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investor clinic

When Finance Minister Joe Oliver tables the federal budget on Tuesday, he's expected to double the annual contribution limit – currently $5,500 – for tax-free savings accounts.

This is great news for the nearly 11 million Canadians who have a TFSA – and provides an extra incentive for those who don't.

Even though TFSAs has been around since 2009, people still have misconceptions about how they work and why they're beneficial. With TFSAs poised to play an even bigger role in our financial lives, now is a great time to brush up on the details.

In this edition of Investor Clinic, I'll answer some common TFSA questions.

Can I contribute existing investments to my TFSA?

Absolutely. Not everyone will have $11,000 of spare cash lying around, so making an "in-kind" TFSA contribution will be the only way some people can max out their annual TFSA limit. But be careful: If you transfer shares that have appreciated in value, you'll have to pay capital gains tax just as if you'd sold the shares. Unfortunately, if you transfer shares that have dropped in value, you won't be able to claim a capital loss. In the latter case, it may be more beneficial to sell the shares first and then contribute the cash, but you must wait at least 31 days before repurchasing the shares in your TFSA or the loss will be denied.

Which is better: A TFSA or an RRSP?

It depends. If you expect your marginal tax rate to be lower in retirement, RRSPs are more advantageous. If you expect your tax rate to be higher in retirement, TFSAs have the edge. If you expect your tax rate to remain the same, TFSAs and RRSPs will be equally beneficial. The key difference is that TFSAs contain after-tax dollars (income tax was already paid) and RRSPs contain pre-tax dollars (the income tax is paid on withdrawals). But why choose one or the other? If you have sufficient funds, take advantage of both.

What happens if I withdraw money from a TFSA?

The flexibility to make withdrawals is a big advantage of TFSAs. You won't have to pay tax on the funds, as you would with an RRSP withdrawal. Also, because TFSA withdrawals aren't added to your income, they won't affect Old Age Security or other income-tested benefits and credits. What's more, unlike with RRSPs, the amount of the TFSA withdrawal will be added back to your contribution room. Keep in mind, however, that your contribution room won't be restored until Jan. 1 of the year following the TFSA withdrawal.

Are TFSAs an ideal place to park short-term cash?

Some people think so, but I don't agree. The advantage of a TFSA is that all investment income and capital gains are completely tax-free. That makes TFSAs a great place for stocks, mutual funds and exchange-traded funds that will likely grow in value over the long run and pay dividends along the way. Think about it: If you're using your limited TFSA room to park cash that earns, say, 1 per cent, how much tax are you actually saving? Answer: not much (On $5,000, you'll save all of $20 annually, assuming a marginal rate of 40 per cent.) Even though interest is taxed at a higher rate than dividends or capital gains, the higher expected return of equities means you will potentially save far more tax by placing them in your TFSA instead. If you've got enough room in your TFSA for everything – stocks, funds, GICs, bonds, cash – then go for it.

Can I contribute directly to a spouse's TFSA?

No, but you can give your spouse cash to contribute to his or her TFSA.

What if I don't contribute in a particular year?

TFSA contribution room is cumulative, so if you miss a year (or fail to contribute the maximum) you can always make it up later. For example, if you were at least 18 in 2009 when the TFSA was introduced and you have not yet made a contribution, you could deposit up to $36,500 in 2015 ($5,000 for each of 2009, 2010, 2011 and 2012, and $5,500 each for 2013, 2014 and 2015).

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