Canadians are looking for ways to build retirement portfolios inside their self-directed Tax-Free Savings Account (TFSA) to complement CPP, OAS, and company pensions in retirement.
One popular TFSA investing strategy involves buying top TSX dividend stocks and using the distributions to acquire new shares.
Power of compounding
Young investors have the benefit of time to help them create a savings fund for their retirement. When dividend payments from stocks are used to buy new shares, the next dividend payment is larger. This, in turn, is used to buy more shares, leading to another higher dividend payment on the next distribution. Over time, the small incremental additions to the initial holding start to compound, potentially turning a small original investment into a meaningful savings fund over the course of 20 or 30 years. The impact can be particularly profitable when steady dividend growth occurs and the share price gradually drifts higher.
Investors who use an online broker can request to have the dividend payment enrolled in a company’s dividend reinvestment plan (DRIP). DRIPs often offer a discount on the shares purchased using the distributions.
TFSA benefits
The government created the TFSA in 2009 to give Canadians an extra tool to put money aside to achieve financial goals. The TFSA contribution limit in 2026 will be $7,000. This brings the maximum cumulative contribution room to $109,000.
All interest, dividends, and capital gains earned inside a TFSA are tax-free. That means the full amount of the earnings can be removed or reinvested without worrying about the need to set some of the profits aside for the CRA.
Any withdrawals from a TFSA open up equivalent new contribution space in the following calendar year in addition to the regular annual TFSA limit.
In retirement, seniors who collect OAS can pull income from their TFSA without being bumped into a higher tax bracket or hit with an OAS clawback if they breach the net world income threshold that triggers the Old Age Security pension recovery tax.
Best stocks for building TFSA wealth
Companies that have long track records of delivering dividend growth throughout the economic cycle should be good picks for a buy-and-hold TFSA focused on dividend reinvestment.
Fortis (TSX:FTS), for example, has increased its dividend annually for the past 52 years and offers a 2% discount on the price of its shares when dividends are automatically used to acquire new stock under the dividend reinvestment plan (DRIP).
Fortis grows through a combination of acquisitions and capital projects. The current $28.8 billion development program is expected to raise the rate base by about 7% per year over five years. As the new assets go into service the increase to cash flow should support planned annual dividend increases of 4% to 6% through 2030.
A $10,000 investment in Fortis shares 30 years ago would be worth about $330,000 today with the dividends reinvested.
The bottom line
Fortis might not deliver the same returns over the next three decades, but the stock deserves to be on your radar. The strategy of buying a diversified portfolio of top dividend-growth stocks and using the distributions to acquire new shares is a proven one for helping investors build long-term wealth.
