Canadian pensioners are searching for ways to get more income from their savings without being bumped into a higher marginal tax bracket or getting hit with a clawback on their Old Age Security (OAS) pensions. One way to achieve the goal involves owning income-generating investments inside a Tax-Free Savings Account (TFSA).
TFSA limit change
The TFSA limit is likely to increase from $6,500 in 2023 to $7,000 in 2024. This will boost the maximum cumulative TFSA contribution space from $88,000 in 2023 to $95,000 next year. Increases to the size of the TFSA limit are implemented in $500 increments and are indexed to inflation.
OAS pension recovery tax
Passive income generated inside the TFSA is tax-free. This means retirees can withdraw the full value of interest, dividends, and capital gains to use as income. In addition, the CRA does not count TFSA earnings when it calculates net world income that is used to determine the OAS pension recovery tax. This is a big deal for seniors who receive generous company pensions, Canada Pension Plan, OAS, and income from other taxable sources, including Registered Retirement Savings Plan (RRSP) withdrawals, Registered Retirement Income Fund (RRIF) payments, or investments in taxable accounts.
As soon as net world income tops a minimum threshold, the Canada Revenue Agency implements a 15% OAS clawback on every dollar above that level. In the 2023 income year, the threshold is $86,912. This means a person with net world income of $96,912 would be hit with a $1,500 reduction in OAS during the July 2024 to June 2025 payment period.
One way to avoid or minimize the OAS clawback is to make sure TFSA contribution space is used up before holding income-generating investments in taxable accounts.
Dividend stocks and GICs for passive income
Rates on Guaranteed Investment Certificates (GICs) have likely peaked, but they remain attractive for income investors who want to reduce risk in their portfolios. In fact, investors can get 5% or higher right now on multi-year non-cashable GICs from Canada Deposit Insurance Corporation members.
Top Canadian dividend stocks are starting to rebound after falling sharply this year. However, many great TSX dividend-growth stocks remain cheap and currently offer high yields.
Stocks carry risks. The share price can fall below the purchase price, and dividends sometimes get cut if a company gets into financial trouble. That being said, good dividend-growth stocks usually recover from pullbacks and typically increase their dividends steadily, even during tough economic times. Each dividend increase pushes up the yield on the initial investment, so investors can see their passive income grow each year.
Enbridge (TSX:ENB) is a good example of a TSX dividend stock that looks cheap today. The board increased the dividend in each of the past 28 years. Recent acquisitions and a large capital program should drive ongoing revenue and cash flow growth to support the distribution.
At the time of writing, Enbridge offers a 7.6% dividend yield.
Bank of Nova Scotia (TSX:BNS) is another stock to consider for passive income. The share price is near $60 at the time of writing compared to more than $90 at the peak in early 2022. Canadian banks are facing some economic headwinds, but the large ones remain very profitable and pay good dividends that should be safe. Investors who buy BNS stock at the current level can get a 7% dividend yield.
The bottom line on tax-free passive income
In the current market, retirees can quite easily get an average return of 6.25% from a diversified portfolio of laddered GICs and high-yield dividend stocks. On a TFSA of $88,000, this would generate $5,500 per year in tax-free passive income that won’t put OAS at risk of a clawback.
