The market correction in top TSX dividend stocks is giving Canadian investors a chance to buy great high-yield stocks inside their Tax-Free Savings Account (TFSA) to generate a steady and growing stream of passive income.
TFSA 101
The government launched the TFSA in 2009 as an additional savings tool to go along with the Registered Retirement Savings Plan (RRSP). A TFSA is more flexible than the RRSP in that the funds can be removed at any time without a penalty or amount being held back for taxes. In addition, the amount that is withdrawn from a TFSA will open up new contribution space in the following calendar year.
All interest, dividends, and capital gains generated inside the TFSA can be taken out as tax-free income. In addition, the TFSA earnings are not used by the Canada Revenue Agency when calculating net world income that determines the Old Age Security (OAS) pension recovery tax. A 15% recovery tax is imposed on OAS recipients when their net world income breaches a minimum threshold.
The TFSA limit for 2023 is $6,500, bringing the maximum cumulative contribution space to $88,000 for anyone who has qualified annually since the program started.
A broad range of investments can be held inside the TFSA. High-yield dividend stocks and Guaranteed Investment Certificates (GICs) are now popular for generating passive income. Stock prices can be volatile, so it makes sense to look for top stocks with steady track records of dividend growth when building a TFSA fund focused on passive income.
Telus
Telus (TSX:T) normally increases its dividend by 7-10% per year. The company has increased the payout 24 times since the spring of 2011.
Telus gets most of its revenue from mobile and internet subscription fees. These are essential communications services needed by businesses and households, regardless of the state of the economy. That means the revenue stream should hold up well during a recession.
Telus expects operating revenue to grow by 11-14% in 2023. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) are projected to increase by 9.5-11%. This is solid guidance in challenging macroeconomic conditions.
Despite the positive outlook, Telus stock is down to less than $26 per share compared to more than $34 at the peak last year. The pullback looks overdone, and investors can now get a 5.6% dividend yield.
CIBC
CIBC (TSX:CM) raised the dividend when the bank reported fiscal second-quarter (Q2) 2023 results. The distribution hike is a signal to investors that the management team is comfortable with the revenue and profits outlook in the coming quarters.
CIBC stock trades below $57 at the time of writing compared to more than $80 in early 2022. The drop is due to recession fears. The Bank of Canada and the United States Federal Reserve are aggressively hiking interest rates in an effort to cool down a hot economy and bring the employment market back into balance, as they try to lower the rate of inflation. Rate hikes take time to work through the system, and there is a risk that the central banks could push the economy into a deep downturn.
The big jump in mortgage expenses combined with a potential wave of job losses could cause a spike in loan losses for the Canadian banks. CIBC has a large Canadian residential mortgage portfolio relative to its size, so the bank would potentially take a big hit if mortgage defaults soar and house prices plunge.
For the moment, most economists predict a mild and short recession. Housing demand remains strong, and supply is constrained. Record levels of immigration are expected to put a floor under any weakness in the Canadian housing market in the next few years.
Investors who buy CIBC at the current share price can get a 6.1% yield.
The bottom line on TFSA passive income
Telus and CIBC are good examples of high-yield dividend stocks that should continue to increase their distributions. TFSA investors can now put together a diversified portfolio of dividend stocks and GICs to get a minimum yield of 5.25%. This would generate $4,620 per year on a TFSA of $88,000.
That works out to an average of $385 per month in tax-free passive income!
