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The Smith Manoeuvre – Canadian Tax Deductible Mortgage (2013)





Have you guys heard of the Smith Manoeuvre (SM)? For those who don’t know what it is, it’s a Canadian wealth strategy to structure your mortgage so that it’s tax deductible. Our U.S. neighbors already get the luxury of claiming their mortgage interest and now there is a way for us Canadians to do the same.

There’s a tax rule in Canada where if you borrow money to invest in an income producing investment (like a dividend paying stock or investment property), you can deduct the annual interest paid on the investment loan from your income tax. Kinda wordy I know, in layman’s terms, if you get a loan with x amount of interest / year, you can claim that x interest during income tax season if you use the loan towards stocks or rental properties. If you’re still confused, please read on below where I will eventually explain everything step by step.

So, who came up with this idea and how does this apply to making a mortgage tax deductible? Mr. Fraser Smith has all the answers and he has written a book on the topic which explains how to do this properly. To summarize the Smith Manoeuvre in a nutshell, it’s where you borrow against the equity in your home, invest it in income producing entities, and use the tax return to further pay down the mortgage. Repeat until your mortgage is completely paid off leaving you with a large portfolio and an investment loan. Voila! Your mortgage is now an investment loan which is tax deductible and hopefully, your portfolio is larger than your loan.

While I have a tendency to optimize, here is a is a slightly modified version of the Smith Manoeuvre (SM):

1. Sell all existing stock from non-registered investment accounts and use it towards a down payment for step 2.

2. Obtain a readvanceable mortgage. This is a mortgage that has 2 entities, the home equity line of credit (HELOC) and the regular mortgage. Nothing unique about this setup EXCEPT that as you pay down the mortgage, the credit limit on the HELOC increases. This is a key feature that is needed when implementing the SM. Note that you usually require at least 25% 20% equity/down payment before you can obtain a readvanceable mortgage. Some financial institutions that offer these mortgages are:

  • RBC – The Homeline Mortgage
  • Firstline – The Matrix Mortgage
  • Manulife – ManulifeONE Mortgage (read my Manulife One Review)
  • BMO – Readiline Mortgage (this is the SM mortgage that I have, email me if you want a referral)
  • For a complete list, check out The Smith Manouevre Resource. Included within the post are mortgage reviews, calculators, taxation issues and strategies related to the SM.

3. Use the HELOC portion of your mortgage to invest in income producing entities like dividend paying stocks or rental property. With every mortgage payment, your HELOC limit will increase. So with every regular mortgage payment, you will invest the new money in your HELOC. Note that you SHOULD NOT use the HELOC money to invest in your RRSP as you will lose the tax deduction on the invested money.  If you don’t already have an investment account, here is a review of the more popular discount brokerages available in Canada.

4. When tax season hits, deduct the annual amount of interest that you paid on your HELOC against your income. So, if you paid $6,000 in interest payments for the year and you have marginal tax rate of 40%, you will get back ~$2,400 of it.

5. Apply the tax return and investment income (dividends etc) against your non-deductible mortgage and invest the new money that’s now in your HELOC.

6. Repeat steps 3-5 until your non-deductible mortgage is paid off.

As you can see, this process will pay down your regular mortgage in a hurry.

The Advantages:

  • You get to build a large investment portfolio without waiting to pay off your mortgage first (the power of compounding).
  • You get to pay down your non-deductible mortgage in a hurry.
  • Your new investment loan is tax deductible.

The Downside:

  • You need to be comfortable with LEVERAGE and investing in general.
  • You need a plan ‘B’ in the case that you need to move and home values have gone down. If you invested properly, your portfolio should at LEAST cover your loan.
  • Your mortgage is NEVER paid off where you keep the tax-deductible loan (this can be a good thing).

In part 2 of this series, I will talk more about general questions regarding the Smith Manoeuvre. Like, making the extra HELOC interest payment IN ADDITION TO the regular mortgage, different investment options, and ways to optimize the SM even further.

Update May 2013 – Big mortgage rule changes!  The mortgage rules have changed where nationally regulated banks can only allow home owners to borrow up to 65% of their equity towards their “revolving” or home equity line of credit portion (only applies to new applicants – I believe existing HELOCs are grandfathered).  However, homeowners can still borrow up to 80% of their equity in total.  This means that the remaining 15% (80% – 65%) has to be in the form of an installment mortgage with a regular repayment schedule. Best to talk to a mortgage broker about how it affects you, let me know if you need a recommendation.

Continue to The Smith Manoeuvre – A Wealth Strategy (Part 2).





440 Comments, Comment or Ping

  1. 4. flaxisfree

    So I have been convinced that Smith Manoeuvre is a good strategy for our financial situation and risk aversion. We have our Manulife One account setup and everything consolidated and beginning to borrow back to invest. My question pertains to RRSPs now that we have committed to this strategy. I read Fraser Smith’s book and have seen other comments that in general you should be investing outside of your RRSP until your entire mortgage is converted into a tax-deductible investment loan. Together my wife and I have about $80,000 in RRSP “room” and it does seem tempting to contribute say $15K this year and then put the $8K tax return towards our M1 account and then reborrow back to invest outside or inside of our RRSP.

    So I understand that we want to convert our mortgage as quickly as possible but it seems to me that the interest savings will not be enough to outweigh the large tax return and sheltered growth involved with our RRSP. Can someone please explain to me why we shouldn’t do any RRSP investing until we convert our mortgage into good debt?

  2. You could theoretically use your line of credit to contribute to your RRSP, but that would defeat the purpose of the SM. The reason being is because when you borrow to invest in an RRSP, the interest is NOT tax deductible.

    FT

  3. 17. Jay Day

    Good insights. A few questions. First do any investment vehicles qualify. I have seen some guaranteed investments paying 8.75%. Second does the interest paid on the HELOC count as a tax break every year. Lastly, my home is worth approx. 350k and the mortgage is about 230k, how much can I get without CMHC calling and how much and how do I get the Remp max. Thanks

  4. 20. Ed Rempel

    Team Wealth Builder (see post 19) had a post from Danmorel explaining a version of the SM described by his financial advisor. It is exactly the version that concerns me. Here is my reply:

    Hi Danmorel,

    You are not being told the whole story. If you have the dividend pay out the distribution and pay it onto your mortgage, then your investment loan slowly becomes NON-deductible. This is because the disribution paid by the dividend fund is not profit, but the amount of your own money they are paying back each month. If you borrow to invest but then take your money back out of the investments (with distributions), then the investment loan is no longer deductible.

    Based on your figures, this is about a 12.5% distribution, which would mean in 8 years you have received 100% back – so zero of your investment loan interest is deductible.

    If you do this strategy and get audited by CRA – you will lose. Most or all or your tax deductions will be denied – and you will have to pay back the tax plus interest and penalties.

    I would suggest reading the book, Danmorel. To do the Smith Manoeuvre properly, you can pay for any leverage by reborrowing the principal you pay down with each mortgage payment. Therefore, you don’t need to destroy all your tax deductions by taking distributions out of the investments.

    My suggestion is to have all of your distributions automatically reinvested (not paid out). This also means you can buy the best funds with the best risk/return profile – instead of any old fund chosen because it pays an unsustainably high distribution (dividend) each month.

    If your advisor doesn’t agree, insist that he do your tax return and put his name on it. We do returns for no charge for all clients to make sure they get the full tax refund from the Smith Manoeuvre. I believe any SM advisor should stand behind their advice. This way, when you lose on your audit, you can sue him for your tax cost and penalties.

    Sorry to break the news to you, Danmorel. If you implement the Smith Manoeuvre properly, it is an exeptional strategy, though.

    Bloodline, we have implemented the SM for hundreds of clients, almost all of which have zero distributions taken from their funds. We find that the actual benefit is usually higher than projected in the book or the SM software because you can reappraise your home every year or 2 (for no charge) and increase your leverage beyond the Plain Jane Smith Manoeuvre. There are also a variety of variations to enhance your benefit (without reducing your tax deductions) and you can also save more money by refinancing all your debts while you get the right mortgage from the right bank for the SM.

    You are probably referring to the IA Clarington Canadian Dividend fund. It is often recommended by financial advisors for its very high (probably unsustainable) distribution. It is a 1-star Morningstar Canadian equity fund. As a below average Canadian equity fund, you should only expect long term returns of about 8%.

    Since the fund pays you 12.5% of your own money back each year, you should expect the fund to decline steadily. If they don’t reduce their distribution, then projecting the fund grows by 8%/year and pays out $12,500/year, it will be down to zero in 12.3 years.

    In the illustration you were shown, did it look like the 12.5% distribution was the annual return of the fund?

    Ed

  5. 21. Jay Day

    frugal trader,

    a couple more questions:

    firstly i noticed a few times that people have mentioned that the RBC homeline plan can accomodate the SM, but after speaking with an advisor there she stated that RBC will not allow u to capitalize the interest. Just wondering whether she is misinformed and is anybody employing that mortgage product for the SM.

    Secondly I noticed ED mentioned that taking a distribution from your SM investment and not paying it down on the loan(is he refering to the mortgage debt?) will in turn cause part of the interest on the loan to become non-tax deductible. Is he just speaking of capital gains or monthly distributions of preferred investments (that you state could be part of your plan) as well.

  6. 22. Ed Rempel

    Hi Jay,

    RBC Homeline is one of the better mortgages for the SM. None of them will automatically capitalize the interest. This is one manual transaction you will need to do each month. It is called “guerilla capitalization”.

    If you take any NON-taxable distribution (return of capital) and don’t pay it entirely onto the tax deductible loan, then the interest on part of that loan is no longer deductible. This is because a ROC distribution is just taking back some of your own money (so it is no longer invested).

    If you receive any TAXABLE distributions (capital gains or dividends), you can do what you want with them without affecting the interest tax deductibility – including paying it onto your mortgage.

    We have found with many scenarios, however, that it is rarely beneficial to pay tax sooner. Trying to defer tax as long as possible helps you get the compound growth that gives you the largest gains from the SM.

    Ed

  7. Jay Day, as Ed mentions, you can do a “manual” capitalization where you pay the amount due from your chequing account, then manually withdraw the same amount from the HELOC.

    In order to keep your HELOC tax deductible, you should only withdraw either dividends or interest distributions. Do not withdraw anything else, even capital gains. Please read this article:
    http://www.milliondollarjourney.com/key-tax-considerations-on-an-investment-loan.htm

  8. 24. Jay Day

    thanks for getting back so fast. a couple of follow up questions.

    With the manual capitalization you say to withdraw from your chequing and then withdraw the same amount from your heloc. But if you just maxed your heloc at say 50K and your interest cost is $300(just for examples sake) are you not going over your maximum amount of your heloc. Assuming this is ok, are you now earning tax deductable interest on 50,300 and so on each month etc, etc.

