[...] Again his would be a worst case scenario (provided you can always track each dollar). Best case scenario would that the CRA would allow you to deduct the full interest from the HELOC although this would get messed up if you decide to take funds out of the account. Withdrawals would most definitely affect interest deductibility. [...]

Figure out your interest costs i.e 100K @ 4% =4K or 333.33 per month.

Double that number to 666.66. This is how much you draw each month. Pay your capital gains tax, and pay 333.33 to the interest, keeping your loan intact.

Mind you this assumes a 100% capital gain, and the use of the Rempel maximum for 100K at the start.

If you were to do this as a
“pure” SM, aka DCA over time then it is a different ball game.

Would a more simple strategy be to just buy 100 shares of a quality Canadian company with borrowed funds, and collect the rising dividends year after year, applying them to the mortgage pre payment?

You could build up your borrowing room over a few months and by a different company a couple of times a year.

After the mortgage is paid off simply collect the dividends and spend as desired.

No complicated accounting. Simplt interest deduction each year, and a T5 slip.

Want to sell those 100 shares? Sell em, and pay down the loan by your ACB.

Stock markets dont scare me, and neither does the gradual shifting of the original non deductible leverage to a deductible leverage.

The accounting nightmare does though.

I like simple.

So Tim Cestnick was wrong then? I was under the assumption that any taxable with-drawls , dividends, interest, AND capital gains does not effect deductibility. This appears to be the case.

But, since the SM goal is to keep the loan “forever”, and you have invested for capital gains then really you have to keep half of your gains inside your portfolio to remain deductible.

Does this not cut your return in half then?

I suppose you could use the principle to pay the interest, keeping the loan deductible. Your return would still be cut in half, BUT now you dont have to use your cashflow to service the loan, giving back your 50% “loss”.

By the way where does CRA stipulate you can use principle to service a loan to keep it deductible?

Personally I think if you do a pure SM and DCA via mutual funds it seems almost like an accounting nightmare. (I recall you do tax returns for long term clients? he he !)

I would think the Rempel Maximum would make for a much easier accounting of with-drawls.

Ed, I dont want to come across as doubting any of your strategies.
I certainly do not. I enjoyed meeting you, and Anne, and look forward to a long term partnership.

But at the end of the day cash in the bank every 2 weeks is the name of the game be it SM, TFSA , RSP, or what have you, and I am just trying to wrap my head around the SM harvest time.

I am always reading and learning. I dont need to know how to tear apart an engine, but it is nice to know how it works. Same with my money. I dont just want to earn it, invest it, and spend it. I find having a pretty good working knowledge of it helps me appreciate it more.

Much is said about the SM mechanics, and building the wealth, rates of return etc. Fraser even has a nice software calculator.
Not much is said how to reap the rewards.

I can’t wait until the new cool strategy is revealed.

Any hints?

The optimal strategy for withdrawing money during retirement after doing the SM varies a lot depending on the situation. If you recall from the article on clawbacks for seniors, the effective marginal tax rates for retirees varies between 21-71%. This tax bracket makes a huge difference in the strategy that will work best.

In short, this part needs to be done custom for each client.

There are a few options with mutual funds:
1. Systematic withdrawal plan – This produces capital gains, depending on how much the portfolio has grown.
2. Smith/Snyder – This produces ROC for 8-12 years and then capital gains.
3. Dividends

A couple of points that will address most of your concern, Brendan:

1. Capital gains withdrawn from a fund leave the investment loan interest tax deductible generally, although you need to be careful of the tracking. So, if you withdraw $10,000 and $5,000 is a capital gain, then your the other $5,000 is your principal. The amount of the loan that remains deductible is reduced by the amount of principal withdrawn. The capital gain portion is fine.
2. The amount withdrawn to pay the loan interest maintains the tax deductibility.

For example, let’s say you borrowed $100,000 at 4%, it grew to $200,000, and then you started withdrawing $10,000/year after you retire. Of this $10,000 of income, $5,000 would be a capital gain and $4,000 can be used to pay the interest on the investment loan. Therefore, only $1,000 of the loan becomes non-deductible.

