TFSA 101: How Pensioners Can Earn $5,225 Per Year in Tax-Free Passive Income

Retirees sip their morning coffee outside.

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 Plan withdrawals, 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.

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