Since 2009, Canadians can legally generate monthly income without sharing it with the taxman. The Tax-Free Savings Account (TFSA) allows you to pay taxes only on your contributions. In other words, the Canada Revenue Agency (CRA) won’t tax your investment gains and income on investments made within the tax-advantaged account – forever. The registered account could be the perfect tool for creating a steady stream of tax-free passive income. Here’s how to turn your TFSA into a monthly paycheque machine.
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Understanding your TFSA’s wealth generation power
A TFSA is more than just a savings account – it’s a powerful investment vehicle that shields your earnings from government taxes. Unlike traditional investment accounts, all interest, dividends, and capital gains earned within your TFSA remain completely tax-free. Even better, you can withdraw funds whenever you need them without any tax implications.
Building your tax-free monthly passive income stream from scratch
Step 1: Maximize your TFSA contributions
First, ensure you’re taking full advantage of your TFSA contribution room. For 2024, the annual limit is $7,000, but if you’ve never contributed before and were 18 or older in 2009, you could have up to $95,000 in total contribution room today. The cumulative TFSA contribution room will increase to $102,000 by January 2025 with another $7,000 annual contribution limit for the next year. The growing total contribution room gives investors and savers more capacity to earn more substantial monthly passive income streams.
Step 2: Choose “ineligible” regular income-generating investments
To create the most tax-advantaged reliable monthly income stream, focus on investments that pay regular distributions every calendar month, and choose those that are ineligible for CRA tax credits. Preferably, choose monthly dividend stocks that are consistently raising their payouts every year.
Although most payouts from Canadian dividend stocks are eligible for dividend tax credits (which reduce your annual tax bill), two classes of TSX passive income plays aren’t. These include real estate investment trusts (REITs) and other high-yield income trusts, such as royalty income companies. They usually have a “.UN” or “.U” in their tickers. Traditionally paid monthly, their distributions are generally taxed as ordinary income.
If you locate these income distributors into any other investment account, other than the TFSA, you may incur income taxes on them.
One option to consider is the Morguard North American Residential Real Estate Investment Trust (TSX:MRG.UN).
Why buy Morguard North American Residential REIT units?
Tenants generally require accommodation throughout all economic cycles, and the Morguard North American Residential REIT’s portfolio of 43 properties, which comprise 13,089 residential suites, should continue to churn out a rising stream of monthly distributions in 2025 and beyond.
Morguard North American Residential REIT’s residential properties portfolio saw an average 6% monthly rent increases and maintained strong occupancy rates of around 97.8% in Canada during the third quarter. Diversification across the Canadian and U.S. economies stabilized the portfolio’s metrics, while a low debt ratio of 38.9% and a distribution payout ratio of under 46% of the portfolio’s funds from operations (FFO) ensure the REIT’s portfolio remains fundamentally intact to sustain increased monthly distributions starting in December.
Management recently raised the distribution by 2.7% in October – marking the REIT’s third consecutive year of distribution increases. The residential REIT is just 24 months away from earning the coveted Canadian dividend aristocrat badge. Management has an incentive to keep the distribution growing. Your TFSA account would love the rising payouts.
The new distribution should yield 4.2% annually.
Step 3: Diversify and structure your monthly income streams
Investors may consider diversifying core TFSA holdings across other REIT types, including industrial and retail property owners. To properly manage liquidity requirements, take note of the usual monthly distribution payment dates from each investment.
Further, adding royalty income distributors could enhance yields and stability as well, while bond exchange-traded funds (ETFs) and preferred share investments may help fortify the TFSA’s income-generating capacity and enhance its returns per unit of risk.
Most importantly, calculate your desired monthly withdrawal rates and set up automatic withdrawal plans, if necessary. A $95,000 TFSA invested in monthly dividend stocks that averages a 5% yield could generate about $4,750 in annual passive income, or more than $395.83 each month in tax-free cash flow.
Ideally, reinvest all excess cash flow from distributions into more monthly dividend stocks to compound your wealth.
