Many people misunderstand the concept of passive income. If it requires more than a few minutes of effort, it’s not truly passive. Activities like managing rental properties or running an Airbnb are often marketed as passive, but in reality, they’re closer to side gigs.
True passive income comes from leveraging existing assets—investments that pay you dividends or other distributions without additional work. Moreover, when these investments are held in a Tax-Free Savings Account (TFSA), which lets Canadians grow and withdraw income tax-free, the benefits are even greater.
Here’s a look at how to build true passive income using TFSAs and a range of exchange-traded funds (ETFs) to help you achieve tax-free financial freedom.
Why Use The TFSA?
The TFSA name is misleading—don’t waste it as just a savings account. Instead, maximize its potential by using it to invest. Why?
Because all gains you earn inside a TFSA, whether from selling stocks at a profit (capital gains), dividends, or interest, are completely tax-free. Even better, you can withdraw your money at any time without penalties or restrictions, making it one of the most flexible accounts available.
Contributions, however, are a bit more complex. Each year, you get more room to contribute—$7,000 in 2025. Plus, any withdrawals you made in previous years are added back to your contribution room for the next year.
If you’re unsure how much room you have, you can check your TFSA contribution limit through the CRA’s My Account service. Alternatively, if you’ve kept track of your contributions and withdrawals, you can use online calculators to estimate your limit.
For instance, if you were a Canadian resident before 2010, born in 1990, and have never contributed or withdrawn from a TFSA, you’d have a whopping $102,000 of room available in 2025.
Learn more: Tax-Free Savings Account (TFSA): What You Need To Know
Generating Passive Income With ETFs
An ETF is essentially a collection of different investment assets—usually stocks, bonds, or both.
When you buy an ETF, you’re purchasing a share of that collection, which means you own a small piece of all its underlying investments.
You trade ETFs just like stocks, but they offer more diversification since they represent a basket of assets rather than a single one.
Learn more: What Are Exchange-Traded Funds (ETFs)?
Why The Distribution Yield Matters
ETFs are especially appealing for passive income because many are optimized to deliver higher yields. The key metric to focus on is the distribution yield, which shows how much income the ETF pays out annually as a percentage of its share price.
Here’s how it works: suppose an ETF trades at $20 per share and pays a $0.10 dividend per share every month. To calculate the annualized distribution yield:
- Multiply the monthly dividend by 12: $0.10 × 12 = $1.20 (annual dividend payout).
- Divide this by the ETF’s current share price: $1.20 ÷ $20.00 = 0.06
- Multiply by 100 to get the percentage: 0.06 x 100 = 6%
So, in this example, the annualized distribution yield would be 6%. This is the percentage return you’d receive from dividends alone if the dividend amount remains steady.
The best part? If you hold these ETFs in a TFSA you don’t need to report or pay taxes on the dividends received. All that passive income is yours to keep, tax-free.
Bond ETFs
The first type of ETF to consider for passive income are bond ETFs. These funds invest in bonds, which are essentially loans to governments or companies. When you buy a bond ETF, you’re indirectly lending money to these entities in exchange for regular interest payments.
Bond ETF share prices don’t typically move much, making them a lower-risk investment. The primary appeal is their consistent monthly distributions. However, the yield from these ETFs tends to fluctuate based on current interest rates—when rates are high, yields are higher, and vice versa.
Bond ETFs: An Example
A popular example is the Global X 0-3 Month T-Bill ETF (CBIL), which holds short-term bonds issued by the Canadian Federal government, called Treasury Bills.
As of January 30, 2025, CBIL pays an annualized distribution yield of 2.87%. For someone with a fully maxed-out TFSA of $102,000, this ETF could generate:
- $2,927.40 in annual passive income.
- $243.95 in monthly passive income.
While bond ETFs are a lower-risk choice, it’s essential to note that yields can change over time. Recently, as interest rates have begun to fall, yields on bond ETFs like CBIL have decreased. Keep this in mind when incorporating them into your TFSA for passive income.
Learn more: Best Canadian Bank ETFs
Dividend ETFs
If you’re comfortable taking on higher risk for potentially higher yields, the natural step up from bond ETFs is dividend-focused stock ETFs.
While bonds involve lending money to a company in exchange for interest, owning stocks means you become a part-owner of the company, entitling you to dividends and the possibility of selling your shares at a higher price.
Many ETFs hold stocks, but some specifically prioritize companies that pay above-average dividends. These dividend ETFs are ideal for passive income investors, as they focus more on yield than on share price growth.
Dividend ETFs: An Example
A popular example is the iShares S&P/TSX Composite High Dividend Index ETF (XEI). This ETF holds 75 Canadian blue-chip stocks known for paying above-average dividends.
Its portfolio includes well-known companies such as TD Bank and RBC in the financial sector, Enbridge and TC Energy in pipelines, and Telus and BCE in telecom.
As of January 8, 2025, XEI pays an annualized distribution yield of 4.87%. For someone with a fully maxed-out TFSA of $102,000, this ETF could generate:
- $4,967.40 in annual passive income.
- $413.95 in monthly passive income.
It’s important to note that while dividend ETFs offer higher yields, they’re more volatile than bond ETFs. Their value can fluctuate more significantly, so be prepared for ups and downs in your investment.
Learn more: How To Evaluate A Stock?
REIT ETFs
If you’ve ever dreamed of generating passive income from real estate but want a simpler alternative to owning a rental property, consider investing in a Real Estate Investment Trust (REIT) in your TFSA.
REITs are companies that own and operate income-generating real estate, such as office buildings, retail spaces, industrial warehouses, healthcare facilities, and apartment complexes.
But instead of dealing with tenants yourself, REITs collect rent from their properties and pay the income to their shareholders as distributions. Like stocks and bonds, REITs can also be held in an ETF for added diversification.
REIT ETFs: An Example
A great example is the BMO Equal Weight REITs Index ETF (ZRE), which holds a portfolio of Canada’s 20 largest REITs, each equally weighted. This means you get exposure to a broad mix of real estate sectors, reducing your reliance on any single type of tenant.
The rental income REITs collect trickles down to their distributions, which ZRE collects and pays out to you monthly. As of January 30, 2025, ZRE offers an annualized distribution yield of 5.27%. If your TFSA is maxed out at $102,000, that means:
- $5,375.40 in annual passive income.
- $447.95 in monthly passive income.
Keep in mind, REITs are even riskier than dividend-paying stocks. They’re more volatile and subject to sector-specific risks, such as downturns in retail or office demand. While REITs can be a powerful tool for passive income, it’s best to include them as a component of your portfolio rather than going all in.
The bottom Line On TFSA Passive Income And ETFs
If you’re serious about generating passive income, a TFSA is the best place to start. It’s simpler than most so-called passive income schemes, like rental properties or side gigs, and it’s guaranteed to be tax-free.
We’ve outlined three types of ETFs that can generate monthly income in a TFSA: bond ETFs, stock ETFs, and REIT ETFs. Each comes with its own risk and return trade-offs. The best approach is to diversify across all three types.
For example, you could allocate 60% to stock ETFs, 20% to bond ETFs, and 20% to REIT ETFs. This way, you balance growth potential, stability, and higher income to create a well-rounded, passive income-generating portfolio in your TFSA.
