Canadian investors are using their self-directed Tax-Free Savings Account (TFSA) to build portfolios of dividend stocks and other investments to generate tax-free income to complement pensions and other earnings.
The challenge is to find the right balance of investments that keeps risk within an investor’s comfort zone while also delivering decent returns.
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TFSA contribution limit
The TFSA limit in 2026 is $7,000. This brings the cumulative total contribution space per person to $109,000 for anyone who has qualified every year since the government created the TFSA in 2009. That means a retired couple would have as much as $218,000 in investment room to build a tax-free income stream.
Ideally, everyone would be able to maximize their contribution each year. That’s not always the case, especially if retirement savings are also being directed into a Registered Retirement Savings Plan (RRSP). It can take some time to build the savings, but even a $10,000 TFSA is a good start to begin creating an income fund.
Best TFSA investments
Guaranteed Investment Certificates (GICs) provide risk-free returns, as long as the GIC is issued by a Canada Deposit Insurance Corporation (CDIC) member and is within the $100,000 limit. The downside of the GIC is that the best interest rates are offered on non-cashable GICs that have longer durations. This means the cash is locked up for the term of the GIC, and the rate is set. That’s not ideal if someone needs to access cash quickly for an emergency expense. GIC rates are lower than they were two years ago, but people can still find multi-year non-cashable GICS in the 3% to 3.5% range, depending on the term and the issuer. This is still above the rate of inflation, so it makes sense to consider GICs for a TFSA income portfolio.
Dividend stocks carry capital risk, as the share price can fall below the purchase price. Dividends can also get reduced if a company runs into cash flow challenges. That being said, dividend stocks also have attractive features. Yields are often higher than rates offered on GICS. At the same time, each dividend increase bumps up the yield on the original investment. Stocks provide good liquidity, as well, as they can be sold at any time to access the capital.
Enbridge (TSX:ENB) is a good example of a dividend growth stock that provides an attractive yield. The company has increased the distribution for 31 consecutive years and currently offers a dividend yield of 5.3%.
This stock can go through some volatility, as occurred from June 2022 to late 2023 when interest rates moved higher, but the long term trend for Enbridge has been to the upside. A large capital program and accretive acquisitions should drive cash flow higher in the coming years to support dividend increases.
The bottom line
The right combination of GICs and dividend stocks depends on the person’s appetite for risk, desired returns, and need for quick access to the funds.
Investors can quite easily build a diversified portfolio of GICs and dividend stocks today to get an average yield of 4%. That would provide $400 per year in tax-free passive income on a $10,000 TFSA.