    Secondly, and no offense Ed but I like frugal’s idea of getting a portfolio and banging away at the mortgage principal even though you advise to maximize compound growth potential. The question being, how can you tell (from globe investor’s site,) which funds are taxable distributions and which are not. For example the Renaissance Canadian monthly income fund paid a .0625 monthly income dividend and a 1.7298 capital gain. Is this example taxable distributions. Also for info sake, globe says it is returning 15.78% over 5 years. Is that with the monthly and annual payouts being kept in the fund or is it appreciation only.

  9. JD, with re-advancable mortgages, as you pay down your non-ded mortgage, your HELOC credit limit increases. So basically, you don’t want to borrow more from your heloc than what the increases will pay for. This is the premise behind the “rempel maximum”, you divide your annual principle payment amount by prime, which determines how much you should borrow from your heloc.

    For example, say on your regular mortgage payment is $500 in principle which equates to a $6000 annual principle payment. Divide your $6000 by prime (6.25%) gives you: $96,000. The $96K is the maximum amount that you can borrow from your HELOC while capitalizing the interest.

    With regards to their distributions, you’ll have to read their prospectus. If the fund is giving distrubutions of 10% or more, then you can be assured that they are giving ROC. A typical dividend paying company usually pays from 2 – 5% yield.

    Check out Part 2 of the Smith Manoeuvre Series. At the bottom of Part 2, I have included a lot of useful links that will hopefully clear up the concept. I would also recommend that you pick up the book.

    Hope this helps.

  10. 26. Jay Day

    Frugal,

    I understand how the Rempel works but not how you can capitalize the interest, to keep your cash flow even. If you take out your maximum for the SM (350k @ 80% less 230k) 50K, where does that leave you for the capitalization. Do the banks allow you to go over each month when you first pay the interest on the loan then withdraw it again to keep the cash flow even. Also with the SM you will want to increase the amount borrowed by the amount of principle paid each month not service the loan. Just having trouble wrapping my head around that hurdle. The book is on its way they were back ordered at Chapters.

  11. 27. Ed Rempel

    Hi Jay,

    Almost all funds that pay a fixed distribution have ROC in the distributions. This is because funds will EITHER payout whatever taxable income they have or they will pay out a fixed amount that is usually higher.

    The Renaissance fund you mentioned is one of the few exceptions. All of those distributions are taxable. The fund pays a 7% distribution, but you would have been taxed on 23% over the last year. This is very high, considering the fund only made 5%! Where do you find these examples, Jay?

    I don’t believe Globefund details the tax cost. We have it in a database, but you might have to call the fund company to get it.

    It sounds to me like you do not have a readvanceable mortgage, Jay. If you have one, then the credit limit on the credit line increases after every mortgage payment.

    To capitalize the interest, you pay it, but then immediately withdraw the exact same amount from your credit line. In effect, the credit line pays its own interest. None of the banks will do this automatically, so it needs to be done manually.

    If you want to pay your taxable income onto your mortgage to pay it off more quickly, try doing the math on an example. We have found that NOT paying tax by compounding all the growth means the mortgage takes a bit longer to pay off, but the additional growth is far more than the extra you would pay down on your mortgage.

    Are you trying to build wealth, or do you just want to pay your mortgage off? What will you do with your extra cash flow once the mortgage is paid off?

    Ed

  12. 28. Jay Day

    Ed

    I was just using this fund as an example to help get some clarification on these types of funds. With this fund for example what do those figures mean tax wise for and investment of say 20k at year end with a marginal tax rate of say 40% in the province of NS(appox.). My credit does go up each month as my mortgage goes down. What I don’t quite grasp is how if I take my maximum SM available, 50k how do i have room at the end of month one to capitalize the interest. My understanding so far is this. ex. 50k + month one interest $300(just for example). Take out $300 from chequing pay interest payment. Then withdraw $300 from HELOC to put back in chequing account. Zero cash flow change but now HELOC is $50300. Since I made a mortgage payment my HELOC has gone up by (say 300), but how can I re-invest this amount, which is one of the principles of the SM if I have to use this increase to service the loan. I must be missing something, if you could relate an example with numbers that would be great.
    I am also not disbuting your figures that show not paying off your mortgage with taxable gains is better in the long run but, as I said I am trying to have a little of both. Build wealth and pay down the mortgage faster. All without a change in cash flow. It still seems quite sound to me (as well as FT, unless you changed his mind) that paying down the mortgage with tax refunds AND preferred tax investments, then reinvesting this amount into your SM is a viable way to build and turn bad debt into good in a timely fashion. Yes you may not have as big an egg going this way as opposed to yours but I feel good in the fact that I can knock years of the mortgage and still build a sizable portfolio.
    Once the mortgage is paid off I try and keep the investment loan for tax purposes, and I want to go the the WSOP. Just kidding about the poker but it would be a good time, I will probably invest fairly aggressively for returns and get ready to enjoy an early retirement. Early for me is 56.

  13. 29. Jay Day

    Also keep in mind I haven’t read the book yet (still waiting for it to come in) so all I have to go is what I have read from here.

    Thanks for your help

    Jay Day

  14. Jay Day, I see your concerns. However, with your $50k heloc, your debt servicing will only be: ~$3200/year. Your principle payments should well cover that amount. To be on the safe side though, you could use $49k to invest, and use the rest to service your debt. As you get your annual tax returns, you will use that to pay down the non-ded mortgage, reborrow and invest.

  15. 31. Jay Day

    Thanks FT

    So you don’t use your principle to re-invest but to pay off the interest portion of the debt? Sorry if it seems redundant, or that I’m slow but this sounds closer to the Rempel Max than the SM. However capitalizing works it seems like that would free you to invest the entire principle increase in new investments and in turn increase your SM and taxable benefit. Number example are good for me if possible.

    Have you started your SM yet? Your comments are very useful and the story is great. One other thing, short of reading prospectus all the time is there any other way (meaning easier) to find good income paying tax preferred funds that allow you to do what you and probably myself want to do with the SM.

    Thanks again

    Jay Day

  16. JD, the Rempel Max and SM are not a different strategy. The RM is a WAY to implement the SM. Basically invests a larger sum upfront, instead of investing a little @ a time. If you want to invest your principle every month, you’ll have to pay the interest charges out of your own cash flow. Up to you really on how you decide to implement the strategy.

  17. 33. Jay Day

    I think I see now. Where you explained it at the top of this blog it says “so with every regular mortgage payment you will invest the new money in your HELOC.” This new investment amount must mean princible less interest cost. This is the amount your good debt goes up each month, not the full amount. Is that where I was going wrong? I see in other comments that some were saying to simply pay the interest cost from your chequing account and then simply take that amount back out of your HELOC to pay back into your chequing account.

    thanks

  18. JD, Yes you are correct. There are 3 ways that you can use your increasing HELOC credit limit.
    1. Use the extra heloc space to pay off the debt servicing of the heloc (capitalize).
    2. Use the extra heloc space to invest in new equities.
    3. Use a combination of 1 and 2 providing that your principle payment is greater than your debt servicing cost.

    Personally, I will be capitalizing the interest.

  19. 35. Jay Day

    FT

    For simplicity sake, these numbers are examples only, (I still need to look at the exact amount of the principle) if my interest on the heloc is say 250 and principle on mortgage is 300, you are saying you are only going to pay off the 250 and not increase your portfolio. Are you just going to wait until year end and increase your investments with your tax refund and income dividends paid on your mortgage then withdrawn to increase heloc. Have you considered the advantages of dollar cost averaging?
    Just wondering about the strategy?

    thanks

    Jay Day

  20. 36. Julie

    Hi FT,
    Thanks for the great blog.

    I bought a condo in July and applied (a sort of) the Smith Manoeuvre, because I got the mortgage and line of credit (Visa one-the first 6 months interest rate is 2.9%) from Scotia bank. I also obtained the leverage loan from B2B through my financial planner.
    Now it’s the time for me to pay the interest to B2B loan and Scotia Visa line credit.
    I transferred investing money to investment account directly from Scotia Visa line credit by check. I am going to pay the interest to B2B and Scotia Visa Line of Credit by transferring money from the line of credit (Scotia Visa) by check again to my bank account (PC), then I will use PC account check to pay the interest of B2B and Scotia Visa Line of Credit.
    Is it the right process? I don’t have any statement right now from Scotia yet, how can I track the money which goes to invest and to pay the investment interest for my case.
    What kind of record do I have to print out from online and to keep for CRA?

    Please advise and many thanks,
    Julie

  21. Hi Julie, your situation sounds a little complex and if CRA audits you, you will need to show a proper paper trail. I think that your best bet would be to speak with a tax professional to get advice.

    But yes, what you explain is the correct process of “capitalizing the interest”.

  22. 38. Julie

    Hi FT,

    Could Ed provide some suggestion? I bet he is also good at tax.

    Thanks,
    Julie

  23. 39. ben

    Hi Ed,
    Can you tell me if the service charge for setup the HLOC is tax deductable?
    thank
    ben

  24. 40. David

    Julie,
    Financial Advice is worth what you pay for it. While many here might offer opinions, I would suggest that you obtain advice from someone you can deal with directly, rather than in an anonymous manner through a blog. You also then have the recourse to demand that they back their advice with appropriate guarantees.

    DAvid

  25. As David says, take advice that you read on the internet with a grain of salt. There is no substitute for talking directly with a tax/financial professional.

  26. Hi Julie,
    just another quick note, If your bank find out that you pay credit by credit, they might contact you as well. Technically, revolving credit is not made to pay other revolving credit. I am not sure it is a good idea.

    Find yourself a good financial planner WITH EXPERIENCE with the Smith Manoeuvre. Make sure to make a good research for your financial planner. Unfortunately, as it is the case with many profession, there are many clowns out there…

  27. 43. Ed Rempel

    Hi Julie,

    Your advisor not explained to you how to implement it properly? Yes, your process sounds correct. FT is right, though, that it is important to keep an audit trail. If you are ever audited, you need to be able to prove that all the money you took out of your chequing went directly to investments or to pay interest on investment loans.

    Unfortunately, you have a Scotia mortgage. Scotia is the most difficult bank for the SM, since they don’t automatically increase the credit line limit or allow investing directly from the credit line. At several of the other banks, you would be able to have B2B and your Visa charge their interest directly to your tax deductible credit line.

    My suggestion would be to open a separate chequing account (or you could use an unsecured credit line) only for transferring all the cash. Put in some money from your SM credit line and then give B2B and your Visa a void cheque to have all their interest charged their directly. Get one from PC to avoid fees.

    At Scotia, you will need to go into the branch every month (unless you have more credit available) to request that they increase your credit line limit.

    Then use the SM CL to replenish your separate chequing account as necessary.

    The advantage of this is that there is no mixing of money, like there is if everything goes in and out of your main chequing account. You have several accounts and all tax deductible money stays together – B2B, SM CL, Visa, and your separate chequing account. Never have any other money go in or out of any of these accounts. Then your audit trail is just showing all transactions in these accounts.

