HOW TO EARN $14,000 PER YEAR IN TAX-FREE INCOME AND MAXIMIZE YOUR CPP PAYOUT

The Canada Pension Plan (CPP) has automated your retirement planning by deducting your contribution towards pensions at the source. This contribution could increase further as the CRA implements the second phase of CPP enhancement in 2024, wherein you contribute additional CPP if you earn more than the maximum pensionable earnings. It might look taxing to you now as your disposable income falls. But it would be rewarding in the long term as you can get 50% more CPP payout if you make these enhanced contributions for 40 years. 

How to maximize your CPP payout

Increasing your income is one way of maximizing CPP payout. Another way is staying in the CPP till age 70. For every month of delay in receiving your CPP payout after age 65, the CRA increases your payout by 0.7%, which sums up to a 42% increase in five years. 

But to have that kind of financial flexibility to delay your CPP payout, you need a passive income backup. So start building your passive income backup alongside your CPP contribution with your Tax-Free Savings Account (TFSA). 

The bear market is a good time to invest in dividend aristocrats and lock in a higher dividend yield. A small monthly investment for 10 to 15 years can compound to a large sum and give you more than you invest in 10 to 15 years. 

I took the example of Power Corporation of Canada (TSX:POW). The stock has a dividend yield of 5.63% and been growing dividends at a compounded annual growth rate of 6%. Most dividend shares don’t give much capital appreciation. In the last 15 years, the stock surged only 15%. 

How to earn $14,000 per year in tax-free income

Let’s assume you invest $4,000 annually through your TFSA and buy POW shares at an average cost of $35 per share. And you opt for the dividend reinvestment option. 

Here is a table of how your investment will compound in the next 15 years. 

The first $4,000 investment could buy you 114 shares of POW at $35/share. Its current annual dividend per share is $2.10, which converts to $239.40 in dividend income for 114 shares. As the TFSA allows your investment to grow tax-free, you can reinvest the entire amount over and above your $4,000 investment. Next year, you can buy 121 shares, bringing your share total to 235.

Assuming POW continues to grow dividends at 5% CAGR, your dividend income will grow and so will your invested amount. At the end of 15 years, you could earn $14,036 in annual dividends on your $118,160 portfolio value (3,376 shares x $35). You could switch to receiving dividends. 

Building an alternate CPP with an income portfolio 

Remember, the stock market is dynamic, and 15 years is a long time. POW might accelerate, pause, or slow dividend growth. Or the management might cut dividends. No one can predict what will happen in the long term.

Hence, keep reviewing the companies you have invested in. Look for any changes in the expectations and adjust your portfolio. Sometimes, you might want to switch to another stock if things worsen for the company you are invested in. Don’t shy away from exiting when the stock consistently fails to meet your expectations. 

A good practice is to invest in three to five income stocks of different sectors to diversify your risk and reduce dependence on one company. 

The post How to Earn $14,000 Per Year in Tax-Free Income and Maximize Your CPP Payout appeared first on The Motley Fool Canada.

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Fool contributor Puja Tayal has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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