How to Use Your TFSA to Earn $1,500 a Year in Tax-Free Passive Income

Many Canadians miss out on the benefits of a Tax-Free Savings Account (TFSA) because it does not allow you to deduct tax from your taxable income. However, you invest your after-tax income in a brokerage account or term deposit. Instead, you can invest through the TFSA and get your investment income tax-free.

Three TFSA stocks that can earn you $1,500 a year in tax-free passive income

A $25,000 investment in a 6% yielding stock can earn you $1,500 a year in tax-free passive income. Yield is the annual dividend per share as a percentage of share price. So if a $100 stock gives a $6 annual dividend in four quarterly installments, its dividend yield is 6%.

With dividend stock prices gaining steam, the yields are fading. The stocks that once had a 7% yield are now giving a 6% yield. Even a 6% yield is worth holding on to.

SmartCentres REIT

SmartCentres REIT (TSX: SRU.UN) offers a 6.2% yield, with a unit price of $29.60. As the largest retail REIT in Canada, SmartCentres offers a safe investment for passive income. It has a 23-year dividend-paying history, with no dividend cuts. In 2004, a 2.5% dividend reduction happened, but the REIT made up for it with a 22% increase the next year. The REIT’s resilience comes from its largest tenant, Walmart.

If you look at the history, SmartCentres brought Walmart to Canada. It then built Walmart-anchored stores to grow its property portfolio and is now developing Walmart-anchored city centres to diversify rent across multi-use properties. Around 14% of its properties are under development, which, when converted to net asset value (NAV) per unit, comes to $9.48. These assets are not yet earning income. Thus, its dividend payout ratio is stretched to 90.6% of adjusted funds from operations.

However, this ratio will ease as rent renews and new properties are occupied. It might take some time, and a 9.8 times leverage ratio could keep the unit price below its NAV of $36.19.

Freehold Royalties stock

Freehold Royalties (TSX: FRU) is also offering a 6.3% yield owing to high oil prices triggered by geopolitical tensions. Before the pandemic, Freehold was not a favourite of dividend seekers. Its turning point was the acquisition of properties in the Permian basin in the United States during the weakest phase of the oil industry in 2020. The oil price recovery helped it monetize the new asset producing premium lightweight crude.

Today, Freehold has no capital, operational, or abandonment costs, a 1.2 times net debt-to-funds-from-operations ratio, and a $1.08 annual dividend per share supported down to US$50/barrel WTI. It is paying 75% of its free cash flow (FCF) as dividends and aims to reduce that to 60% in the long term by repaying debt and buying new royalty lands.

While I may not suggest a long-term hold for this cyclical stock, you can enjoy high dividends until oil prices remain above US$60/barrel.

Dividend growth stock for your TFSA

Cogeco Communications (TSX: CCA) is the only stock among the three that pays quarterly dividends and grows them. Its advantage is its capital-light model of leasing fibre infrastructure and providing broadband services. The subscription revenue is sufficient to service its 3.2 times net debt-to-adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

It is paying 30% of its FCF as dividends. This ratio is likely to remain stable as the company expects to grow FCF by 0–10% despite a 2–4% dip in revenue. Cogeco is restructuring its business and looking to reduce its debt, which will contribute to higher FCF.

TFSA investing tip for $1,500 in annual passive income

An $8,300 investment in all three could start earning you $1,581 in annual passive income, with monthly payouts from SmartCentres and Freehold Royalties beginning in August.