    My other suggestion would be to discuss this all with your advisor (unless he is just a mutual fund salesperson) and to insist that your advisor does your income tax return and puts his name on it. This way, you can sue him if you ever lose an audit.

    Your situation is more complex, since your mortgage is at Scotia and you have the Visa as well. Did you have a mortgage broker do the mortgage? Scotia is far more complex for doing the SM than the other banks, but it is the only major bank that makes their SM mortgage available through mortgage brokers.

    Ed

  28. 44. Ed Rempel

    Hi Ben,

    Good question. The general rule is that if you refinance in order to setup the SM, then reasonable cost of setting it up would be tax deductible.

    This would not include penalties to get out of your previous mortgage, but you can usually claim legal and appraisal fees. Just like interest, what makes it tax deductible is the purpose of the cost.

    What do you mean by service charge? Did you get charged more?

    We don’t come across this directly much, since we can almost always get an SM mortgage from a bank for no cost at all – no legal or appraisal fees. And no service charge or broker fee.

    Ed

  29. 46. Julie

    Thanks Ed, FT, FB and David for the very useful comments.

    Yes, I implement SM by myself according to everyone’s intelligence (thanks Ed and FT again) and my financial planner just help me do investment. As I mentioned at my previous email, I just use Scotia Visa Line Credit for the first six months (2.9% interest rate very attractive) then switch to HELOC.

    Julie

  30. 50. Craig

    Given that interest rates are on the rise, is the Smith Manoeuvre becoming less attractive? Has anyone calculated if there is a threshold for interest rate and required rate of return at which point the tax advantage of SM no longer works?

    I’m all setup to do SM with my HELOC, but I’m now hesitant with the higher interst rates and especially given the recent market volatility.

    Thank you.

    Craig

  31. With the recent events, interest rate might stay at 6.25% for a while. However, predicting interest rates is a very dangerous game. You have to look at the SM over a long period of time. As you are about to start it, your interest cost won’t be much in term of dollar for now until interest rates go down later on in time. You are better off starting now a 6.25% and benefit from a lower rate later on.
    Keep in mind that any rate increase is affecting you by 60% of the increase only (assuming that you are in a 40% tax bracket).
    Cheers,
    FB.

  32. 52. Cannon_fodder

    Craig,

    Determining if the SM makes sense depends on a few factors: your marginal tax rate, the LOC interest rate, the mortgage interest rate and the growth rate of your investments, and your comfort with the process.

    Implementing the SM would likely have:

    - no or a positive effect on your marginal tax rate
    - no or a negative effect on your mortgage rate (e.g. implementing Manulife One which apparently has a higher rate than a conventional mortgage)
    - no effect on your LOC rate
    - unknown effect on your investment growth rate as it may cause you to choose different investment vehicles, or choose a different strategy (e.g. buy and hold vs. sector balancing).

    To be dangerously simplistic, its benefit is greatly reduced the closer one gets to an investment growth rate which is lower than the LOC interest rate * (1 – your marginal tax rate).

  33. 53. Craig

    Cannon_fodder,

    Great formula. So assuming a 40% marginal tax rate and a 6.25% LOC rate, then the “breakeven” point is an investment vehicle that yields only 3.75%. That seems too low, but if true then it definitely eases my concerns about what level of return I would need to get in order for SM to still make sense. I thought it would be much higher than that.

    Thanks for the comments.

    Craig

  34. 54. Cannon_fodder

    Craig,

    Yes, that is about right. There are other factors that can affect it and an investment vehicle never goes up in a straight line, but running through my calculator does show that the formula is a decent guide.

  35. 55. Manipulating Smith

    Craig,

    I don’t agree with your breakeven point. If you take a simple case: $200,000 mortgage, mortgage interest rate at 6.25%, LOC rate at 6.25%, 25 year mortgage, 3% inflation, no dividends, tax refund from LOC reinvested into mortgage, 40% tax bracket, no movement of investment funds until year 25 you get a breakeven investment growth rate of 8.25%.

    This is assuming you completely liquidate your investment portfolio, pay off your $200,000 LOC at year 25. You get credit for the tax refunds you applied to your mortgage at the mortgage rate minus the year difference (i.e. tax refund in year 1 would be compounded 24 years at mortgage rate) and you also have to pay for the months / years you couldn’t capitalize on your LOC interest get the mortgage was already paid off plus inflation. This also assumes all rates are fixed and constant. When you look at it that way the risk is a bit higher.

    Regards,
    Manipulating Smith

  36. 56. Cannon_fodder

    MS,

    I don’t understand your statement about not being able to capitalize the LOC interest when the mortgage is paid off. Are you saying that once the mortgage is paid off (3.51 years early) that you can not claim the LOC interest deduction any longer?

    With your numbers, my calculations show over the 25 years, you took an additional $139,274 in tax deductions and you were left with an investment portfolio net of LOC of $156,481 before taxes. (The portfolio would be worth $47,564 net of LOC and before taxes when the mortgage is retired 3.51 years early.) Neither portfolio value is adjusted for inflation.

    If you didn’t implement the SM, you would not have an investment portfolio. So how are these two scenarios equal or ‘break even’?

    If, on the other hand, your investments grew at only 3.67% you would still pay off the mortgage 3.51 years early but only have an investment portfolio worth $71 (net of LOC, before taxes, not adjusted for inflation) at the end of 25 years.

    There’s a really good point you are trying to make but I’m not able to grasp it.

  37. 57. Manoeuvring Smith

    Cannon_fodder,

    Regarding the LOC interest, I was referring to not being able to use the LOC to pay for the interest since the LOC is maxed out. I assume you don’t get your LOC increased by having your house reassessed.

    I have to apologize, I made some very poor assumptions in my previous’ post analysis, so I will try to correct myself and make it a bit more clear. I tried to match your numbers but the closest I could get was 156989 instead of 156481 and 47607 instead of 47564, so I will use rounded approximate figures.

    The point I was trying to make was that using the SM to reduce your total mortgage cost and develop an investment portfolio is great. In the above example the mortgage is paid off in 3.5 years (42 months). So no more mortgage payments right? What would be the breakeven point if you decided to use the mortgage payments (~$1309) for something else instead of the SM after the mortgage was paid off? So you still have to pay the ~$1000 per month for the LOC and you still get the tax refund which you reinvest in your portfolio, so after 25 years if you cashed in your portfolio (after tax), paid your LOC, and included the 42 interest payments at about $1000 plus inflation, what effective growth rate on the investments would you need, I calculate about 6.7%. I consider the $1000 per month a loss because that’s after tax money out of your pocket. I define breakeven as having yours earnings equal to your losses in an investment.

    Should it not be considered a cost if you continue to inject the equivalent of your mortgage payments (i.e. pay off the interest on the LOC and invest the rest) into the SM after your mortgage is paid off? This is out of pocket money that you saved because you reduced your mortgage doing the SM and should not be required in the SM. If you include this money and do not consider it a cost then yes 3.67% (I got 4.2%) would be the breakeven point but you just used about $54,000 (~1309*42) of your own money to inflate your portfolio! I think if you’re going to include this in the SM then you should also include the loss of $1309 per month in determining the required breakeven point (I get 7%).

    Does this make sense, I’m no expert this is only my question/opinion/research?

  38. 58. DAvid

    The Smith Manoeuvre requires that you continue to make ‘mortgage’ payments for the length of the original amortization. The real increase in the portfolio only comes as you add your former mortgage payments to your investment portfolio. you retain the loan simply to leverage your portfolio, and it continues to generate tax refunds that help pay the interest.

    While you can manage you finances in many different ways from this, they are not Smith’s manoeuvre.

    Cannon_fodder’s calculator closely mimics Smith’s own, so the numbers you see in it (and the approximations discussed here) are realistic from the perspective of the original.

    DAvid

  39. 59. Cannon_fodder

    MS,

    Great discussion. First, I should point out that the mortgage would be retired 3.51 years EARLY, not IN 3.51 years with the SM! I know you corrected yourself later, but just thought I’d point that out to other interested readers.

    As David pointed out, the real explosive growth in the portfolio is putting all of the mortgage payment – LOC interest into the portfolio. I would wager that others (e.g. Ed Rempel) would suggest that you might be better of getting another or bigger HELOC that has an interest cost which eats up whatever is left from the mortgage payment after the original LOC.

    In this particular scenario, if you assume that you start at the beginning of the year and you apply your tax refund at the end of June (I can adjust my calculator for different refund dates) you would still only have an additional investment of just under $31k to make during those remaining 3.51 years. The $31k is the total of mortgage payments – LOC interest + tax refunds. (In reality, there is an additional $5k that might form part of a refund in the year following.)

    Anyway, it seems to me that the argument you are making is really against the SM post mortgage termination, not during the entire 21.49 years previous to that.

    I was taking the position with Craig about looking at the entire run of the SM over the amortization period of the mortgage and looking what the investments would need to return in order for one to say that the SM neither helped nor hurt me. The simple way to do that was to keep plugging lower and lower returns until the portfolio was basically $0 after the 25 years. Because, if I hadn’t implemented the SM that is exactly what I would have seen – the same amount of cash leaving my pocket with the same result – no mortgage and $0 worth of investments.

    I certainly would support the argument that the risk involved in implementing the SM to only break even would not be worth it, thus there should be an expected additional return to justify it. But that would be up to each individual to determine.

    I would disagree with your position because you are changing tack – on the one hand you are implementing the SM and then when the mortgage becomes zero, you then want to suggest that the additional mortgage payments are out of pocket costs. However, if you didn’t implement the SM you would still be making those same payments to pay down the mortgage.

    Personally, if I paid down the mortgage I would not keep just feeding the money against the LOC and into the portfolio – I would increase my LOC to purchase more investments and continue to make those same ‘mortgage’ payments as I had always intended to. Once I start slipping into retirement and both my income and marginal tax rate start slipping, it may be time to start paying down any LOC value because I might have to, or perhaps if I’ve done well enough (I haven’t really thought this through) I would have started to move into income producing investments like blue chip dividend stocks to help cushion the loss of work income.

    I look forward to your response – always good to hear different perspectives, especially since I haven’t implemented the SM – yet!

  40. 60. ronb-hi

    Hi,

    Just starting the SM and looking into guerilla capitilization. I can’t seem to find anyone that offers a Line of Credit for prime like Smith states continually in his book. What is he referring to in his chapter? It doesn’t make sense to have a L.O.C. for prime + 4%.

  41. 61. DAvid

    Most Home Equity (secured) LOC are at prime, and most of the accounts that you would use to set up the SM would allow you to split the HELOC into multiple streams. These are the form of LOC that Smith suggests using.

    Unsecured LOC are available from Prime +1 (or better)if you have a good FICO score. If you are being offered Prime +4, possibly you should look into improving your credit rating as part of your overall financial planning.

