People entering retirement are increasingly concerned about being able to cover rising living costs. Defined-benefit (DB) pensions are rare these days, and contract work or living as a digital nomad is more common, which can impact the amount of money people get from government pensions.
Ideally, we would all like to retire young enough to actually enjoy life in the golden years. This, however, presents other income challenges.
Retirement income sources
A defined-contribution (DC) plan is a good option for people who work for a company that offers this benefit. The company normally contributes an amount that depends on the contribution made by the employee, usually with the company match ranging from 50% to 150%. If a DC plan is available, people should try to maximize the allowed contribution amount to get the full benefit. This money belongs to the employee, but the income stream that comes from it in retirement is determined by the size of the savings rather than being guaranteed, as is the case with a DB pension.
Gig workers or self-employed people don’t have the DC plan option. In addition, they sometimes don’t contribute to the Canada Pension Plan (CPP) and will, therefore, receive no CPP benefits.
Time out of the country counts against Old Age Security (OAS) payments. This impacts people who decide to live abroad for several years or arrive in Canada later in life.
Registered Retirement Savings Plans (RRSP) are useful for lowering taxable income and for setting extra cash aside. The amount is 18% of earned income, up to a limit, but the amount a person can contribute to an RRSP is reduced by the amount that goes into a DC or DB pension at work.
Timing of retirement income is another factor. People who have been in Canada for most of their lives and qualify for full OAS have to wait until age 65 to access the income. CPP can be accessed as early as age 60 but at a reduced amount. Company pensions are often available as early as age 55.
Government pensions are adjusted for inflation, but the adjustments might not be adequate to cover the actual inflation faced by retirees on an individual basis. Many people now enter retirement with mortgages or are paying rent. These expenses, as we have seen in the past few years, can surge significantly. Those who own a home outright still have to contend with soaring insurance rates and rising property taxes.
TFSA benefit
The government launched the Tax-Free Savings Account (TFSA) in 2009 to give Canadians another tool to save for financial goals. In 2024 the TFSA contribution limit is $7,000. This brings the cumulative maximum contribution space to $95,000 per person.
All income generated inside a TFSA is tax-free. This means the full value of interest, dividends, and capital gains can go straight into your pocket. Funds can be withdrawn at any time. The amount removed from the TFSA in a given year will open up equivalent new TFSA contribution space in the following calendar year in addition to the regular TFSA limit. This provides savers with good flexibility if a large amount of cash is needed for a one-off expense.
Investors can currently get non-cashable Guaranteed Investment Certificate (GIC) rates ranging from 4% to 5%. This is attractive for people who do not want to take on any capital risk. Otherwise, the share prices of many top TSX dividend-growth stocks have declined to the point where they appear undervalued and now offer high dividend yields.
Enbridge (TSX:ENB), for example, has increased its dividend annually for the past 29 years. The stock trades near $48 at the time of writing compared to $59 in 2022.
Acquisitions and capital projects are expected to boost distributable cash flow by at least 3% per year over the medium term. This should support ongoing dividend increases in the same range. Investors who buy ENB stock at the current level can get a dividend yield of 7.6%.
The bottom line on tax-free passive income
Investors can quite easily put together a diversified TFSA of GICs and top dividend stocks to get an average yield of 5.5% today. On a TFSA of $95,000, this would generate $5,225 per year in tax-free passive income. That works out to more than $435 per month.
Everyone’s retirement income situation is different, but using the full benefit of a TFSA to complement or replace other pension income can help Canadians meet retirement goals.
