TFSA Passive Income: How to Earn $5,280 Per Year and Pay Zero Tax to the CRA

Canadian Dollars

The soaring cost of living in Canada is pushing investors to seek out better returns on their hard-earned savings. At the same time, people don’t want to pay more taxes. Retirees who receive Old Age Security (OAS) also have to watch out for the OAS clawback.

One way to generate steady passive income while avoiding a tax hit is to hold investments inside a self-directed Tax-Free Savings Account (TFSA).

TFSA limit increase in 2024

The TFSA limit will increase from $6,500 in 2023 to $7,000 in 2024. This will boost the maximum cumulative contribution room per person to $95,000 from the current level of $88,000.

Earnings on TFSA investments are tax-free. That means people can withdraw and spend the full amount of interest, dividends, and capital gains income. Any funds removed from the TFSA during the year will open up equivalent new contribution space in the following year, along with the regular TFSA limit.

The government indexes the TFSA limit to inflation and increases the amount that people can contribute in $500 increments.

OAS clawback

Seniors who have high retirement income have to watch out for the OAS pension recovery tax, also known as the OAS clawback. In the 2023 income year, the threshold is $86,912. Every dollar of net world income above this amount triggers a 15-cent reduction in the total OAS that will be paid in the July 2024 to June 2025 period. So, a senior with a net world income of $96,912 in 2023 would take a $1,500 OAS hit next year.

An income of $87,000 sounds like a lot for retirement earnings, but people have to pay a good chunk of this to the Canada Revenue Agency. It is quite easy for someone to hit the clawback threshold if they receive a decent company pension, OAS, and Canada Pension Plan, along with RRSP withdrawals, Registered Retirement Income Fund payments, or income from taxable investments.

This is why it makes sense to take full advantage of the TFSA contribution space before holding income-generating investments inside taxable accounts.

Good investments for TFSA passive income

Investors have a window of opportunity right now to get great yields on their savings while reducing overall portfolio risk. Guaranteed Investment Certificates (GICs) now offer rates above 5% for non-cashable certificates for up to five years. As long as the GIC is issued by a Canada Deposit Insurance Corporation (CDIC) member and the value is within the $100,000 limit, the GIC is a risk-free investment.

Dividend stocks have taken a pounding in the past year, largely due to the surge in interest rates. This highlights the risk involved in owning stocks. However, many top dividend-growth stocks now appear undervalued and offer high dividend yields.

Enbridge (TSX:ENB), for example, has increased its dividend for 28 consecutive years.

The company’s assets continue to perform well, and growth initiatives are expected to boost revenue and cash flow in the coming years to support the dividend. At the time of writing, Enbridge provides a 7.65% dividend yield.

BCE, another popular dividend stock, now offers a 7.1% yield. The board has increased the distribution by at least 5% in each of the past 15 years.

Bank stocks also look cheap today. CIBC raised its dividend earlier this year, despite the economic headwinds. This suggests the board is comfortable with the profit outlook. The stock’s dividend yield is currently 6.5%.

The bottom line on TFSA passive income

Investors can currently build a portfolio of laddered GICs and top dividend-growth stocks to easily get an average yield of 6%. On a TFSA of $88,000, this would generate $5,280 per year in tax-free income that won’t bump you into a higher tax bracket or put OAS at risk of a clawback.

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The Motley Fool recommends Enbridge. The Motley Fool has a disclosure policy. Fool contributor Andrew Walker owns shares of Enbridge and BCE.