Canadian retirees can take advantage of their Tax-Free Savings Account (TFSA) contribution space to build a portfolio of investments that generates steady passive income that won’t push them into a higher tax bracket or put their Old Age Security (OAS) pensions at risk of a clawback.
The surge in interest rates over the past year, along with the decline in the share prices of top TSX dividend stocks, is giving pensioners a chance to get attractive returns while also reducing portfolio volatility.
TFSA limit
The TFSA contribution limit in 2024 is $7,000. The amount increased from $6,500 in 2023 and brings the total maximum cumulative TFSA contribution space to $95,000 per person. TFSA limit increases occur in $500 increments and are indexed to inflation.
All interest, dividends, and capital gains earned inside a TFSA are tax-free. This means the full value of any investment earnings can be removed as passive income without having to share some with the Canada Revenue Agency (CRA).
Any money removed from the TFSA during the year will open new equivalent contribution room in the following calendar year, along with the regular TFSA limit increase. The flexibility is helpful for people who might need to pull out a large amount for a short period of time and want to replace the funds at a later date.
OAS clawback
Seniors who receive OAS pension payments need to keep an eye on their total taxable income during the year. The CRA has a system in place that implements an OAS pension recovery tax when net world income is above a minimum threshold. In the 2024 income year this amount is $90,997. Every dollar of net world income above this level triggers a 15-cent reduction in the total OAS that will be paid in the July 2025 to June 2026 payment period.
For example, a retiree with a net world income of $100,997 would be hit with a $1,500 OAS clawback.
Anyone who has a good company pension and collects full Canada Pension Plan and OAS, along with other taxable income that includes Registered Retirement Savings Planwithdrawals, Registered Retirement Income Fund payments, or earnings on investments in taxable accounts, can quite easily hit the $91,000 income level. This sounds like a lot, and it is certainly decent pension income, but the CRA takes a big chunk, so the amount left over at the end of each month might still make it tough to cover living expenses, especially if someone still has a mortgage.
As such, it makes sense to avoid the OAS clawback, if possible.
Top TFSA investments for passive income
Investors who prefer to avoid any capital risk can simply hold Guaranteed Investment Certificates (GICs) inside their TFSA to generate income. At the time of writing, investors can get non-cashable GICs from Canada Deposit Insurance Corporation members that pay between 4% and 5%, depending on the term. If that’s good enough to meet your income goals, this is a reasonable option.
The downside to a GIC is that rates could be much lower when the GIC matures, so the income on the invested money could drop on renewal. In addition, non-cashable GICs offer higher rates, but the money is not accessible until the GIC matures.
Dividend stocks are another option for generating income, but they come with risk. The share price can fall below the purchase price and dividends can be cut if a company runs into financial difficulties. On the positive side, some dividend yields are much higher than the rates offered by GICs and the return on the initial investment increases each time the company raises the dividend payout. Also, stocks can be sold at any time to access the capital in the event of an emergency need for the funds.
Many top dividend-growth stocks currently trade at discounted prices and offer high yields. Enbridge has increased its dividend for 29 consecutive years and currently provides a yield of 8%.
Management expects the capital program and acquisitions to generate distributable cash flow growth of 3% through 2026 and 5% in the following years. This should support ongoing dividend increases.
Telus is another dividend stock that looks oversold. The communications company has increased its dividend annually for more than two decades and currently offers a 6.9% yield.
The bottom line on top investments for passive income
Retirees can quite easily put together a diversified portfolio of GICs and high-yield dividend stocks to get an average yield of 5.5% today. On a TFSA of $95,000, this would generate $5,225 in annual tax-free passive income that won’t put your OAS at risk of a clawback.
FAQs
Retirees can quite easily put together a diversified portfolio of GICs and high-yield dividend stocks to get an average yield of 5.5% today. On a TFSA of $95,000, this would generate $5,225 in annual tax-free passive income that won't put your OAS at risk of a clawback.
What passive income is not taxed? ›
By keeping assets in tax-deferred accounts like IRAs and 401(k) plans, you won't have to pay tax on your income and gains until you withdraw the money from the account. In the case of a Roth IRA, you may never have to pay tax on your distributions at all.
Is TFSA good for seniors? ›
There are lots of good reasons to use a TFSA in retirement. You can keep contributing to a TFSA for as long as you live, unlike an RRSP which you must convert to a RRIF at age 71. If you have more retirement income than you need, you can place it in your TFSA, providing you have contribution room.
