How can one turn their TFSA into a powerful passive income generator? With various specialty income ETFs with sky-high yields growing in popularity, perhaps one doesn’t need to put their portfolio at great risk to score heftier dividends. Of course, there’s always a catch when it comes to pursuing higher yields. Higher rewards tend to accompany higher risk.
And in the case of covered call ETFs (or ones with mild cash leverage), the total return mix is wildly different, with dividends (or distributions) doing more of the heavy lifting, as capital gains look to take on more of a “supporting act.”
Indeed, does it make sense to shift some of the return from capital appreciation to the payout? If you’re an income investor looking for monthly payments and is all right with paying higher fees and perhaps settling for a lesser total return (that’s capital gains plus dividends accumulated), it might be a move worth considering.
In my humble opinion, I’d much rather keep things simple and settle for a dividend ETF, like the Vanguard Canadian High Dividend Yield Index ETF (TSX: VDY). It owns shares of large-cap dividend payers, and while the yield, currently just north of 3%, isn’t all that remarkable, I do think that it provides a decent amount of income without having to surrender much, if any, of the capital gains potential.
Arguably, something like the VDY delivers on both fronts quite well, with shares up 32% in the past year (compare that to 19.8% from the TSX Index or just 9.6% from the S&P 500) while offering a much larger payout.
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Turning a TFSA into a passive income machine?
For those who need more than 3%, though, I do think that there are easier, albeit more complex, tactical plays to stretch that yield as far as it can go without putting yourself in danger. If you want an average of $800 per month worth of income tax-free from the likes of a TFSA, you’re going to need a hefty amount of principal. There’s really no way around that. So, $800 in monthly passive income works out to $9,600 per year.
That’s quite hefty, but not impossible if you’ve stayed on top of your TFSA contributions. Given the cumulative limit is now $109,000 (it’ll be closer to $116,000 in just under two months’ time), I’ll assume that investors are looking to put such a sum to work on income-generating investments within a TFSA.
Based on a 3% yield, like that which is offered by the VDY, it generates close to $3,300 per year in annual income; that’s not nearly enough to cut it, even if you’ve got a six-figure TFSA to put to work. In fact, you’d need a TFSA that’s worth more than $300,000 to make $800 per month in income with a 3% yield. For those with a $150,000 TFSA (let’s say you’ve stayed on top of contributions while investing the proceeds), a 6.5% yield or so could be enough.
The ZWU is a stellar 7.5% yielder that can help raise the bar on yield
The BMO Covered Call Utilities ETF (TSX: ZWU), which sports a 7.5% yield (giving a bit of wiggle room), could be the security to consider to meet one’s income needs. Of course, covered call ETFs tend to have dynamic yields that depend on how much options premiums are going for at any given time. And let’s not forget about the higher MERs. Either way, though, it is technically possible via the ZWU to crank up the tax-free income if you’ve got a sizeable TFSA and are ready to raise the bar on the yield.
I guess it’s more a matter of whether TFSA investors should crank up the yield that high.
In my view, settling for 3% could be a better move for those willing to forego passive income in the present for growth and dividend growth in the future. Remember, just because you could be getting more income doesn’t mean you should at the expense of future growth. Like with most things, there’s a balance to be achieved, and if you can hit it, it’s my view that you’ll be more optimally set for better results over the long term.
