Retirees are using their Tax-Free Savings Accounts (TFSAs) to build portfolios of investments that can generate steady streams of reliable, high-yield passive income. At the same time, they want to minimize risks on the invested capital.
The TFSA limit in 2023 is $6,500. That brings the cumulative total TFSA contribution space to $88,000 for any qualifying Canadian resident who was at least 18 years old when the government created the TFSA in 2009.
Each year, new TFSA room opens, with the limit indexed to inflation and increased at $500 intervals. The 2024 TFSA limit will likely be at least another $6,500.
All interest, dividends, and capital gains generated inside the TFSA can go straight into your pocket as tax-free income. This means the earnings won’t push you into a higher marginal tax bracket, and seniors do not have to worry about the extra income causing a clawback on their Old Age Security (OAS) pensions.
Best TFSA investments for passive income
For most of the past decade, investors have relied on dividend stocks to provide the yield they needed on their savings. This was due to the very low rates being paid on Guaranteed Investment Certificates (GICs) as a result of low interest rates.
Over the past year, the situation has changed. The Bank of Canada has increased interest rates dramatically in its effort to get inflation under control by cooling off the economy. High interest rates make debt more expensive. This eats into cash flow for businesses and households and eventually forces a reduction in spending. As consumption falls, businesses reduce staff, and that halts upward pressure on wages, which, in turn, should slow down price increases on products and services.
Retirees with no debt and big savings can benefit from the jump in GIC rates that typically occurs as interest rates rise. At the time of writing, investors can get rates above 5% for GICs ranging from one year to five years.
A GIC is a risk-free investment as long as the GIC is issued by a Canadian Deposit Insurance Corporation (CDIC) member and is within the $100,000 insurance limit. Using GICs along with high-yield dividend stocks to generate income can reduce overall risk in the TFSA portfolio.
GICs have some drawbacks. The funds are locked up for the duration of the term, so there is no access to the money in the event of an emergency. In addition, the payout rate is fixed.
Dividend stocks come with risk. The share prices can be volatile, and dividends sometimes get cut if a company gets into financial difficulties. Top TSX dividend stocks, however, tend to recover from market corrections and have good track records of dividend growth.
Stocks can be sold at any time to access the invested capital, providing investors with flexibility. Rising dividends boost the yield on the initial investment, which can have a meaningful impact on growth in passive income over time. The pullback in the share prices of some top TSX dividend stocks now looks overdone, and good companies now offer attractive yields.
Enbridge has increased its dividend annually for 28 years and now offers a yield of 7.4%. BCE raised its dividend by at least 5% annually over the past 15 years and currently provides a 6.7% yield.
These stocks are leaders in their respective industries and should continue to deliver steady dividend growth, even through challenging economic conditions.
The bottom line on TFSA passive income
Investors can use a mix of GICs and top high-yield dividend stocks to boost average returns while lowering overall capital risk in TFSA portfolios targeting reliable passive income.
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* Returns as of 8/16/23
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- TFSA Pension: How to Earn $5,500 Per Year in Tax-Free Passive Income
- 5 Spectacular Dividend Stocks Yielding 5% or More
- Why This Dividend Stock Can Provide Your TFSA With Lifelong Income
- TFSA Wealth: How to Harness the Power of Compounding
- How to Use Your TFSA to Earn $440 Per Month in Passive Income and Avoid the OAS Clawback
The Motley Fool recommends Enbridge. The Motley Fool has a disclosure policy. Fool contributor Andrew Walker owns shares of BCE and Enbridge.