Does withdrawing from TFSA count as income? ›
Any amount contributed as well as any income earned in the account (for example, investment income and capital gains) is generally tax-free, even when it is withdrawn. Administrative or other fees in relation to a TFSA and any interest on money borrowed to contribute to a TFSA are not tax-deductible.
What happens if you overcontribute to your TFSA? ›
The tax of 1% on an excess TFSA amount applies from the first $1 of excess contributions. This tax of 1% per month is based on the highest excess TFSA amount in your account for each month in which an excess remains.
Is Social Security considered passive income? ›
While you don't have to work for your monthly Social Security checks, you did have to work to establish your Social Security benefit, so there's a bit of gray area here. But in many ways, Social Security and other retirement income sources like pensions can be considered passive income for most practical purposes.
What is legally considered passive income? ›
Passive income includes regular earnings from a source other than an employer or contractor. The Internal Revenue Service (IRS) says passive income can come from two sources: rental property or a business in which one does not actively participate, such as being paid book royalties or stock dividends.
What is the downside of a TFSA? ›
No tax deductions: The biggest drawback of a TFSA, is that your contributions are made with after-tax dollars and are not tax deductible, unlike the FHSA and RRSP. Contribution limits: Though there is no lifetime maximum contribution limit, there is an annual contribution limit, stipulated by the Government of Canada.
Is it better to keep money in savings or TFSA? ›
TFSAs are most useful as investment accounts. Investments, in general, give you the best returns over the long run and can provide much higher returns than simple savings accounts. So, an investment account will serve you best over a longer stretch of time.
What is better than TFSA? ›
TFSA vs RRSP: the basics
In general terms, Registered Retirement Savings Plans (RRSPs) are better suited to high-income earners who want to save for their retirement, their first home or to further their education.
Tax-free withdrawals can be made at any time and for any purpose (pending the terms of any specific contracts, if your money is invested). There are no limits on how much you can withdraw from your TFSA at any one time.
Which bank has the highest interest rate for TFSA? ›
Top high-interest TFSA rates in Canada:
| Savings Account | Interest Rate | Insurance |
|---|
| Canadian Tire Tax Free High Interest Savings® Account** | 3.70% | CDIC |
| Canadian Western Bank WestEarner® TFSA Account | 1.00% | CDIC |
| CIBC TFSA Tax Advantage Savings Account® | 0.70% | CDIC |
| EQ Bank TFSA Savings Account** | 3.00% | CDIC |
19 more rowsApr 24, 2024
Your TFSA lifetime contribution limit is $75,500. Your ongoing contribution amount. There is new contribution room every year. For 2024, you can contribute up to $7000 plus any unused contribution room from previous years.
What happens if you make millions in your TFSA? ›
If you run up a multi-million-dollar TFSA balance by trading options frequently, the CRA may deem your trading activities to be a business and tax you accordingly. In this scenario, you'll pay even more taxes than you would in a normal account, because income taxes are higher than capital gains and dividend taxes.
What is the danger zone for TFSA contributions? ›
One financial planner calls the first four months of the year a “danger zone” for making deposits to tax-free savings accounts. During this period, Canada Revenue Agency info that shows TFSA contribution room for the current calendar year can be based on incomplete information.
How do I know if I overcontribute to TFSA? ›
The CRA can send out a letter or a proposed TFSA return to Canadians who, under certain situations, may have over contributed to their TFSA. You can also receive a proposed TFSA return if you made contributions to your TFSA while you were not a resident of Canada.
Is all passive income taxed? ›
Typically, passive income is subject to a taxpayer's usual marginal tax rate, which is based on their tax bracket. But taxpayers whose modified adjusted gross income is above a certain threshold may also be subject to the Net Investment Income Tax (NIIT).
How can I make $1000 a month in passive income? ›
Passive Income: 7 Ways To Make an Extra $1,000 a Month
- Buy US Treasuries. U.S. Treasuries are still paying attractive yields on short-term investments. ...
- Rent Out Your Yard. ...
- Rent Out Your Car. ...
- Rental Real Estate. ...
- Publish an E-Book. ...
- Become an Affiliate. ...
- Sell an Online Course. ...
- Bottom Line.
Tax-Exempt Mutual Funds and ETFs
Instead of buying individual municipal bonds and other tax-free investments, you could buy a basket of them in the form of mutual funds or exchange-traded funds (ETFs). These funds provide the benefit of diversification.
Is rental income taxed as passive income? ›
In most cases, rental income is treated as passive income, even when an investor spends time overseeing a rental property business.
