Retirees and other income investors can take advantage of their Tax-Free Savings Account (TFSA) limits to build portfolios of Canadian investments to generate tax-free passive income.
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TFSA limit
The TFSA limit in 2024 is $7,000. This brings the cumulative maximum contribution space to $95,000 for anyone who has qualified every year since the launch of the TFSA in 2009. For 2025, the TFSA limit will probably be $7,000. Increases to the size of the TFSA limit are linked to the rate of inflation and occur in $500 increments.
Tax-free income
Interest, dividends, and capital gains earned on qualifying TFSA investments are tax-free. This means the full value of the earnings can be reinvested or removed as income without worrying about sharing some with the government. Seniors receiving Old Age Security (OAS) pensions also benefit in that the TFSA income doesn’t count toward the net world income calculation the Canada Revenue Agency uses to determine the OAS pension recovery tax. When net world income tops a minimum threshold, each additional dollar of earnings triggers a $0.15 reduction in the total OAS that will be paid the next calculation year. In the 2024 income year, the threshold is $90,997.
People who collect good company pensions, full CPP, and full OAS might reach this level quite easily. As such, it makes sense to take full advantage of the TFSA contribution room to hold income-generating investments.
Good investments for a TFSA
Rates offered on Guaranteed Investment Certificates (GICs) dropped considerably over the past year, but investors can still get 3% to 4% depending on the term and the provider. GICs are a good option for investors who don’t want to take any risks with their investments and are comfortable with a smaller return.
Dividend stocks can provide yields that are higher than rates offered on GICs. However, owning stocks comes with capital risk. Share prices can be volatile, and dividends are not 100% safe. That being said, many top TSX stocks have track records of annual dividend growth that stretches decades.
Fortis (TSX: FTS) is one example of a top Canadian dividend-growth stock. The board just raised the dividend for the 51st consecutive year. In addition, management expects the $26 billion capital program to generate enough revenue growth and cash flow growth to support planned annual dividend increases through at least 2029.
Stocks with steady dividend growth tend to move higher over the long run. At the time of writing, Fortis provides a yield of 4%.
Bank of Nova Scotia (TSX: BNS) is another stock to consider. This is a bit of a contrarian pick in the TSX bank sector due to the underperformance of the stock in the past five years compared to its large Canadian peers. However, BNS is working on a new growth strategy under the new chief executive officer to turn things around. Investors can currently get a solid 5.9% dividend yield from BNS stock.
The bottom line on TFSA passive income
The right mix of GICs and dividend stocks is different for every person, depending on risk tolerance and desired returns. In the current market conditions, investors can quite easily put together a diversified portfolio of GICs and dividend stocks to get an average yield of 4.5%. On a $95,000 TFSA, this would generate $4,275 per year in tax-free passive income.
A retired couple with combined TFSA holdings of $190,000 could generate $8,550 per year, which wouldn’t put OAS at risk of a clawback.