    Read around a bit more, there’s lots of information available on this topic or contact a Financial Planner if you need greater detail.

    DAvid

  42. 62. ronb-hi

    Do you have any names of places that offer LOC at those low rates? I’ve tried RBC and Coast Capital (for example) and the best they offer is Prime +3%. There’s nothing wrong with my FICO, btw.

  43. 63. Craig

    Ronb-hi,

    A great comparison of all HELOCs was done in the following post: http://www.milliondollarjourney.com/smith-manoeuvre-maneuver-mortgage-comparison.htm

  44. 66. Cannon_fodder

    In today’s Toronto Star – Retirement Planning section, there was a small article on the Smith Manoeuvre with comments both pro and con from individuals in the financial / investment industry.

    Found the link online!

    http://www.thestar.com/article/265155

  45. Thanks for the link CF.

    It’s interesting to note the contrast between the conservative advisors who basically don’t like leveraging of any kind (which I don’t agree with) and the pro-SM mortgage guy who talks about “blue-chip stocks paying 7 per cent a year” which is ridiculous.

    All the more reason to learn as much as you can about investing and risk and then decide how much leverage (if any) is appropriate for your situation, independent of a commissioned salesperson (FA or mortgage personnel).

    Mike

  46. 69. Connie

    Is the Scotia Total Equity Plan good to implement SM?

  47. Hi Connie,

    I would definitely suggest you to read Ed Rempel’ series on his best picks for the Smith Manoeuvre (see comment #68).

    From what I read so far, it would be preferable to combine a regular mortgage along with a HELOC in order to benefit from a low mortgage rate on the fix portion and still use the variable part to invest.

  48. 71. Connie

    Thank you, I see he does not recommend the Scotia STEP, This is what I have but my line of credit does increase with every mortgage payment. I haven’t tried to access it so perhaps I would have to go in the branch.

  49. Connie,
    maybe you should get help from a local mortgage broker that knows how to manage a SM. A guy like Ed could definitely help you out!

    Generally, they know more about all the product characteristics and will determine with you which product suits you best.

  50. 73. Connie

    I am meeting with my lender Friday and now I have a million more questions for her. This site has been very thought provocing. I am in the process of taking the equity out of my primary res to purchase another. After reading on this site I think I should look at the alternatives. Thanks so much!!

  51. 74. Ed Rempel

    Hi Connie,

    Your Scotia STEP shows your credit available rising with each mortgage payment, but you generally need to go into the branch to sign a form to increase the limit on a credit line in order to access it. You also cannot invest directly from the credit line. It can work, but almost all our clients there found it to be too much work.

    I have seen a couple of cases where a local Scotia branch manager was willing to do all the manual work every month in order to avoid losing the mortgage, but this is rare.

    Will you have a penalty to get out of your STEP? If so, it is worth doing the math to figure out whether or not it is worth it to move now or get a 2nd readvanceable mortgage and do as much of the SM as you can until your mortgage comes due.

    Ed

  52. 75. Ed Rempel

    Hi FB,

    Thanks for the kind words. I just want to be clear, though, that I am not a mortgage broker.

    We are financial planners that have implemented the SM for over a hundred clients. We have contacts with all the banks and financial institutions that have SM mortgages (including the best SM mortgages not available through mortgage brokers), but we don’t do the mortgages ourselves. We do give free referrals to the best SM mortgage, though.

    Ed

  53. Ed,

    I thought you were doing everything, sorry about that. Maybe you should add it to your practice? I heard that mortgage broker were making great commission on mortgages ;-)

  54. 77. Ed Rempel

    Hi FB,

    Good thought. You’re right – we could easily get an extra commission on the mortgage.

    My problem though, is that all the best SM mortgages are not available to mortgage brokers(See my article on SM mortgages, so we would have to recommend an inferior mortgage to our clients.

    We’re doing fine and I think part of the reason we have been getting so many clients is that we are only concerned about getting the best product for our clients – not about what commission we could get.

    Ed

  55. 80. Ann

    I am a real novice as far as investing goes so would like some advice on the following. I am 52 and recently took early retirement with a small pension of $15000 annually. I have 2 rental properties with rents of $475 and $650 each have mortgage payments of $250 and $450. The higher rental property has a BNS Step Mortgage with HELOC of $23000 now. My boyfriend and I have bought a house together ($155000)but most of my income is going toward expenses. I also have about $30,000 in savings as well as $70000 in RRSP. Any suggestions with what I should be doing in this situation?

  56. 81. Ann

    What can /should be done with a rental property when it is paid off?

  57. 82. Ann

    If I need some extra income from my rental, would it be good to make a prepayment before the end of Dec.07 and then another 1 in Jan.08 so that I would have about a year more to pay off. This would deplete some of my savings and then affect the tax deductions I have now as well as having to pay tax on that extra income so is it really a good idea?

  58. Ann, that’s a pretty tough question without more information. Do you like the real estate game? If so, how about buying more cash positive properties to fund your retirement?

    Also, if you make pre payments on your rental, your monthly payments are going to remain the same. It’s the amortization of the mortgage that gets reduced.

  59. 84. Ann

    Yes, I am interested in real estate,the only problem being is that my current main residence I qualified for when I was working has a mortgage in my name of $950 per month locked in for 10 yrs and only 10% downpayment and 1 year paid off. All expenses are shared with myself and boyfriend. Because it is in my name and my retirement income is so low I cannot get a loan from the bank.

  60. 85. Ann

    Forgive my lack of knowlege, but just to clarify what you mean about more cash positive properties. Am I correct in saying it is a property that gives you some money at the end of the month after mortgages and any expenses are paid?
    Should you have the lowest mortgage payment and longest amortization possible to give you more income and not worry about paying it off quicker because of the tax deductions etc?

  61. Ann, Yes, that’s what I mean by cash flow positive properties. That is, the net rental income is positive after all expenses. Personally, I only buy a rental property if it’s cash flow positive and amortize it for as long as possible. The reason being is what you said, I can write off the mortgage on a rental property.

  62. 89. thean

    I’m in my early 30’s, and I have considerable capital in my house. I’ve been looking into the Smith Manoeure (SM), and am having a hard time making SM work, given my understanding and assumptions. I apologize for the length of this =) Also, I’m a relative n00bie but do know a little bit about finance. I have not read the SM book yet, but plan to do so soon (work full time, in school part-time, the book is on the to-do list).

    The first problem that I am having is that I do not understand where this tax refund comes from. I understand that loans towards securities that provide income are tax deductible, but I understand this will just lower the taxes that you will owe on your investment income. For example, let us say you invested $10,000 in dividend bearing securities, that paid annual dividends at a rate of: D = .075. Let us also say the interest rate of the loan is current prime: i = .0585 annually.

    Therefore, you would receive $750 in dividends and have to pay (or capitalize) $585 of interest. If I understand the tax implication of this rule, this simply means that I pay interest on the spread, or real return of this investment ($750 – $585 = $165). So then let’s say that my marginal dividend tax rate is approximately 25%. If so, I would owe the government about $41 ($165 * .25) at the end of the year…So no tax refund, but definitely owe less than I would if this tax benefit did not exist. Therefore no tax refund, am I correct? I could take the difference ($165-41=$124) and apply it to my mortgage and repeat. Making more on your investments than the amount of interest you are paying is crucial if you want the SM to work in your favour, and the [realistic] spread is very tiny.

    All of that aside now. I believe that trying to find securities which pay 7.5% (or higher) dividend income is not very realistic, at least not without substantial risk. If I am wrong, please enlighten me=) If you invest in the market, you might be able to get a 7.5% return if you factor both dividends plus growth of the value of the securities (capital gains)…but then you would have to sell those securities at the end of the year, or at least, sell a 7.5% return’s worth (and then you also have the costs of the transactions to consider).

    So, this means that I’m paying $600 in interest, because I choose NOT to capitalize my interest, during my hypothetical first year (increasing marginally year-to-year). And my mortgage is $124 smaller (in addition to my regular mortgage payments). Technically, this will mean my *real real* rate of return would be 21% ($124/600).

    Again, if all my assumptions and understandings are correct, I wonder what my return is, if I just put that $600 to my mortgage (and continue to do this until the mortgage is paid down, also increasing at the same amount my interest payments would have)? And the thing to consider is that this strategy has 0 risk (guaranteed return). I will also calculate this as part of said spreadsheet. So far, based on what I have read, this is the strongest argument against the SM. So I’d actually like to see a quantitative comparison of the two.

    If you consider the Sharpe index (expected return minus riskfree rate divided by std dev), the SM will always lose. But the question is, can you get the SM down to you tolerable risk range that will also provide a real return? This of course, is a key question, that I still need to spend some time contemplating. If anyone has any good advice here, please!

    My next step is to create a detailed spreadsheet showing some scenarios for my particular position…but I just wanted to confirm my understanding of this before I poor hours into it =) And I know there are several spreadsheets already available, but I feel more comfortable doing something like this by doing all my own work and trying to ensure I understand every last detail.

  63. 90. DAvid

    Congratulations on your money management skills so far!

    Many of your questions have been answered in previous postings in this and the anti-Smith Manoeuvre thread.

    Firstly, Smith does not consider paying the interest from earnings of the investments. You can have a tax efficient investment that pays no distributions. This option is promoted by many SM advocates. Interest is effectively paid from your pocket, by investing less that the total reduction in principal each month. The tax refund is quite simple to calculate: interest paid on investment x marginal tax rate. it is recieved on the entire investment interest cost.

    As a skeptic, I asked the same question as you: “Why not just put the $xxx on the mortgage, and I was shown that I would be ahead to apply the Smith Manoeuvre (by some tens of thousands of dollars) See messages 45 and 48 in the Anti-Smith Manoeuvre on this site.

    Also, have a look for cannon_fodder’s spreadsheet on this site. It is easy to understand, and will help you determine if this option is indeed for you.

    DAvid

  64. 91. thean

    Thank you for the kind comment and the feedback, I continue my research.

    For some reason, I am unable to get at that spreadsheet. Everytime I click on the link, it brings me to the main page, as I assume the link is broken (or there is something wrong on my side). I’m trying to get at it from here:

    http://www.milliondollarjourney.com/smith-manoeuvre-potential-returns-spreadsheet.htm

  65. thean, sorry, it was a broken link from my upgrade a few days ago. The spreadsheet is now available for download.

  66. 93. wade

    Hey Thean,
    I’ve been reading this tread with a lot of intrest. I’m an advisor with Sunlife, and I do something similiar to this with some of my clients. First of all, good work on all the details. Most people forget that the ‘real rate of return’ is lower because of the taxation of the dividend income from the stocks/mutual funds. Here is my only tip for you: There are now several Mutual Fund Companies that structure the dividend payment as a ROC (return of capital) so that it is tax free. This lower’s the ACB of the MF instead. The funds are called T-CLASS funds and CI FUNDS and FIDELITY are 2 such companies that have these. This really helps the ‘real rate of return’. Now one word of caution, it is up in the air wether or not CCRA will allow you the tax deduction if the dividend is declared “return of capital”. SO CHECK WITH AN ACCOUNTANT!!

