Canadians can use their Tax-Free Savings Account (TFSA) to generate tax-free income on a range of investments, including stocks, bonds, and Guaranteed Investment Certificates (GICs).
TFSA limit
The TFSA limit for 2023 is $6,500. This brings the maximum cumulative TFSA contribution room to $88,000. The TFSA limit will increase by at least $6,500 in 2024. Individuals and couples who have qualified for the full TFSA limit since the launch in 2009 have significant investing room to generate meaningful tax-free passive income on their savings.
GICs or dividend stocks?
Interest rate increases implemented by the Bank of Canada are designed to get inflation under control. The added benefit of higher interest rates has been a big jump in rates offered on GICs. That’s great news for retirees and other debt-free investors who want to get decent returns on their savings without taking on any risk to the principal investment.
GIC rates are currently in the 5-5.5% range, depending on the term. For some people, that’s good enough to meet their needs for passive income, and this return is above the June inflation rate of 2.8%, so you can actually get ahead a bit.
As long as the GIC provider is a Canada Deposit Insurance Corporation member and the amount invested is within the $100,000 limit, the GIC is a no-risk investment. However, there are downsides to buying GICs. The principal is locked up for the duration of the term, so there is almost no way to access the funds in an emergency. In addition, the rate is fixed for the term. If rates jump considerably, as they have in the past two years, investors could miss out on better returns.
Dividend stocks come with risk. The share price can fall below the price paid, and dividends sometimes get cut or eliminated if a company runs into financial problems. On the positive side, the market correction over the past year, largely caused by soaring rates, has driven share prices of good stocks down to cheap levels and dividend yields from some great dividend-growth stocks are now above GIC rates.
Enbridge and TC Energy, for example, have increased their dividends annually for more than 20 years and currently offer yields above 7%.
Stocks can be sold at any time to get access to the invested funds, so there is more flexibility. Finally, as dividends increase, the yield on the initial investment rises.
Investors have to decide how much they want to earn on their savings and what level of risk they are willing to take to potentially get higher returns. For most people seeking passive income, a combination of GICs and good dividend stocks is probably the way to go in the current environment.
The bottom line on TFSA passive income
TFSA investors can quite easily put together a diversified portfolio of GICs and high-quality dividend stocks that will provide an average yield of 6.3% today. On a TFSA of $88,000, this would generate $5,544 per year. That’s $462 per month in tax-free passive income!
