XDIV:CC - TFSA Magic: Earn Enormous Passive Income That the CRA Can't Touch

2024-02-01 16:10:00 ET

Canadians should consider using the benefits associated with the Tax-Free Savings Account , or TFSA, to create a passive-income stream for life. The TFSA is a tax-sheltered registered account introduced back in 2009.

So, any income earned in the TFSA is exempt from Canada Revenue Agency taxes. This income can be in the form of dividends, interests, and even capital gains.

It means Canadians can use the TFSA to buy and hold quality dividend-growth stocks and create a tax-free passive-income stream for life. The maximum cumulative TFSA contribution room has increased to $95,000 in 2024, a portion of which can be deployed across quality dividend stocks . Let’s see how.

Should you invest in high-dividend stocks?

The first step is to identify a portfolio of dividend stocks that enjoy a wide competitive moat, allowing them to benefit from predictable cash flows across business cycles. These stocks should ideally be part of mature industries while growing cash flows and earnings at a steady pace, resulting in consistent dividend hikes over time.

In addition to a company’s dividend yield, you need to analyze its financials to ensure the payout is sustainable in good times and bad. So, you need to look at several other metrics, such as cash flow growth, payout ratio, and balance sheet debt, before you make an investment decision.

In the last two years, central banks have hiked interest rates substantially to offset inflation, resulting in higher interest expenses. The rising cost of debt has driven shares of companies in capital-intensive sectors such as real estate, energy, and utilities lower.

In fact, several debt-heavy Canadian companies, including Northwest Healthcare and Algonquin Power & Utilities , were forced to cut their dividends as their payout ratios were unsustainable amid a challenging macro environment.

Both these companies are part of recession-resistant sectors and provided shareholders with a tasty yield prior to the dividend cut. In addition to a significant dividend cut, the two TSX stocks currently trade at 60% from all-time highs, burning investor wealth in the process.

We can see identifying long-term dividend winners is quite difficult. Instead, you should consider investing in dividend-powered exchange-traded funds , or ETFs, to lower portfolio risk and benefit from diversification.

Invest in dividend ETFs such as XDIV

iShares Core MSCI Canadian Quality Dividend Index ETF ( TSX:XDIV ) is a low-cost fund that offers you a tasty dividend yield of over 6%. Moreover, these payouts have doubled in the last seven years, indicating an annual growth rate of 10%.

The XDIV ETF was introduced in 2017 and manages close to $1 billion in total assets. Since the ETF was launched, it has returned 8.5% annually.

If you allocate $50,000 in the ETF, you will generate $3,028 in annual dividends. Further, your payout will double in the next 10 years if dividends are increased by 7% annually.

Some of the largest holdings of the XDIV ETF include blue-chip stocks such as Manulife , Royal Bank of Canada , Pembina Pipeline , Sun Life Financial , and Toronto-Dominion Bank , which account for 45% of the fund.

The post TFSA Magic: Earn Enormous Passive Income That the CRA Can’t Touch appeared first on The Motley Fool Canada .

Fool contributor Aditya Raghunath has positions in Algonquin Power & Utilities. The Motley Fool recommends NorthWest Healthcare Properties Real Estate Investment Trust and Pembina Pipeline. The Motley Fool has a disclosure policy .

2024