  67. 94. Greg

    Hello all

    Been reading for the last couple of hours and have some very basic and uneducated questions around the Smith Maneuver / Readvancable Mortgages.

    I’m being transferred with work and as such they will be buying my house and cover all costs associated with purchasing a new one – including discharging the mortgage so this seems like a great time to make the switch.

    My house is selling for $173,000 with $115,000 outstanding on the mortgage, so $58,000 in equity available. The town I’m moving to is up north so property values are lower and I’m expecting to be able to get something in the $140,000 to $160,000 range.

    I’m single, debt free, monthly income after taxes and such is $4150-ish (of course monthly expenses are paid out of that).

    My question is which mortgage / LOC product would suit this situation. I was originally thinking of the Manulife All in One but as I read through here is seems not to stand up well compared to some others. Also I’m not sure I fully even understand all the principles involved. I worked through with Canon Fodder’s spreadsheet and while I really like the outcome I’m not sure if I’m applying all the numbers correctly.

    Oh, and lastly, I am hoping to get a duplex or at least a single detached with a separate and legal apartment to generate some extra income to help pay down the mortgage and I was wondering if there are any restrictions with a readvancable mortgage and having tenants.

    Sorry for so many questions and thanks for an excellent resource for the financially impaired

    Greg

  68. Hey Greg, MDJ has tons of information regarding readvancable mortgages. Check out the links below:
    Ed Rempels Picks
    SM readvancable mortgage comparison
    DIY readvancable mortgage picks

    Hope this helps!
    FT

  69. 96. Ed Rempel

    Hi Ann,

    I just noticed your posts. Your issue with being retired and having equity but not enough income or tax deductions is common.

    I have a couple of suggestions for you. First of all, you can use your 2 rental properties and your home to do the SM 3 times. This should also give you a much healthier amount of equity (stock market) investments, since almost all of your money is tied up in real estate now.

    Do you have a fair amount of equity in the rental properties? You can borrow against this equity to invest and have these and the SM investments pay you an income (similar to the Smith/Snyder strategy, which can be useful for retirees).

    Taking this income does create a tax problem, since the leverage interest becomes non-deductible over time, but it provides you income from your equity.

    Second, you can do the Cash Dam on both rental properties, in order to make your home mortgage tax deductible much more quickly. This can convert quite a bit of your home mortgage into tax deductible interest against your rental properties.

    Third, you can pay your cash down onto your mortgage and then reborrow to invest. This way, you convert $30,000 of your mortgage to tax deductible.

    Fourth, You can convert your RRSP’s to RRIF’s (after making whatever final RRSP contribution makes sense in your tax bracket), and then use the RRIF’s to pay your leverage loan interest. This is called a “RRIF Meltdown”. The RRIF withdrawals are taxable, but they pay tax deductible interest, so this off-sets the tax (although this tax deductibility declines over time). Then you can have the non-RRSP leveraged investments pay you income. This allows you to get money out of your RRSP’s in a tax-efficient manner.

    I don’t know your full situation, but these 4 strategies will probably work well for you.

    Ed

  70. 97. Ed Rempel

    Hi Thean,

    The reason you are having trouble understanding how the SM would work for you is that you have 2 incorrect assumptions.

    Do you live in Quebec? If not, then you do not need any taxable investment income in order to claim the interest expense. If your investments are 100% tax-effient and pay no dividends, distributions, or taxable capital gains, you can still deduct all of the interest expense.

    This is the same as nearly all businesses do. If a business loses money, they can still claim all of their interest expense.

    This is where the tax refunds come from – you can claim all the interest as fully deductible, but it is possible to invest so you pay little or no tax on the investments as they grow.

    Your other incorrect assumption is that the SM requires cash flow. With the SM, all the interst cost is reborrowed (capitalized). There is no point in using any cash flow to pay deductible interest when you could use it to pay non-deductible debt.

    You chose to not capitalize your interest in your example, but then you are not doing the SM.

    Since the SM requires zero cash flow, there can be no comparison to paying your mortgage instead.

    By the way, I looked at Cannon Fodder’s spreadsheet a few months ago and it is accurate.

    Ed

  71. 98. Ed Rempel

    Hi Wade,

    Sorry to tell you that it is not “up in the air” whether CRA will allow you to deduct the interest if the distribution is a return of capital. They will not.

    CRA is concerned about the “current use” of money that is borrowed to invest (IT-533). Return of capital means you are getting some of your original principal back. Therefore, the current use of that money is that it is no longer invested.

    For example, if you borrow $100,000 and get $8,000 in return of capital distributions, you have now taken back $8,000 of the $100,000 and it is not invested. Therefore, the interest on only $92,000 of the investment loan is tax deductible.

    After 12 years or taking an 8% distribution, you have taken your entire $100,000 back and none of the interest on the loan is tax deductible.

    That is also the same point where the book value of the fund reaches zero. Once the book value reaches zero, the entire distribution is considered to be a taxable capital gain.

    The problems with that strategy is that you must do the math every year to calculate how much of the loan interest is tax deductible, and after 12 years, you end up with a tax problem – you have no interest deduction while the entire distribution is taxable.

    If you sell after the 12 years, your book value is zero, so the entire amount you sell it for is a taxable capital gain.

    Ed

  72. 99. Ed Rempel

    Hi Greg,

    There is no problem doing the SM on a rental property. The rental propery mortgage is already deductible against the rent, but your mortgage payments are reducing this mortgage and the tax deduction.

    The SM uses the unused equity to borrow to invest, so that interest is also tax deductible, but on a different line on your tax return.

    With a rental property, you can also do the Cash Dam, to make your home mortgage tax deductible more quickly.

    FT is right that the best mortgage for the SM varies, depending on your situation. We are still offering “Ed’s Mortgage Referral Service” as mentioned in the section on my picks for the best SM mortgage. If you send us an email with answers to the 10 questions about your situation, we will recommend which mortgage will work best for you and give you our contact for that mortgage.

    Ed

  73. 100. thean

    Ed,

    Thank you very much for reading my post carefully and for the clear answers. I now understand the mechanics of the SM and am also a believer.

    I’m not sure that I’m going to attempt it myself yet, as its a long-term strategy. I’m about to start an EMBA, and am considering going back to school full-time after that (law school). In order to do that, I will need to sell my house, and invest the proceeds (and use that majority of that to fund school).

    Having said that, if I do go back to school full-time, the SM could be quite risky. I would be assuming that I could make a return in the short-run (within 3~ yrs), which may be a risky venture given the fluctuations in the market right now. I think I will watch the market for a few months and contemplate before deciding firmly on this.

    However, no matter what, it should help me build my capital back up as efficiently as possible post-full time school.

    Then again, if I don’t decide to go back, I can start with this anytime once I’ve made that decision.

    Thanks again!

  74. 101. Ed Rempel

    Hi Thean,

    If you will actually need the majority of the money from the equity ofyour home within the next 3 years, then I would not recommend the SM. We only recommend it as a long term strategy, since the markets can be quite unpredictable short term.

    I have a couple of questions for you. Do you expect to go to school in the same city where you live? After you are done school, will you also be planning to still live in the same city?

    Are there no alternatives that will work for you, however? You will lose some money selling your house now (commissions and costs) and it will cost some money buying another place after school. If you will be in the same city the entire time, all you need is to find an option that loses you less than the costs of selling and then buying a home.

    Have you looked into the Life-long Learning program? It is similar to the HBP and allows you to borrow up to $20,000 from you RRSP’s to go back to school. You could take a loan now to top-up your RRSP while you are still working, if you don’t have the $20,000 available within your RRSP.

    The other option, if you have significant equity in your home, could be to borrow to invest and then have the investments pay your income while you are in school. This can cause some tax issues, since the investment loan loses its tax deductibility as you take money out of the investments, but the tax consequences should not be very costly for you while you are in school. This might be able to provide anough income to keep you in your home (which I assume you would prefer to do if you can).

    You can repair this tax deductibility in your last year of school by selling your investments to pay down the loan and then reborrowing to invest again.

    My suggestion, without knowing your entire situation, is that if you will be in the same city, consider other options to keep you in your home while you are in university.

    Ed

  75. 104. New Home Owner

    I just spoke to a financial planner and she told me that it is not worth it for me to do the Smith Manoeuvre.

    I have about 30k in equity in my home, and a mortgage of about 235k. I make about 60k a year. She told me that I would have to reapply for CMHC and that all the legal and administrative fees wouldn’t make it worth it. She said I should wait untill I have much much more equity in my home (over 100k) before I consider this.

    What do you guys think of that – I personaly don’t want to believe it. I think the sooner I start the better…

  76. 105. FrugalTrader

    New Home Owner, unfortunately I’m with your banker on this one. Before you start the SM, you should have AT LEAST 20% equity in your home in order to avoid CMHC fees.

  77. 109. Martyn McKinney

    I have a question which is affecting my analysis of the SM in my situation.

    I have tried to simplify it below.

    A rentaI property is purchased for $400,00 and $100,000 is put down.

    Because it is an investment property, the interest on the $300,000 mortgage is tax deductible.

    If the next day, after putting down the $100,000, it is decided to decrease the $100,000 equity theoretically to zero by taking out a $100,000 HELOC.

    My question is, does it matter what this $100,000 is used for in order for it to have the interest on the increased mortgage to qualify as being 100% tax deductible?

    It seems to me from a tax point of view, that freeing the original down payment is the same as having no down payment which should permit the interest on a new mortgage equivalent to the initial purchase price of the property to be tax deductible.

    What if the decision to increase the mortgage occurs not one day, but 20 years after the property is purchased?

    Does it matter to what use the money from the increased mortgage is put as long as it does not exceed the original purchase price?

    I own a rental property in which I also live and I am wondering whether I might get prorated interest deductibility by simply pulling out my original down payment instead of using the SM to achieve tax deductibility on the prorated portion of my mortgage.

  78. 110. FrugalTrader

    If you borrow against your rental property, the proceeds must be used to produce income in order for the loan to remain deductible (afaik).

    Another issue is, if you have greater than 80% LTV, they will charge a CMHC fee, which is undesirable in my opinion. With that said, on your $400k rental, you can take out $20k as a heloc.

  79. 111. Ed Rempel

    Hi Martyn,

    Your question is a very common misconception. A lot of people mistakenly believe that any interest on money borrowed against a rental property is tax deductible.

    In actual fact, what you borrow AGAINST is not relevant in determining if interest is deductible – only what the money is used for.

    If you borrow against a rental property and spend the money, whether one day or 20 years after purchase, the interest is not tax deductible.

    CRA will look for clear traceability that the borrowed money was used to invest and that it is still invested.

    Ed

  80. 112. Martyn McKinney

    Thank you for your responses.

