Canadian retirees and other investors are using their self-directed Tax-Free Savings Accounts (TFSA) to generate income on savings that can help offset the hit from rising living costs.
The rally in the stock market over the past year and recent cuts to interest rates have investors wondering where they can still get decent returns from dividend stocks and guaranteed investment certificates (GICs).
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TFSA limit
Since its inception in 2009, the cumulative maximum contribution space in a TFSA has grown to $95,000. The TFSA limit is $7,000 in 2024 and will likely be $7,000 again for 2025, bringing the maximum total room to $102,000 next year. That means a retired couple would have as much as $204,000 in TFSA room to generate tax-free income.
Interest, capital gains, and dividends generated inside a TFSA are tax-free and can be fully reinvested or pulled out as tax-free income. This is particularly helpful for people who are in higher marginal tax brackets. It also benefits seniors who collect the Old Age Security Pension (OAS) and have retirement income that is near or above the minimum threshold for the CRA’s OAS clawback. In the 2024 income year, this amount is $90,997. Every dollar of net world income above that amount triggers a $0.15 reduction in OAS that will be paid next year. For example, a senior with net world income of $100,997 in 2024 would see their OAS reduced by $1,500 for the July 2025 to June 2026 payment timeframe.
As such, it makes sense for most people to use the full contribution room available inside a TFSA before holding income-generating assets in a taxable trading account.
Good investments for TFSA income
Retirees who want to take on zero risk in their TFSA and are content with lower returns should consider GICs. Unfortunately, the 5% to 6% rates that were available a year ago have dropped considerably due to the series of cuts to interest rates that occurred in recent months. That being said, investors can still get GIC rates in the 3% to 4% range depending on the term and the issuer. This is above the 1.6% inflation rate for September, so investors are still ahead.
Dividend stocks are another popular investment choice for TFSA income. Owning shares carries risks; stock prices can fall below the purchase price and dividends can be cut if the company gets into financial difficulties. On the upside, good dividend-growth companies tend to boost their distributions annually, and many offer yields that are above GIC rates.
Enbridge (TSX: ENB), for example, raised its dividend in each of the past 29 years. The company continues to grow through acquisitions and capital projects, expanding revenue and distributable cash flow.
Investors who buy ENB stock at the current level can get a dividend yield of 6.4%.
The bottom line on TFSA passive income
The right balance between GICs and dividend stocks depends on risk appetite and the return needed from the invested funds. In the current market, investors can quite easily build a diversified portfolio of GICs and dividend stocks to get an average yield around 5%. On a TFSA of $95,000, this would generate $4,750 per year in tax-free passive income that won’t put your OAS at risk of a clawback.
