If I were in charge of naming the Tax-Free Savings Account (TFSA), I would probably call it the Tax-Free Income Account. That might encourage people to stop parking cash in it and actually put the account to work.
While the TFSA is excellent for sheltering capital gains and long-term growth, it can also be a powerful tool for building passive income. Dividend-paying investments fit naturally here. Income earned inside a TFSA is not taxed, and that makes compounding far more efficient over time.
That said, I am not a fan of building income portfolios one stock at a time. If the goal is reliable TFSA income, an exchange-traded fund (ETF) makes more sense. For that role, there are two Canadian-focused options from Vanguard that stand out.
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Canadian blue-chip dividend stocks
My first pick for TFSA passive income is Vanguard FTSE Canadian High Dividend Yield Index ETF (TSX:VDY).
This ETF starts with the universe of Canadian large-, mid-, and small-cap stocks and selects those that rank in the top 55% by dividend yield. The result is a relatively concentrated portfolio of 56 companies, dominated by financials and energy.
VDY currently offers a 12-month trailing yield of about 3.55%. Costs are reasonable for a dividend-focused fund, with a 0.22% expense ratio. Performance has also been solid.
Over the past 10 years, assuming dividends were reinvested and no taxes were paid, annualized total returns have been roughly 13.28%, which is strong for an income-oriented strategy.
Canadian REITs
To complement VDY and add real estate exposure, I like Vanguard FTSE Canadian Capped REIT Index ETF (TSX:VRE).
This is a passive ETF that holds Canadian real estate investment trusts (REITs) across multiple property types, including residential, healthcare, industrial, retail, and office. The common thread is ownership of income-producing real estate, where rent collected from tenants flows through to investors.
VRE currently delivers a 12-month trailing yield of about 2.84%. The fund is narrowly focused on a single sector, so it is not diversified on its own. That said, because VDY does not hold REITs, VRE can work well alongside it when sized appropriately.
The main drawback is cost. The expense ratio is 0.39%, which is higher than VDY, but that is fairly typical for Canadian REIT ETFs.