    I am aware that interest on money borrowed against a rental property is tax deductible only if the money is put at risk.

    My question was concerned with the tax deductibility of the original down payment.

    If I buy a rental property and pay cash (no mortgage) and the next day I decide that I want to create a 100% mortgage on the property and use the money to buy a sailboat, is the interest on this money tax deductible?

    What if I decide to create a mortgage equal to my original down payment 20 years later?

    It is analogous to initially putting a 100% mortgage on the rental property and buying the sailboat with the cash. In this case I have deductibility and a sailboat, but do I have deductibility and a sailboat in the other case?

  81. 113. Martyn McKinney

    I was unable to edit my previous post possibly because its time stamp is incorrect.

    I thought that I could give a better description below.

    1. I have $100,000 cash.

  82. 114. Martyn McKinney

    I was unable to edit my previous post possibly because its time stamp is incorrect.

    I thought that I could give a better description below.

    1. I have $100,000 cash.
    I buy a sailboat with the money.
    I buy a rental property worth $100,000 with a $100,000 mortgage on the property.

    I now have a sailboat and a mortgage with interest that is tax deductible.

    2. With my $100,000 cash, I buy the property.
    I decide the next day to take out a $100,000 mortgage (my down payment) and buy a sailboat.
    Is the interest on the money borrowed in this case tax deductible?

  83. 115. DAvid

    Martyn,

    “1. I have $100,000 cash.
    I buy a sailboat with the money.
    I buy a rental property worth $100,000 with a $100,000 mortgage on the property.”

    The interest is deductible. You could even use the sailboat as collateral. The interest is deductible because you used it to purchase an investment from which you expect to earn income.

    “2. With my $100,000 cash, I buy the property.
    I decide the next day to take out a $100,000 mortgage (my down payment) and buy a sailboat.
    Is the interest on the money borrowed in this case tax deductible?”

    No, unless the purpose of owning the sailboat is to generate revenue from it’s use (i.e. bareboat rentals, charters, etc.) If you merely purchase a chattel, interest is not deductible.

    The interest is also not deductible if your ‘investment purchase’ can only increase in value as a capital gain, as a pure capital gain is not considered ‘income’. Thus gold, art, and antique autos, are not eligible, because you have to sel the assset to realize a gain.

    DAvid

  84. 118. Henri

    I’ve heard that the downside of a re-advancable mortgage (and any mortgage where an amortized mortgage is combined with a HELOC under one charge) is that it is not as easy to switch the mortgage to another lender, because of the costs involved to discharge and re-register. Apparentely, as a result, your bank may purposely not offer you a competitive rate come renewal time at the end of your term. I’ve also heard that this is why some of the big banks are encouraging their clients to get a HELOC when they set up a mortgage when they set up a mortgage … as means to hand-cuff them. Can anyone confirm whether it is indeed more costly and/or difficult to move a re-advancable or combined mortgage? Does anyone have any renewal experiences they’d like to share? Was the mortgage renewal rate competitive?

  85. 120. Andre Peartree

    Can I use the Smith Manoeuvre to invest in a child’s RESP?

  86. 121. DAvid

    Andre asks: “Can I use the Smith Manoeuvre to invest in a child’s RESP?”

    Although you could use the distributions from the investments of an SM portfolio to fund an RESP, an RESP (or an RRSP) does not meet the test set by the CRA for interest deductibility. The purpose of an RESP is to save for a child’s education, not to generate income. The government supports the RESP in other ways, including the grant portion that accumulates.

    Hope this helps in your financial planning.

    DAvid

  87. 122. Andre Peartree

    Is the Smith Manoeuvre really necessary? Why can I not simply invest in stocks with a low interest credit card balance that I move around from card to card (to take advantage of the low rate introductory offers) and say that the interest payed on the balance that corresponds to the value of the stock purchases is to be written off? Would that be illegal? I thought I heard that there were court cases that ruled in the favour of the tax-payer saying that they were free to organize their finances the way they wanted and that the link between the loan and the investment did not necessarily have to be as tied together as they are with the Smith Manoeuvre

  88. 123. FrugalTrader

    Andre, The SM is really a long term investment strategy. Do you think that you can find low interest CC’s everytime that the introductory rate is about to expire? To me, that seems like much more work (and risk).

  89. 124. Andre Peartree

    For as long as I have had a mortgage at variable rate (5 years) (usually .80% below HELOC mortgages) I have been able to have to keep my regular LOC at zero by shifting debt to low rate credit cards paying no fees and rates of .99% to 4.9%, below what you can get in a HELOC. So it has not really been a risky strategy I have saved 1000′s in interest payments. The worst that could happen is that I would have to shift the debt to a regular LOC.

    However the question is out there can your investments be loosely tied to your loans or do they need to be directly tied to your loans in order to make the deduction claim?

  90. 125. FrugalTrader

    Andre, The rule of thumb that I’ve heard is that as long as you have a proper paper trail to show that you borrowed to invest, then CRA should have no problems. However, you should give CRA a quick call to make sure that your process is correct.

  91. 127. Hopeful1

    Hi FT,

    I just heard about this SM strategy on the radio and started searching about it on the net when I ran into your website. There seems to be a great in-depth discussion about it here. Unfortunately I don’t have enough financial knowledge to understand half of the discussion. =) Although I’m really excited and wondering if this would be applicable at all to my unique situation. I’m posting my story here hoping that you or one of the financial experts here would be willing to give me a little advice and point me to the right direction before I go hunting for a financial planner. I reside in western Canada and just purchased my house about 2 yrs ago. My house is curently valued at 360K. I have a closed variable mortgage of about 80K (@prime – 0.8) and a “very flexible” personal loan from my brother who lives abroad of about 280K (@4%, open, fixed interest, no contract, no time limit) which I had used to fund the house purchase 2yrs ago. I am currently paying about 1300 monthly towards my personal loan.

    Could I use this SM strategy to convert my personal loan to a tax deductible loan? Or should I focus on trying to implement it to my 80K mortgage?

    Thank you very much in advance for any input or comment any one can give.

  92. 128. FrugalTrader

    Hopeful,

    That is a unique situation indeed. If I were you, I would contact an accountant or CRA to figure out how to use a personal loan for leveraged investing.

    However, you would need a home equity line of credit (HELOC) in order to buy investments. By the looks of it, you don’t have enough equity in your home to obtain one. That is, if the banks count the family loan as part of the mortgage.

    If they don’t, then you would be entitled to a $360k x 80% = $288k – $80k = $208k HELOC. In which could be used for investments. Personally, I wouldn’t feel comfortable doing this as it’s too much leverage on the property because of the family loan.

    Since you are fairly new to the concept, you should do some further research before proceeding as the SM is a fairly advanced personal finance topic.

    Remember that there is increased risk involved with leveraged investing. If you’re invested in the dropping market now and you can’t sleep at night, then you may want to reconsider this extreme form of investing.

  93. Hi Andre!

    What you are proposing with the credit cards is a bit risky and has nothing to do with the SM.
    Arbitraging your cards is probably loosing money now-days for you.
    The Smith Manoeuvre is using the accumulated equity in the property for the purpose of investing for the long term.
    The two can be done at the same time in theory, but I wouldn’t risk any credit card debt on the shaky, short term performance of investments.

  94. 131. Ed Rempel

    Hi Hopeful1,

    I just noticed your post. You can make your loan from your brother tax deductible, but it is probably priority to make your mortgage tax deductible first, since it is a higher interest rate.

    It is difficult to do the SM with a personal loan, but at some point, you can convert it with a version of the Singleton Shuffle. Probably when your mortgage is fully tax dedcutible, you could borrow against your home to pay off your brother and set up a new mortgage. Then reborrow from your brother to buy investments. This makes your brother’s loan tax deductible. Then you can SM this new mortgage to convert it as well.

    Claiming the interest from your brother’s loan as a tax deduction could end up in him having to claim all the interest as income, though, depending on his situation.

    Ed

  95. This guy wouldn’t be in business if he lived in the U.S.

    When is Canada going to come to its senses and make mortgage interest tax deductible. It’s much better than the principal residence exemption. While you’re at it, get rid of the RSP and increase the TFSA.

  96. 135. james

    Saw a financial planner and he told me that the SM was illegal in Quebec. Any thoughts?

  97. James,

    I live in Quebec and I started mine last year. My accountant didn’t see any problem with Qc laws.

    The only difference with Qc is that your interest is only tax deductible on Investment Income (for the QC income tax part).

    You can have more info here:
    http://www.thefinancialblogger.com/category/smith-manoeuvre/

    Cheers,

    FB.

  98. 137. paulette

    Entering investment is also same as to gamble you never know but the safest thing to do is not to put all your eggs in one basket. Try spreading it to other containers.

  99. Paulette,
    I never heard of people winning nights after nights, years after years at the casino. However, There are fund managers who perform and beat the market over several years.

    Investing is far away from gambling.

  100. 139. JR

    I tend to agree with paulette that investing in the stock market is a form of legalized gambling.

    As an individual I know 100% certain that I cannot win everytime playing the markets, but do know the hedge fund managers, brokers and institutional market traders (I call employees) all make money from retail traders no matter if the market goes up or down.

    Like banks that have so many service fees and charges, stock trading fees will always be there. So as an individual retail investor one has to understand that the street traders (brokers, fund managers etc) always pay themselves first. This to me is the same comparison to a casino owner

  101. JR, I suggest you buy ETF’s or well diversified mutual funds managed by those “employees”. If you hold them more than 10 years, you will definitely make money.

    I can’t guarantee the same thing about the casino ;-)

  102. 141. Ed Rempel

    Hi JR & Paulette,

    The way a lot of people invest, you are probably right that it is like gambling. However, done right over the long term, it is not.

    There is a difference between a calculated risk and a gamble. A calculated risk is when you have done your research and the odds are strongly in your favour. Since the stock markets always go up in the long run, picking good investments and then holding them forever will almost definitely make you money in the long term.

    With gambling, the odds are strongly against you. The more you gamble, the more likely that the odds will work and you will lose money. This is why regular gamblers essentially always lose money.

    Your comments about fees being charged to various “employees” would also apply to bond markets, but you would probably not consider them to be gambling.

    Ed

  103. 142. Peter

    “Strategically Challenged Newbie”

    My wife and I owe 82K on our 5yr variable rate mtge from ScotiaBank @ 4.75% term up Sep 09. We have no long-term debt, just a two year lease committment to Honda @ $378 per mo.

    She has 45K in a LIRA, another 40K in an RSP and I have 40K in my RSP. We have 6K in savings which we will use this year for holidays and my daughter’s wedding. She is 47 and I am 52 yrs old.

    I would like to start a non-registered investment portfolio of dividend paying blue chip stocks.
    Should I borrow on a LOC? When and should we implement the “RRSP Meltdown Strategy”?
    Should we employ the SM?
    ScotiaBank states we have 31K in built up equity. Townhouses are selling for approx 160K in our area so our borrowing capacity coupled with a stellar credit rating should qualify us high. I know you can’t borrow your way to success but we are trying to find a way for our capital to make babies, so we can enjoy a big family when we retire.

