Actually, the Smith Manoeuvre is not that complicated. You just get the right mortgage, invest from the credit line after each mortgage payment and then capitalize your interest. Once it is setup, there is usually only one manual transaction to do each month.

The Manulife One is actually a more complex mortgage for the Smith Manoeuvre than some with the banks. With Manulife One, you normally invest from a sub-credit line, so you have to transfer and change the limit of your credit line each month.

Because you are forced to pay for full banking with Manulife One, it really only makes sens if that is your main bank account. Then you have both your mortgage and Smith Manoeuvre credit line as subaccounts, which makes it somewhat more complicated.

We have found better mortgages with some of the banks.

And by the way, Manulife has incentivized agents to promote Manulife One. That is the only mortgage that compensates financial advisors. It would be nice for us to recommend them, but we are more concerned about getting a good Smith Manoeuvre mortgage a bit of mortgage compensation.

Ed

I aplaud Manulife for their Manulife One program. It’s close enough to the ideal ‘manoeuvre’ but its clear most people don’t even know about it.

Again reality vs ideals.

I hope for the best but I acknowledge when its wishful thinking.
Perhaps if they incentivized agents to promote sucha product….

Im not sure if anyone has mentioned this but to answer your question to why you would pay down your mortgage instead of pumping it back to the rrsp is mainly because as you pay down your mortgage your heloc goes up dollar for dollar. You are then left with a higher heloc as the cycle goes. Hope that clears it up.

-CDN Dividend Paying Stocks?
-Mutual Funds?
-Fixed Income (Bonds, Bond Index)?
-A combination of the above?
Other?

I would be curious to know everyone’s responses….

Cheers!

The first questions that come to mind:

1. Do you understand that you are going to be borrowing to invest? Do you and your wife feel comfortable about this? Do you feel comfortable knowing that your total debt will not go down like it would if you simply paid down your mortgage?
2. Do you understand that the additional tax refunds due to borrowing will be quite small at the beginning (unless you borrow a significant lump sum or your payments will pay down a large amount of the principal)?
3. Do you feel comfortable with a long term approach (let’s say at least 10 years)? Do you expect to evaluate the effectiveness of this approach over a long time frame?
4. Do you feel comfortable investing when the market is down? Do you feel comfortable holding on when everyone else is panicking? Do you feel comfortable knowing that you could find yourself in a position where you’ve borrowed tens, maybe hundreds, of thousands of dollars and actually have less equity than your deductible loan balance?

The more ‘YES’ answers to the above, the more likely you could be a good candidate for the SM. If your MTR will still be high after you will be the sole breadwinner, that also helps. But, it’s your investment personality that will be the key factor.

Go in with your eyes open and try to imagine what you and your wife would have done, and be honest with yourself, if you took out the mortgage this time last year and went through the last 12 months.

We are about to drop down to one income as my wife is going to stay at home with the kids.

We have always maxed RRSPs, then put extra savings and tax return on the mortgage. While my wife is not working we will still put some money into RRSPs but won’t be able to max them out. Extra money on the mortgage will not be an option either. Obviously staying home with the kids is important to us, and we are willing to make this financial sacrifice financial for the next 4-5 years. But I am curious if there is someway to make this work out a little better.

Reading about the Smith Manoeuvre on this site is making me curious. Would this be a good way to go in terms of building up a non-registered portfolio while paying down the mortgage quicker? Does it make sense to focus on this while the RRSPs don’t get maximized?

Thanks for your comments.

Thanks, it does.

Just roll an RRSP loan into your mortgage. This usually gives you a lower rate and allows you to SM it.

I’m not referring to having a mortgage in an RRSP or anything like that. This is just a simple refinance.

The SM requires a non-deductible debt that can be converted to deductible. That non-deductible debt can be from many sources – mortgage, RRSP loan, car loan, non-deductible credit line, credit cards, etc. Any of these can be converted into a mortgage or credit line on which you can do the SM.

Does that answer your question, Cannon?

Ed

How do you convert RRSP leverage into a mortgage? How can you borrow money to invest in an RRSP at mortgage rates and not be forced to use all of the money to buy a house?

Do you mean that if you already are contributing $X to your RRSP that you would borrow an additional $Y and consequently your tax refund will also now equal $Y?

With interest rates so low and stocks so beaten down, we decided it was an excellent time to forgo the traditional monthly contributions to our RRSP and borrow instead with the idea we will pay back the loan within a year. Frankly, the way the interest rates are going, we probably will do the same thing next year.

The fact is that the SM-RRSP hybrid only beats the traditional SM if you have a large difference between your MTR when you contribute and your MTR when you cash out your investments.

Off the top of my head you really are asking which is better (using hypothetical numbers):

Mortgage – $200,000
Expected Tax Refund – $5,000
MTR – 40%
Mortgage Rate – 4%
HELOC Rate – 4.75%
Investment growth rate (RRSP or non-registered) – 7%

1) Pay down your mortgage by $5,000 thus reducing the interest costs on the principal (it’s comparable to the benefit of putting $5,000 into a TFSA at 4% for as long as it takes you to pay down the mortgage), then pay a deductible interest only loan of $5,000 at 4.75% and invest $5,000 into a non-registered portfolio earning 7%.

versus

2) borrow an amount equal to $5,000 / (1-MTR) = $8,333 at a non-deductible 4.75% and take the original $5,000 tax refund plus the additional $3,333 tax refund to pay the loan back quickly while enjoying $8,333 being invested in the RRSP at 7%.