Many options in retirement require tracking of how much of the loan remains deductible. The Smith/Snyder does have have the side effect of losing the tax deductibility of your loan, but it can be sometimes be the most effective, for the highest tax brackets in the short term, especially for those low-income seniors in a 71% tax bracket (affected by the GIS clawback and income tax).

Dividend strategies work for low income seniors, but usually not for those affected by any of the various clawbacks.

We do have another cool strategy that will probably be in an article soon.

Ed

Thanks for jumping in and pointing out the March 3, 2009 article. Sometimes we think so much alike it is scary!

Maybe you build up with the Sm and then convert to the Smith/Snyder?

Hope not.

FT take your time on the post. I have about 15 years till I retire!

Sure if you reinvest ALL the money from the fund sale the loan remains deductible, but at some point you will want to draw money to live off of.

I guess I am wondering how do you do that and keep the investment loan “intact”, as the puure SM wants you do keep the loan forever.

Retirement situation would be the same.

Maybe that is how the draw down works? Sell your fund units, pocket the capital gain and reinvest the balance?

I just cant seem to wrap my head around selling mutual funds for a capital gain without incurring a ROC.

Yes, I did have the pleasure of meeting Ed. In fact, I’ve been a customer of his (he helped me arrange a very good rate on my BMO Readiline mortgage at no cost to me) and he purchased a customized, Excel-based SM calculator from me.

I know Ed is quite busy as he seems to come by here infrequently but then pepper the site with responses to many questions.

If this is not the best source for information about the SM, both in theory and practice, then I don’t know what is. An article on the drawdown phase of a leveraged portfolio would fill in a critical gap in the discussion.

While I understand the mechanics of the SM perfectly, I admit my knowledge of mutual funds is limited. I always thought of them as stocks per say that dont pay any dividends (they become MER food).
The objective of funds is to buy them and hope they go up when you have to re sell them.

I have a strong bias towards dividend growth stocks and my initial plan was to purchase such stocks via the SM through my DRIP accounts.

Most reading I have done on managed funds isnt too positive. While there are good managers, finding them before they “do good” is the hard part.
I guess you can say the same for stocks as well. Just because a company has done well for decades (think GE cutting the dividend after decades of raising them ) is no guarantee they will do so in the future.

While there are no guarantees there certainly are reasonable assurances.
Will BMO always pay a dividend? Not 100% for sure, BUT the fact that they have been paying them for longer than Canada has been a country leaves me assured they will continue to do so.

Same goes with a managed fund. I am thinking of the Templeton growth fund for example. It has a very long excellent track record, and I would believe that it would continue to do so so long as the same manager/management style is intact.

I think the key is to stick with it for the long term. Actually after reading the Dick Davis Dividend the premise of the book is that everything works, but not everything works all the time, meaning that dont jump on the growth bandwagon when CNBC is happy, and then switch to value when CNBC is sad.

Be it index funds, managed funds, growth stocks, value stocks, dividend growth stocks, just pick a style and stick with it.

ANy how after reading about index funds I think they would be a good way to implement the Sm. This is where I got thinking what do you do when you retire?

How do you pull your money out of the financed account and maintain deductibility?

I agree there is not too much said about this. Sure with dividend growth stocks it is simple. Buy the stock, dont sell and withdraw your dividends each month as you need them.

Mutual funds withdrawn as a pure capital gain would be the same as a ROC (half of the withdrawal anyway) according to FT’s article on keeping your loan deductible.

I am sure I am screwing things up in my head anyway.

I would also encourage Ed to help us understand this issue better.

Cannon have you met Ed in person? I met Ed and his wife Anne this summer in Winnipeg. Very nice people.

I got a very good “vibe” from both of them and liked the fact that i did not get a typical cookie cutter “financial plan” that you seem to get with most CFP’s.

Up until I met them I didnt see myself considering managed funds, but after our meeting I can see myself working with them for the long term.

Anyhow I am going off the rails here. Maybe others can chime in about winding down or harvesting your SM with mutual funds as your investment?

First let me apologize if my comment seemed rude. I have seen too many people on sites like this contemplating strategies that are too advanced for them – they get caught up in the hype and sometimes that is due to overeager ‘helpers’ believing that everyone should think like they do.

I don’t really see a difference with your situation because it is mutual funds, so your question is really a very good one. I know of mutual funds that have yields very much similar to a bank stock – around 4% or so and that is certainly not eaten up by the MER.