    ASSETS
    House – 160K
    Car – 5K
    Savings – 6K
    RSP’s – 121K
    Life Insurance Policy – 10K
    TOTAL ASSETS – 302K

    LIABILITIES
    Mortgage – 82K
    TOTAL LIABILITIES – 82K

    TOTAL ASSETS – TOTAL LIABILITIES = 220K

    NET INCOME
    Pension – $8,433.72
    Peter – $20,221.92
    Spouse – $35,376.96
    TOTAL NET INCOME – $64,032.60

    FIXED EXPENSES
    Mortgage – $11,450
    Car Lease – $4,536.00
    Condo fees – $2,160
    Taxes – $1,815
    Car/ Condo Insurance – $2,712
    Life insurance – $922.80
    TOTAL FIXED EXPENSES – $23,595.80

    VARIABLE EXPENSES
    Food – $12,000
    Telephone/Internet – $2,040
    Cable – $1,020
    Enbridge Gas – 1,500
    Hydro – 1,000
    Dining Out – $1,200
    Charity and Gifts – $2,000
    TOTAL VARIABLE EXPENSES – $20,760

    TOTAL FIXED + VARIABLE EXPENSES – $44,355.80

    TOTAL INCOME – TOTAL EXPENSES = $19,676.80

    Any strategy suggestions would be most appreciated. Right now I am paralyzed like a deer caught in the headlights. Is borrowing to invest the prudent thing to do? We would like to retire in ten years. Approx combined gross company pension income in ten years would be $25K not including CPP. Thanks
    ______________________________________________
    Peter

  104. 143. Nom de Pleume

    I’ve been reading comments about the SM with interest (no pun intended) and have a question about what would qualify as a tax-deductible investment using borrowed money. What I would like to do is to invest in some offshore sovereign bonds currently yielding 16 – 18 percent using money drawn from a HELOC. As this would not be a Canadian investment, would the interest I have to pay on the loan still be tax deductible?

  105. 145. Ed Rempel

    Hi Peter,

    I can give you some general comments. Without knowing your entire situation and what types of people you are, I can’t give any real advice.

    The SM generally works for people that invest long term and can ride out the inevitable market declines. You will probably need quite a bit more investments to maintain your existing lifestyle, perhaps plus some extra travel and entertainment money less the mortgage payments, after your retire. The SM can be very helpful for building up a retirement nest egg without using your cash flow.

    You have some equity and are paying your mortgage down quickly. The SM benefit should be reasonably high, depending on what strategy you use.

    Judging by your high insurance costs, you may the types that really like guarantees. If so, then perhaps the SM is not right for you, though.

    You also seem to have a negative bias to leverage, based on your comment “you can’t borrow your way to success”. (The truth is the opposite – all 400 or the Forbes 400 richest Americans made it there by borrowing to invest in companies.) If you are jittery about debt, than even good debt may lead you to do the wrong thing in down markets.

    Why is your mortgage rate so high? At 4.75%, this is prime. A variable rate mortgage should be well below prime – such as prime -.65 to -.85%. It is probably worth it for you to pay the penalty to get out of your mortgage to get a proper discount.

    Your cash flow shows lots of available cash, but you are missing many variable expenses, such as gas & car repairs, general spending money, clothes, health care, entertainment, home repairs & renovations, and vacations. Do you really spend nothing on all of these? It would be worth it for you to figure out how much money you would actually need to have the retirement that you want in 10 years. This may help you to figure out if you can make it without the SM.

    The RRIF Meltdown is normally best left until after you retire in order to give your investments longer to grow without tax. Depending on exactly what tax bracket you will be in after you retire, there may be an exception to this, since you are in low tax brackets now. However, in general, RRIF Meltdown = Leverage + RRIF withdrawals. For most people building their retirement nest egg, it is usually best to do the leverage but not the RRIF withdrawal.

    If you are a newbie, we would recommend not to pick your own stocks. Also, dividend paying stocks are taxed very highly for most seniors (see the TFSA article about clawbacks), depending on what tax bracket you will be in. Investing with professionally-managed mutual funds focussing on capital gains will probably end up working better for you and save you tax after you retire.

    You would need a more accurate forecast of your tax bracket in retirement to figure these out properly. From your info, you will probably be close to the $37,000 threshold above which tax on seniors becomes very high.

    I hope these general comments are helpful, Peter.

    Ed

  106. 146. Ed Rempel

    Hi Nom,

    It is not necessary that investments are in Canada for the interest to be tax deductible.

    However, the strategy you mention has some drawbacks. First, the interest will be fully tax deductible each year, so you would not be getting refunds. You would need to claim all the interest earned in order to claim the deduction.

    The high interest makes them sound safe, but countries with high interest rates almost always have high inflation which leads to declining currencies. Currencies are hard to predict, but it would be reasonable to expect large annual currency declines from those bonds. That would be a high risk strategy.

    Tax-efficient equities or mutual funds can give you tax refunds and might be less risky. Remember, sovereign bonds can go to zero in high inflation (eg. Germany in the 1920′s), while stock markets have never gone to zero.

    Ed

  107. 147. KG

    Hi, how are you? I’ve enjoyed the advice, and learnt a lot. I was wondering about a couple of tax implications.

    1)
    It has been suggested that when mutual funds offer dividends, that they be reinvested instead of having them paid out. However, isn’t it better to have them paid out, and put towards the mortgage? This frees up the equivalent credit on the LOC which can then be borrowed and invested in the original mutual funds?

    Simplified Example:
    $100,000 mortgage,
    $1,000 mutual funds.

    If $40 of dividends are reinvested, we have:
    $100,000 mortgage,
    $1,040 mutual funds.

    Instead, take the $40, pay off the mortgage
    the mutual fund is valued at $1,040, and the mortgage is still at $100,000. However, if the $40 was paid out, put against the mortgage, then we have:
    $99,960 mortgage,
    $40 LOC,
    $1,000 mutual funds.

    And then you pull out of the LOC, and invest in the mutual fund, and we have:
    $99,960 mortgage,
    $1,040 mutual funds.

    Same result in the investment, but less mortgage too. Did I mess up in my logic???

    2)
    I’m trying to evaluate a strategy which attempts to accelerate the Smith Man. More info at TDMP.com, if you’re interested.

    I understand that Return of Capital reduces the ACB of an investment, unless that distribution is used to pay down the loan, then re-borrowed and reinvested in that investment. This would keep the ACB the same.

    a) IF this is the case, does CRA still require that the potential for dividend / interest income to be paid in order for this to be tax deductible? I would assume so.

    b) Could this work similar to example 1), where it goes through the mortgage first?

    i.e. if the ROC is paid out, then paid to the investment loan, and re-borrowed, that would keep the ACB at the same level, so what if the ROC was paid to the mortgage, the LOC credit that it produced could be borrowed to pay the investment loan, and then reborrowed. Would that still keep the ACB intact???

    This seems to be the basis of the Tax deductible mortgage (TDMP), where they set up an income generating fund which pays a fixed 8% monthly (which I understand to be at least partially ROC), to generate a monthly income which goes to pay down your mortgage, free up credit on the LOC, and get used for investing. Somehow this still stays deductible. I can’t think of how else it would work.

    Thanks for your advice – hope the questions make some sense.

    KG

  108. 148. Ron

    I am not sure if these questions have been asked but here goes. I am thinking about implementing the smith Manouver but I am not sure if I should.
    First of all I just mooved into a new house in last december, I did a lot of the work myself and with the recent increase in real Estate in this area I have a fair amount of equity built up(at Least I think so) about $100,000 to $120,000. My mortgage is 5 year fixed at 5.24%.
    1. My first question is my legal fees would be a couple of thousand dollars to switch my mortgage in order to take advantage of the HELOC, Is this too much or should I wait until I get closer to the end of my term to reduce the costs?
    2. If I did go ahead could I use the equity to purchase a rental Property or at least a down payment on one. Would the interest on this then be tax deductable the same as if I bought stocks?

    Thanks

  109. 150. FrugalTrader

    Ron, I would check to see what the costs are to cancel your existing mortgage first. If it were me, I would probably wait until the 5 year term is over.

    Yes, the HELOC can be applied towards rental properties and still be tax deductible.

  110. 151. Ed Rempel

    Hi KG,

    Your example has a few flaws in it:
    1. The original investment loan does not maintain its tax deductibility. In your example, I am assuming you would borrow $1,000 to put into the fund. Once you take a $40 ROC distribution, only $960 of the loan is tax deductible. Your mortgage is $40 lower, but $40 of your investment loan is not deductible. In short, receiving the ROC distribution changes nothing (other than giving the advisor a new commission) – you owe the same total ($99,960 mortgage plus $1,040 loan), the same amount is tax deductible ($1,000 of the $1,040 investment loan), & you have the same amount invested. However, you will have to calculate every year that you have the investment loan what percentage of your loan interest is deductible. This is called the “Snyder Tax Calculation”.
    2.The ROC is not income, or fund profit – it is giving you back some of your principal. Your example shows the fund at $1,040 paying a $40 distribution. It seems that you are thinking the fund made a profit of $40 and then paid it out. That is not what ROC is. No matter what the fund does, it gives you back $40 of your original principal.
    3. Since ROC is principal, not income, it does nothing towards satisfying CRA’s requirement of investing for income. CRA is looking for investments that would be expected to have taxable income in the future – paying out non-taxable principal is not relevant.
    4. The ACB refers to the investment. If you take a ROC distribution, the ACB of the fund is reduced. Many people think this is tax-free, but it is only tax-defered. For example, if you receive an 8% distribution, then after 12 years, your ACB is zero and the entire distribution is taxable as a capital gain from then on. If you then sell the fund, for it’s original value (say $100,000), the entire $100,000 proceeds of sale is taxable, since the ACB is then zero.
    5. Regarding your question about the difference between paying the ROC onto the loan vs, the mortgage, in both cases, the ACB of the investment is reduced by $40 and $40 of the investment loan is no longer tax deductible. The difference is that if you paid the $40 onto the loan, then the interst on the remaining $960 is all still deductible. If instead you pay it onto the mortgage, then the interst on only $960 of your $1,000 investment loan is deducitble.

    In short, there is no benefit of the ROC distribution, plus it is much more complicated because you would then have to do the “Snyder Tax Calculation” every year on your tax return. I realize it looks cool, but when you understand it, there are no benefits at all. There are a lot of posts on MDJ about this.

    We would recommend to avoid any strategy involving paying out a ROC distribution (except possibly if it is paid entirely onto the investment loan).

    Ed

  111. 152. Ed Rempel

    Hi Ron,

    It is probably worth breaking your mortgage, since the 5.25% is very high compared to about 4.0% that variable mortgages are at now.

