000. If you were 18 or older in 2009, then you would have accumulated $95,000 in TFSA contribution room. If you haven’t used any of it yet, then you can deposit $95,000 today. If you put the other $5,000 into an RRSP or an FHSA, then you will have a fully tax-sheltered/tax-deferred index fund portfolio that pays $2,850 per year.

COMPANYRECENT PRICENUMBER OF SHARESDIVIDENDTOTAL PAYOUTFREQUENCY
IShares TSX Index Fund$35.362,745$0.26 per quarter ($1.04 per year)$713 per quarter ($2,854 per year)Quarterly

TFSA investing: The Foolish takeaway

Investing in a TFSA is always a wise decision. Investing in general is a wise decision, and TFSA investing is the wisest type of investing of all. It’s not very often that the government gives you a free tax break. When they do, make sure you take advantage of it!

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.

Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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