Retirees are searching for ways to get more income out of their savings, as they face steep increases in their cost of living. At the same time, they don’t want to be bumped into a higher marginal tax bracket or get hit with a clawback on their Old Age Security (OAS) pension. One way to achieve the goal involves holding income-generating investments inside a Tax-Free Savings Account (TFSA).
TFSA advantages
The TFSA limit is $6,500 in 2023 and will increase to $7,000 in 2024. Canadians who have qualified since the inception of the TFSA in 2009 currently have as much as $88,000 in contribution space. This will jump to $95,000 next year.
All interest, dividends, and capital gains earned inside a TFSA are tax-free. This means investors can pull the full amount of their earnings out of the account to use as extra income. The Canada Revenue Agency does not add the TFSA income to earnings from taxable sources such as the Canada Pension Plan, OAS, and company pensions. In addition, the TFSA profits don’t count towards the net world income calculation used to determine the OAS pension recovery tax. In the 2023 income year, the OAS clawback threshold is income of $86,912. Every dollar in earnings above that amount triggers a 15-cent reduction in the OAS that will be paid in the July 2024 to June 2025 period.
This can add up quickly, so it makes sense to maximize investment space in the TFSA before holding income-generating investments inside taxable trading accounts.
Best investments for passive income in a TFSA
The rates retirees can get from Guaranteed Investment Certificates (GICs) have soared in the past 18 months as a result of the big increase in interest rates. Non-cashable GICs from insured providers are now available with rates above 5% for four-year and five-year GICs and above 5.5% for shorter terms. These are attractive returns on zero-risk investments. As long as an investor doesn’t need access to the invested funds during the term of the GIC, this is an attractive option today.
The surge in interest rates has also driven down share prices of top TSX dividend stocks to the point where many now look oversold and offer high yields. Enbridge (TSX:ENB), for example, has increased its dividend in each of the past 28 years. The dividend now provides a yield of 7.9%.
Telus (TSX:T) is another stock that has increased the dividend annually for more than two decades and now has a dividend yield of 6.4%.
Stock prices can fall below the purchase price, and dividends are not guaranteed, so investors need to keep these risks in mind when chasing higher yields. However, top dividend-growth stocks normally have safe dividends, and the share prices usually recover from pullbacks. Stocks can also be sold at any time to access the invested funds.
The bottom line on TFSA passive income
Retirees can easily get an average return of 6% today on a portfolio split between dividend stocks and GICs. A TFSA of $80,000 would generate $4,800 per year in tax-free income that won’t put OAS at risk of the clawback. That works out to an average of $400 per month!