So, regardless of whether it is mutual funds or stocks themselves, I think just such a scenario (”Ok, now I’m retired. What do I do with this SM/HELOC now?!”) merits its own entry.

Perhaps Ed Rempel could be coerced to offer up how he deals with this situation for various client types.

I hadn’t thought too much of it because I’m not likely to keep the investment loan intact. It comes down to a loss of flexibility in that, regardless of inflation or not being the “best” use of my money, you do lose about of flexibility when you have a HELOC that would be hundreds of thousands of dollars.

Plus, I’ve built an SM portfolio that has a dividend yield in excess of my carrying costs (both before and especially after taxes). When my wife and I “retire”, we may end up moving to BC and their very preferential treatment of dividend income will be an additional boost. My hope is that we will have enough capital built up that it will provide a dividend income stream that will not require us to touch the capital, and thus the HELOC question is moot.

Perhaps the downside to the ROC discussion is that you don’t control the distribution amounts or schedule – the mutual fund company does. Whereas, an SM portfolio invested in equities that don’t have an ROC portion allow you to strategically and surgically sell investments, that will lessen the deductable portion, as you deem necessary.

I wouldn’t be surprised if there are exponents of the SM that say, “Don’t worry. With all of that growth in your house value, you can quickly replace whatever is lost by borrowing even MORE from your house and add handsomely to your investments while realising an even bigger tax writeoff.”

Good question – I honestly hadn’t thought that much about this inevitability.

I do however sometimes have trouble saying or typing what is inside my head, or at least i come across the wrong way.

My concern is how mutual funds effect the deductibility of the investment loan.

In my dad’s RSP he has a nest egg and withdraws 1k per month to suit his needs. 1 K worth of funds are sold and put into his bank. CRA collects tax as all RSP withdrawls are taxed the same regardless of source.

But if I were to DCA over several years and now want to retire I am confused to how mutual funds work with an investment loan.

For example lets say that my ACB over time is 50 dollars per fund unit. Now when I take money out lets say the units are 100 dollars.

If I need 1k income per month I sell 1K of units, BUT since 500 is capital gain then the other half is my original investment, so my loan would lose 500 dollars of deductibility per month.

To me this is the same as a ROC fund is it not?

Ed Rempel says to not use ROC funds but I dont see how you can take your money out of your non reg account without taking back some of your capital.

I know mutual funds have dividends and interest but most of that is eaten up by the MER. Or at least that is how I understand mutual funds.

FT uses the Tim Cestnick example of taking 5 K out of your account, which reduces the 10K loan by 1/3.

Isn’t this the same scenario with mutual funds?

Hopefully I have made myself more clear, and someone can point out where I am wrong, if in fact I am wrong.

I don’t hold mutual funds in a non-registered account but if I’m not mistaken, they still classify distributions as interest, dividend, capital gain or ROC. So, in essence, you could build a similar, income producing portfolio using mutual funds or their ETF counterparts.

Even if you hold dividend paying stocks, wouldn’t you reinvest the dividends in more stock? That would change your ACB if you did.

Frankly, if you find it too difficult to keep track of your investments, then perhaps you shouldn’t be contemplating the SM until you are. I’m aware that there are free spreadsheets out there that will help.

If I DCA over 15 years, when I sell I am (hopefully) taking some capital gains. Will this not reduce the deductibility of the loan? Or do i “pay back” the original value first and then only take out the gain? i.e I purchased 100 dollars of funds that are now worth 200. So, I have to pay down the loan by 100 and pocket the 100 gain? Or do I leave the original 100 in the account and take out the gain?

Not sure if I make sense but it seems like an accounting nightmare when you retire.

Wouldnt it be easier to simply hold dividend paying stock, and never sell? Just withdraw the dividends?

In FT’s example of the 10k loan growing to 15k means taking out 5k will screw 1/3 of your loan up.

Isnt this what will happen to a mutual fund account in a SM?

Most cash flow from a fund is from selling units not dividends.

FT is correct. CRA is concerned about the “current use” of the money borrowed to invest. If you receive any ROC payments, your loan is still deductible as long as you reinvest the entire amount directly and can trace it – or if you pay the entire amount down on the investment loan (and can trace it).

Ed