TFSA Passive Income: How Retired Couples Can Earn $10,450 Per Year Tax-Free

Retirees can use this investing strategy to boost returns while lowering portfolio risk.

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Soaring living costs are driving Canadian pensioners to seek out better returns on their hard-earned savings. At the same time, retirees want to avoid being bumped into a higher tax bracket. Those who collect Old Age Security (OAS) also have to watch out for the OAS pension recovery tax.

Fortunately, investors can use their Tax-Free Savings Account (TFSA) to generate attractive tax-free passive income that won’t put OAS payments at risk of a clawback.

TFSA limit and rules

The government launched the TFSA in 2009 to give Canadians an alternative option to set cash aside to meet future financial goals. Since inception, the maximum contribution space per person has grown to $95,000. The TFSA limit is $7,000 in 2024, up from $6,500 in 2023. Limit increases occur in $500 increments, indexed to inflation.

All interest, dividends, and capital gains earned inside a TFSA are tax-free. This means the full value can be removed and used as income or reinvested to build the portfolio. Withdrawals open up equivalent new contribution space in the following calendar year in addition to the regular TFSA limit. This provides good flexibility for people who might need to remove a large chunk of cash for a short period of time and want to replace it in the TFSA later.

One thing to remember is that the money can’t be put back into the TFSA in the same calendar year it is removed unless there is equivalent unused TFSA limit room still available to cover the amount. Also, it is best to own TSX dividend stocks in the TFSA. Dividends from American stocks held in a TFSA are subject to a 15% withholding tax.

OAS clawback

Many people receive retirement earnings from multiple sources that are all considered taxable income. As such, a good company pension, full Canada Pension Plan (CPP) payments, and full OAS pension payments can quite easily push a retiree’s annual earnings close to the minimum threshold for the OAS clawback. In the 2024 income year, this amount is $90,997. Retirement income at this level is pretty good, but the Canada Revenue Agency takes a big chunk, and the amount left over can still make the monthly budget a bit tight, especially if retirees are single and have mortgage payments or pay high rent.

Every dollar above the minimum threshold amount triggers a 15-cent reduction in the total OAS that a person will receive in the next OAS payment period. For example, a senior who had a net world income of $110,997 in 2024 would see OAS cut by $3,000 for the July 2025 to June 2026 segment.

Where possible, it makes sense to maximize TFSA contribution space to hold income-generating investments before buying investments inside a taxable account.

Good TFSA investments for passive income

The steep rise in interest rates over the past two years drove up rates offered on Guaranteed Investment Certificates (GICs) to as high as 6%. That’s great for retirees, but the party won’t last. In fact, the Bank of Canada’s recent interest rate cut has led to a drop in GIC rates that had already pulled back from the 2023 highs. Investors can still get rates in the 4-5% range, depending on the term. For a risk-free investment, this remains attractive.

Looking ahead, the Bank of Canada is expected to continue to lower interest rates through the end of 2025. This will put additional downward pressure on GIC rates, so the rates investors will have available for renewal when the GIC matures will likely be lower than the rates offered today.

Investors who can handle some volatility might consider owning top dividend-growth stocks. Share prices in several leading Canadian dividend payers currently trade at discounted levels and provide attractive yields.

Enbridge, (TSX:ENB), for example, has increased the dividend in each of the past 29 years, and investors should see the streak continue, supported by anticipated growth in distributable cash flow.

Enbridge trades near $48 per share at the time of writing. It was as high as $59 in 2022 so there is decent upside potential. Falling interest rates will reduce borrowing costs for the company and should bring investors back to the stock. Enbridge currently provides an annualized dividend yield of 7.6%. Each dividend increase will boost the return on the initial investment.

The bottom line on TFSA passive income

Investors can currently put together a diversified portfolio of GICs and high-yield dividend stocks to get an average yield of 5.5%. On a $95,000 TFSA, this would generate $5,225.00 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.

That means a retired couple could generate annual tax-free passive income of $10,450, or an average of $870.83 per month!

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 Enbridge.

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