TFSA Pension: How to Earn $5,270 Per Year in Tax-Free Income

Introduced in 2009, the Tax-Free Savings Account (TFSA) is a popular registered account in Canada. As the name suggests, any returns generated in the account are exempt from Canada Revenue Agency taxes. These returns can be in the form of interests, dividends, and capital gains, which makes the TFSA a popular choice for growing long-term wealth.

The TFSA contribution limit increases every year. In 2024, the contribution room increased to $7,000, bringing the cumulative limit to $95,000. So, let’s see how you can earn $5,000 per year in tax-free passive income by investing across asset classes.

Invest in GICs

Investors can consider allocating 20% of their TFSA contributions to fixed-income products such as Guaranteed Investment Certificates, or GICs. Similar to a fixed deposit, you can deposit a certain sum of money with a bank or a financial institution and earn interest on these deposits. Interest rate hikes since the start of 2022 have meant several banks now offer you a yield of 5% on GICs. So, an investment of $19,000 (20% of $95,000) in GICs can help you earn $950 in annual interest payouts.

Invest in dividend stocks

Blue-chip dividend stocks offer you an opportunity to create a steady and recurring passive-income stream. Investors can consider allocating another 20% of their TFSA contributions to quality TSX dividend stocks such as Enbridge (TSX: ENB). Given Enbridge’s tasty dividend yield of 7.6%, a $19,000 investment in the energy giant will help you earn $1,450 in annual dividends.

While Enbridge is part of a cyclical energy sector, it has raised dividends by 10% annually since 1995, enhancing the yield at cost significantly. With a payout ratio of less than 70%, Enbridge has the flexibility to raise dividends further, target accretive acquisitions, and lower balance sheet debt, all of which should drive future cash flows higher.

Investors can identify other dividend stocks that generate stable cash flow and are equipped to maintain their payouts across market cycles.

Invest in dividend ETFs

Canadian investors who lack the expertise or time to identify individual stocks can consider allocating a majority of their TFSA contribution room to dividend-paying ETFs (exchange-traded funds). One popular TSX dividend ETF is iShares Core MSCI Canadian Quality Dividend Index (TSX: XDIV), which has returned more than 10% annually in the last five years, easily outpacing broader indices such as the TSX.

The XDIV ETF is designed for long-term holding and provides access to Canadian stocks with above-average dividend yields and steady or increasing dividends. It selects securities with strong overall financials, solid balance sheets, and less-volatile earnings.

Some of the top holdings of the XDIV ETF include Royal Bank of Canada, Manulife, Enbridge, Toronto-Dominion Bank, and Sun Life Financial, which account for almost 45% of the fund.

The XDIV ETF pays shareholders a monthly dividend and offers a yield of over 4.9%. So, an investment of $57,000 in the XDIV ETF will help you earn $2,868 in annual dividends.

The Foolish takeaway

Given a contribution room of $95,000 and an allocation of 20% each towards GICs and Enbridge stock and the rest towards the XDIV will allow TFSA investors to earn over $5,270 in annual dividends in the next 12 months.