How to Use a TFSA to Earn $250 Per Month in Tax-Free Passive Income

Hint: you’ll need this covered call ETF yielding over 11%.

Tony Dong, MSc, CETF®

Tony turned a series of 2017 marijuana stock losses into a freelance career advocating for ETF investing. He currently holds a Master’s in Risk Management from Columbia University and is a Certified ETF Advisor (CETF®). Tony is the founder of ETF Portfolio Blueprint (etfportfolioblueprint.com) and the Lead ETF Analyst for ETF Central, a partnership between Trackinsight and the NYSE. His analysis has also been featured in publications like Kiplinger, 24/7 Wall St., U.S. News & World Report, TheStreet, and Benzinga. Tony also provides independent content and marketing consulting services to various Canadian and U.S. ETF issuers. His editorial opinions for The Motley Fool remain independent and objective.

Published August 16, 2024 11:45 am EDT

Forget rental properties—the best passive-income tool you might not be utilizing to its fullest is the Tax-Free Savings Account (TFSA).

While typically celebrated for its growth investment potential, the TFSA can also be an excellent source of tax-free income.

If you’re looking to structure your TFSA to generate $250 per month in passive income, here’s how you can set it up.

Pile of Canadian dollar bills in various denominations — Source: Getty Images

Picking the right ETF

If you’re looking to generate income with a smaller investment, a higher yield is key.

While some dividend stocks and royalty trusts might offer 6-8% yields, I recommend an exchange-traded fund (ETF) for better diversification and regular monthly payouts.

Consider Hamilton Enhanced Multi-Sector Covered Call ETF (TSX:HDIV).

HDIV holds a diversified portfolio of eight other Hamilton ETFs, each employing a covered call strategy aligned to reflect the sector composition of the S&P/TSX 60.

In a covered call strategy, the ETFs sell rights—known as call options—to other investors.

These options allow buyers to purchase stocks within the ETF at a predetermined price before a specific date. Selling these rights generates immediate income from the premiums paid by the buyers.

However, while selling covered calls can limit HDIV’s share price growth due to the capping of upside potential, it consistently earns premiums, which are distributed monthly.

Adding another layer, HDIV employs leverage, meaning it can borrow up to 25% of its total value to invest further into its underlying ETFs, amplifying both the risks and returns during market fluctuations.

As of July 31, HDIV offers an 11.98% yield, and over the last three years, with dividends reinvested, it has provided an annualized return of 11.37%.

In fact, the ETF has managed to outperform the TSX 60 so far, although investors should keep in mind that future outperformance is not guaranteed.

How much do you need to invest?

Assuming HDIV’s most recent August monthly distribution of $0.171 and the current share price at the time of writing of $16.34 remained consistent moving forward, an investor using a TFSA would need to buy roughly $23,889 worth of HDIV, corresponding to 1,462 shares to receive around $250 monthly tax-free.