Looking at liabilities and assets you have:

Scenario 1

Mortgage is $195,000
Deductible loan of $5,000 at an effective rate of 4.75% x (1 – 40%) = 2.85%
Investments of $5,000 in non-reg portfolio

Scenario 2
Mortgage is $200,000
Investments of $8,333 in RRSP
Assume loan interest costs are negligible because we do this on February 28th and get our tax refund within a couple of weeks.

In 20.67 years Scenario 1 would be:
Mortgage $0
Deductible loan of $200,000
Nonreg investment portfolio of $257,383 with ACB $118,688

Scenario 2 would be:
Mortgage balance would be $15,901
Investments of $33,741 in RRSP
Non reg investment portfolio of $233,516 with ACB $111,700
Deductible loan of $184,099

I won’t bore you with the math, but if you agree with everything so far, the only way Scenario 2 comes out behind is if your MTR when you cash out is greater than 39%. So, SM + borrowing to top up RRSP wins in this case.

No. By “RRSP leverage”, I meant the money borrowed to contribute to RRSP. It is not deductible, so it is best to convert it to a mortgage to get the lowest rate and Smith Manoeuvre (is that a verb?) it. As opposed to the actual SM, where you have a tax deductible credit line and only want to pay interest on it.

Ed

That way I’d be doing a SM, but still contributing to RRSPs and reducing a tax rate that I expect to be lower in retirement?

For simplicity, all scenarios use a perfect case of tax efficiency. No declaration of any income until the very end. In reality, for most people this would likely not happen and the drag on the non-registered portfolio would weaken its case.

When you said on point 2 to put the “RRSP leverage” did you mean “RRSP refund”?

I now understand exactly what you are saying and I totally agree. I had thought you meant that there would be no borrowing from the HELOC at all. Your idea is that you borrow the principal paydown but when you get that juicy tax refund, just plow that back into the RRSP rather than pay down the mortgage and reborrow.

If I remember correctly, FT provided me with more background information that wasn’t posted here and that played into my earlier response.

The original question said that he(she?) was going to pay as much mortgage as could be afforded, and then reborrow the equity to buy RRSPs. I’m asserting that its better to:

1. Just make regular mortgage payments; no extras.
2. Go ahead and borrow equity created by the regular mortgage payments and buy RRSPs.
3. Instead of putting ‘extra’ into the mortgage, put that directly into RRSP.

So you end up with the same RRSP balance in the end, but more of your debt stays in the cheaper mortgage instead of the more expensive HELOC. I’m saying that flowing the ‘extra’ payment through the mortgage and HELOC is the red herring.

Dan.

Interesting article. I’m not surprised that the Smith Manoeuvre strategy beats this RRSP strategy. There are several technical reasons for this:

1. The RRSP refund is only a tax deferral, while the SM refund is a tax savings.
2. The growth of the RRSP investments is fully taxed on withdrawal, while the growth of the SM investments is tax-preferred, usually as capital gains.

I have a question – what tax-efficiency did you assume on the SM investments? How much tax was paid year-to-year on the 8% growth?

The way to maximize this is with a combination that focuses on tax brackets now and on withdrawal. The SM strategy will almost definitely be better, except possibly if you can structure it to create a higher MTR today than after you retire.

Try this combo strategy:
1. Do both SM & RRSP stratgies in a mix that gives you the maximum refund, without having your taxable income drop to the next lower tax bracket.
2. Put the RRSP leverage in the mortgage at the lower rate and then Smith Manoeuvre it.
3. Build up a large portfolio of both RRSP & non-registered.
4. If possible without affecting your tax brackets, plan it so that you max your RRSP contribution room and convert the mortgage to fully tax deductible before retiring.
4. Withdraw during retirement in the proportion that keeps you in the lower tax brackets, taking into account the clawbacks on seniors. This generally means a taxable income below $40,000 in today’s dollars, which probably means that the RRSP cannot be too large.

The right mix depends a lot on your situation and probably takes a lot of planning, but in most situations will be mostly SM.

Ed

The context of the reader’s question was that s/he had significant RRSP contribution room and wondered if it would be better off to quickly fund a retirement account as opposed to paying down debt. Like you said, it is the oft-posed question, “Should I put more money to pay down my mortgage or put it into an RRSP?” with the variant being that perhaps one doesn’t have the cash flow to support additional RRSP contributions.

Reinvesting the RRSP refunds into more RRSPs would, without additional cash flow, be a very slow way to increase your RRSP holdings. Of course, it also would allow one to actually decrease the non-deductible debt.

I think it is good to question conventional wisdom in order to be more confident when deciding on one’s personal path to findependence.

This might satisfy your curiousity. I tweaked the spreadsheet again to implement the process you talked about, namely reborrowing principal payments, paying the HELOC interest and then diverting the rest to a TFSA. Now, this is quite hypothetical since even if you can use a TFSA for yourself and spouse, you will be limited to only $10,000 per year right now. Thus, in some scenarios you might run into that limit but not in our example.

Keeping everything the same, after 21 years are up, we would find:

Mortgage balance: $ 60,673
TFSA balance: $ 232,851
HELOC balance: $ 179,327

Thus, your liabilities which are not tax deductible total $240k and your assets which have no tax liability are free and clear at $232,851. Now, this is obviously better than a traditional mortgage approach because we have $53,525 net benefit of the TFSA vs. the HELOC balance (the mortgage balance is not changed).

In all, after 21 years, we still have a net deficit of $7,149. On the other hand, with the SM even if we liquidated all of our non-registered holdings at once at an MTR of 46.41% (the highest in Ontario and comparable to other provinces) we would actually be able to wipe out the entire HELOC and have $25,708 left.

Again, the SM wins.