HOW TO USE YOUR TFSA TO EARN $5,000 PER YEAR IN TAX-FREE INCOME
Canadians are using their Tax-Free Savings Account (TFSA) to build portfolios of investments that can generate a steady stream of passive income. One popular TFSA investing strategy involves buying Canadian dividend-growth stocks in addition to holding Guaranteed Investment Certificates (GIC).
TFSA benefits
Canada launched the TFSA in 2009 as a new vehicle to help people set cash aside to meet financial goals. The TFSA contribution limit is $7,000 in 2024. This brings the cumulative lifetime maximum contribution space per person to $95,000.
Interest, dividends, and capital gains earned inside the GIC on qualifying Canadian investments are all tax-free. This means the full value of the gains can be reinvested or removed as extra income. This is helpful for people in high marginal tax brackets and for seniors. The Canada Revenue Agency doesn’t include TFSA earnings in the net world income calculation used to determine the Old Age Security (OAS) pension recovery tax that kicks in when a senior has earnings above a certain threshold.
As such, it makes sense for most people to fully use their TFSA contribution space to hold income-generating investments before putting money in a taxable investing account.
TFSA withdrawals automatically open up equivalent new contribution space in the following calendar year in addition to the regular annual TFSA limit. The government increases the size of the annual TFSA limit in step with inflation at $500 increments.
GICs or dividend stocks
GIC rates went as high as 6% last year. That was a windfall for income investors. Interest rates are now falling, however, and rates offered on GICs are also pulling back, with the best rate on a non-cashable GIC now below 4.5% from most financial institutions. A rate of 4% is still a decent no-risk return, and it makes sense for people to continue to hold GICs as part of their portfolios.
Dividend stocks come with risk. The value of the share price can fall below the purchase price, and dividends can sometimes be cut when a company runs into financial trouble. That being said, a number of Canadian stocks have increased distributions for decades and should continue to boost the distributions.
Each dividend increase bumps up the yield on the original investment. Over time, the impact can be considerable for investors seeking passive income.
Enbridge (TSX:ENB) is a good example of a dividend-growth star. The board raised the dividend in each of the past 29 years. Enbridge operates oil and natural gas transmission networks that are strategically important for the smooth operation of the Canadian and U.S. economies. The company also has energy export facilities, renewable energy assets, and natural gas distribution utilities that generate steady revenue streams. Enbridge is working on a $24 billion secured capital program to drive growth and expects distributable cash flow to increase by at least 3% annually over the medium term.
Investors who buy ENB stock at the current level can get a dividend yield of 6.7%.
The bottom line on TFSA investing
Investors can quite easily put together a diversified portfolio with GICs and high-yield dividend stocks today to get an average yield of 5.5%. On a $95,000 TFSA, this would generate $5,225 per year in tax-free passive income.
The post How to Use Your TFSA to Earn $5,000 Per Year in Tax-Free Income appeared first on The Motley Fool Canada.
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More reading
- 3 Great Canadian Dividend Stocks to Build Retirement Wealth
- 3 Top Canadian Dividend Stocks for Stress-Free Passive Income
- Where Will Enbridge Stock Be in 5 Years?
- 3 Magnificent Ultra-High-Yield Dividend Stocks That Are Screaming Buys in September
- 2 Stocks to Buy Right Now With $5,000
The Motley Fool recommends Enbridge. The Motley Fool has a disclosure policy. Fool contributor Andrew Walker owns shares of Enbridge.
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