Canadians are increasingly responsible for looking after their own retirement planning. One option is to use the Tax-Free Savings Account (TFSA) to build a self-directed pension that can complement payments from the Canada Pension Plan (CPP) and Old Age Security (OAS).
TFSA limit and benefits
The TFSA is a useful savings vehicle for all Canadians, regardless of their pension situation. However, self-employed people and gig workers who do not have an employer pension plan or might not even have RRSP contribution space, depending on how they pay themselves, can use the TFSA to create a pension.
The TFSA contribution limit is $6,500 in 2023. That brings the cumulative maximum contribution room to $88,000. Each year, the government increases the allowable contribution room, and the size of the TFSA limit is indexed to inflation with adjustments in $500 increments.
TFSA contributions are made with after-tax income. Investments made inside the TFSA grow tax-free. Any earnings generated inside the TFSA and removed are not counted towards personal income. This means the full value of the gains can go straight into a person’s pocket when the time comes to start taking a stream of passive income from the TFSA.
Once a person begins to collect OAS, the income from the TFSA won’t bump up their net world income calculation used by the Canada Revenue Agency to determine the OAS clawback. The income threshold in 2023 is $86,912. That sounds like a lot, but it doesn’t take long for a senior with multiple income sources to hit that level.
TFSA money that is removed during the year opens up equivalent new contribution space in the following calendar year, along with the regular TFSA limit.
Power of compounding
One popular strategy for generating good total returns on a TFSA investment involves owning top TSX dividend stocks and using the distributions to buy new shares. The compounding process is slow at the start, but the long-term gains can be substantial, especially when dividends increase at a steady pace and the share price rises.
Fortis
Fortis (TSX:FTS) is a good example of a stock that has delivered good total returns for patient investors. The board increased the dividend in each of the past 49 years, and management intends to boost the distribution by 4-6% annually through at least 2027.
Bank of Montreal (TSX:BMO) is another leading TSX dividend stock to consider for a pension portfolio. The bank has paid investors a dividend annually for nearly two centuries and has large operations in both Canada and the United States that should benefit from economic growth in the two countries.
BMO stock looks undervalued right now after the pullback and provides investors with a 5% dividend yield.
The bottom line on top stocks for total returns
Near-term volatility should be expected in the markets, but Fortis and Bank of Montreal already look attractive at current prices for investors seeking top dividend stocks to add to a diversified portfolio targeting dividends and total returns. If you have some cash to put to work, these stocks deserve to be on your radar.
