Canadian investors have another $7,000 in Tax-Free Savings Account (TFSA) contribution room in 2026. With stock prices near record highs and fixed-income rates rising, it makes sense to consider a mix of fixed income and dividend stocks when putting new money to work.
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TFSA benefits
All interest, dividends, and capital gains earned inside a TFSA are tax-free. This is a big deal, particularly the interest part, because interest income earned in taxable investment accounts is treated the same as income from employment. The higher a person’s marginal tax rate, the larger the net benefit from holding interest-paying investments inside a TFSA.
Dividends and capital gains get some special tax treatment when held in taxable accounts, but taxes are still paid on those earnings, as opposed to being tax-free in the TFSA.
Dividend stocks or GICs?
Stocks that have a good track record of delivering steady dividend growth, regardless of the state of the economy, are top candidates for a TFSA focused on generating income and long-term capital gains.
Each time a company increases the dividend, the yield on the initial investment rises. In addition, stocks can be sold on any trading day, so they provide liquidity in the event there is an emergency need to access the savings.
Share prices, however, can fall below the purchase price, and dividends sometimes get cut. This is the risk investors take when owning stocks. That being said, most top dividend-growth companies eventually recover from pullbacks and rise to new highs.
Enbridge (TSX: ENB), for example, has increased its dividend in each of the past 31 years. The stock has enjoyed a nice rally over the past 12 months, but still provides a dividend yield of 4.8%.
Enbridge is working on a $40 billion capital program that is expected to boost distributable cash flow by 5% per year over the medium term. Additional projects are under consideration that could be put into the project pipeline. Enbridge also has the financial clout to make large strategic acquisitions to drive growth.
What about Guaranteed Investment Certificates (GICs)?
GICs are another option for TFSA investors to generate income. The invested capital is 100% safe as long as the GIC is issued by a Canada Deposit Insurance Corporation (CDIC) member and is within the $100,000 limit. Rates offered on GICs have moved considerably higher in recent months due to soaring yields on government bonds. At the time of writing, non-cashable GICs pay 3.5% to 4%, depending on the term and the issuer.
The downside with non-cashable GICs, which pay the best rates, is that the cash is locked up for the term of the certificate. Another point to consider is that the rate paid is fixed during the term, and rates available in the market when the GIC matures could be lower, so the reinvestment of the funds could generate a smaller return.
The bottom line
The right combination of dividend stocks and GICs depends on a person’s desired returns, risk appetite, and their need for liquidity in the portfolio.
Investors who don’t want to take on any capital risk and are comfortable locking up their savings for a timeframe of up to five years can take advantage of the recent jump in GIC rates. Inflation in Canada is currently below 3%, so the GIC rates are attractive. Those who want liquidity, higher yields, and a shot at capital gains, however, might lean more towards top dividend-growth stocks.
For most people, a mix is probably the best choice. In the current market situation, TFSA investors can quite easily put together a diversified portfolio of dividend stocks and GICs to get an average return of better than 4%. This strategy reduces risk while still delivering a decent yield and provides upside potential.