    There should be no legal fees at all, since banks will commonly absorb them. There will be a penalty to get out of your current mortgage, though.

    Calculating it definitely can be complicated, since the alternative is that you put a 2nd credit line on your home to borrow to invest. You can borrow all the principal in both scenarios, but you don’t gain the principal portion of future mortgage payments to use for paying the interest on your initial lump sum.

    If you want a definite calculation, we offer this as a free service at:

    http://www.milliondollarjourney.com/ed-rempels-picks-for-the-best-smith-manoeuvre-mortgage-iii.htm .

  112. 153. Peter

    Hi Ed,

    Thank you so much for replying to my May request “Strategically Challenged Newbie”.
    I forgot what thread I posted my request on and did not see your reply until today. How’s that for challenged?
    I tracked our expenses for the month of June and we have implemented our budget. We will track for three months to give us a good average to find out where our money is going. I did leave a few variable expenses out in my request, that I budgeted for.
    I will be visiting the Scotiabank on Thurs. to find out what’s going on. You’re right that is high. It started out at 3% in 2004.
    Life Insurance costs include a policy my wife has on her ex-husband costing 32$ a month. This is to cover his child-support if something happens. I would like to cash it out next year and apply it to our mortgage on renewal. The rest is term insurance for us both .
    We are not risk adverse providing it is low-risk investing.

    My wife and I will both be collecting Canadian Forces pensions @ 60 yrs of age = 22k gross. They will be indexed @65 yrs of age and i don’t know what that will work out to be.
    We will both apply for CPP @ 60 so I will be collecting five years before her. About 11K combined at that time.
    We are also working on a co. pension with present employers but these projections won’t be avail until we have been members for at least three years. We then have OAS @ 65.

    At present projections based on today’s numbers @ 65 I will be collecting around 28K in CPP,OAS and CF Pension. I still have my private co. pension to come.

    Tricia will receive 16K @60 and another OAS payment of $5800 @65.
    This does not also include her co. pension.

    When we both reach 65 our pension calculations work out to 48K without allowing for indexing and our co. pensions. This is 50% of our current gross income, with more to come and inflation also.
    We still have 13-18 years to grow our RSP’s of 121K to help in retirement.
    I would also like to start a non-registered account with blue chip Cdn dividend paying stocks to hold for the long term and help fund retirement.
    My RRSP deduction limit is $14,087 and Tricia’s is $25,017.
    We are trying to put this retirement plan to bed. Thanks for allowing me to share and your advice is most welcome.
    __________________
    Peter

  113. 154. nicolas

    hello all, i tried to read as much as i could, but there is a couple years of reply’s to this very interesting topic.

    my question is fairly simple i fear. there was a statement made in the original article, something along the lines of “the payments never go away, they just transfer from mortgage payment to interest payments on the line of credit.”

    how does the cycle end? must i sell all of my investments, pay off the line of credit, and then resume investing without using borrowed money?

    thanks to all,
    nicholas

  114. 155. Controller

    This site is great, I like the spin you guys ar putting on the idea of wealth creation. Just to get my head around this Smith Manoever, I am trying to make sense of how this would keep you cash flow neutral. Can someone provide an example that illustrates that point? Let’s say that I took out 190K mortgage 5 years ago (balance now 160K due to some double-up, prepayments etc) on a house that was 250K, (now worth 380K). Base payments are $1200/mth (600 bi-weekly). I am trying to wrap my head around how I could pay that same 1200/mth and end up paying my mortage off faster and end up with investments to boot. Maybe I just need to understand how these re-advanceable mortgages work? I have basically been putting whatever extra disposal income into stocks and so I have about 80K (net equity after margin portion)of stocks in a discount brokerage outside my RRSP, which looks like I could borrow against to pay against my mortgage and leave me with a 80K balance on my mortgage. (but obviosly would still have a 80K loan) I have 18months left in mortgage term.

  115. 156. Slack Investor

    Controller,

    I think from a Smith Manoeuvre perspective, your best option is to take the 80K of non-registered investments that you have and pay that directly against your mortgage (you may have to refinance to be able to pre-pay this much, but it may be worth the penalty). This would leave you with an 80K mortgage balance and 300K in home equity that you can borrow against with a HELOC. Then borrow 80K again and invest that, now your mortgage payments will be lower and you can use the freed up cash flow to cover the interest charges (which are tax deductible) on the 80K. Any leftover cash flow can then be applied against your mortgage to accelerate payments and do the same thing all over again.

    For example, if on a monthly basis you have an extra $100 cash flow after paying mortgage and interest payments. You can increase your mortgage payments by the $100 per month, and at the same time withdraw $100 per month from the HELOC to invest (thus increasing your tax deductions).

    Also, at the end of the year when you get your tax refund check, you can top up your mortgage again and borrow the same amount.

    And so the cycle goes.

    I hope that helps.

  116. 157. Controller

    Hey guys, I think I want to inquire about a HELOC with my bank (RBC), what should I expect in terms of an interest rate considering the economy of late. I noticed in some of the earlier posts, that P -0.9 was an expecation. I can get a president’s choice secured LOC for prime, but I was wondering what the big banks are offering through some negotiation?

  117. 158. Andre

    I have never seen a HELOC advertized at P- anything. Typically it is P only. THis is the biggest downfall I see with HELOC’s as you could get a variable mortgage @ P – 0.6, 0.8. Then if you need to borrow further you can continue applying and cancelling credit cards at low introductory rates. I recently borrowed 9K @ 1.9 % for 6 months and have a mortgage @ P-0.8. If I consolidated the 9K + my mortgage into a HELOC I would be paying an extra 0.8 on the full value of my mortgage and an extra 2 or 3% on the 9K I just borrowed …

    I think there is legal precedent for providing flexibility in justifying investment loans in Canada but am unsure. But for this reason I have been shying away from HELOC and using the lowest possible rate for any borrowing.

    Let me know who is getting HELOC’s @ P-0.8 and I may reconsider …

  118. 159. FrugalTrader

    Controller, I would be impressed if you got a HELOC rate at better than prime. Typically, the HELOC is at prime, but the “installment” portion can be discounted.

  119. 160. petr

    i plan on doing something similar to the sm here in toronto called the tax deductible mortgage plan. I am a novice to this all but i think it is similar to the ed rempel way. i have a quick question tho do u believe i should have a fixed or a variable mortgage

  120. 161. DAvid

    Petr,
    There is a discussion on this topic on Canadian Capitalist’s blog:
    http://www.canadiancapitalist.com/2007/01/28/the-smith-manoeuvre-debate
    beginning at about message #166.

    You might wish to review the comments there.

    DAvid

  121. 162. Ed Rempel

    Hi Petr,

    Some versions of the tax deductible mortgage plan are similar to ours and some are not. The critical difference is whether an investment that pays out monthly distributions is used.

    These funds (sometimes called an “engine”) usually pay out a tax-free “return of capital” distribution, which has been discussed at length on this site and causes a tax problem.

    This distribution is not income, but is giving you back a bit of the principal you invested. If you borrow to invest and then cash in the investment and pay it onto your mortgage, you cannot expect to still expect to deduct the interest on the investment loan. Similarly, if you receive the return of capital (ROC) distribution, you cannot expect to still deduct the interest on that portion of your investment loan.

    In answer to your questions:

    1. Be very careful with any plan involving return of capital distributions. Insist that any financial advisor recommending it do your tax return and put his name on it, if he claims there is no tax problem.
    2. The Smith Manoeuvre does not involve taking any money from investments. Projections we have done show that expected long term returns are almost always higher without the distributions. (See other articles on this blog.)
    3. Variable is historically cheaper, and today the difference between variable and fixed rates is very high (more than 1%). Stick with variable.

    Ed

  122. 163. petr

    hey david thanks for the link i did find some info about variable vs fixed but it seemed to be around post 50 or so i think. If i am looking at it correctly a variable would be best as this is almost always under the interest of the heloc loan. is this correct? Has anyone heard of the tax deductible mortgage plan out of toronto? what do they think and anybody the can recommend to do it, thanks once again all i am hoping to start this up in november and i am trying to wrap my head around this after going to the seminar in oakville. I have some figures they gave me for my scenario if this helps. What would be the main worrisome point in this strategy ie mortgage rate> heloc rate?, i know the investment aspect is risky but it seems if your in it for more than 15 yrs you should be ok.

  123. 164. FrugalTrader

    petr, most HELOC rates are at PRIME. The installment portion of the mortgage can be with a variable rate which should be prime – x %. So yes, the mortgage portion should always be cheaper than the HELOC providing that you go variable and not fixed.

  124. 165. peter springer

    The opening paragraph is misleading. You cannot make the interest on your mortgage tax-deductible like they do in the states. Only the interest on the HELOC is deductible, which you would not have if you didn’t do the maneuver. It makes sense that the interest you pay to borrow for investing is deductible, it is a cost that is used to figure out your gain or loss. If you can consistently make a higher rate on the investments than you pay for the HELOC, then you will do well.

  125. 166. rush_hour

    Hi,
    I stumbled over this website just when i am in the process of looking for a mortgage for my first home.
    First of all, let me mention this is an excellent blog and provides really good information.
    I have been researching info. on mortgage and came to know about smith manoeuvre (SM) here.
    Would you think SM remain as attractive when prime goes up, ’cause the idea is to borrow money from the lender at prime, invest and expect to gain good return (say 8 to 10%). But as the prime increases margin of profit decreases. Also 50% of capital gain is taxable that further reduces the cash flow. I was wondering what do you think of investing in a rental property.

    I am planning to put 20% downpayment for my new home. Scotia is giving me P-.75 open STEP insured but as mentioned here it is not favorable for SM. How about National bank, do they offer competive rates and at the same time preferable for the SM.
    Does RBC homeline plan offer good rates? ’cause it seems its a hybrid of fixed and variable (at prime).

  126. 167. MIke McKay

    For people utilizing this strategy we have created an online tracking system. http://www.strategenpro.com.

    Features include:
    -detailed history
    -illustration tools
    -income allocation
    -ability to use actual investments

    Try out the demo.

  127. 168. Ed Rempel

    Hi Mike,

    There is a significant error in your tracking system. Your example shows funds with the T series paying out distributions. These distributions are return of capital (ROC). Any amount of these distributions that you receive will reduce the amount of the loan on which the interest is deductible.

    In your example, you have $1,368.94 monthly distribution in year one, which would be $16,427.28. Therefore, the interest on $16,427.28 of the investment loan is no longer deductible.

    With an investment loan of $181,466.67, you can only claim the interest on $165,039.39 of this loan.

    This declining interest deductibility is called the “Snyder tax calculation”. CRA expects you to do it accurately every year to prove your claim for the interest deduction.

    Ed

  128. 169. Scott

    I just purchased a home for 245k, I put 49k (20%) down so that I could utilize the BMO Readiline. I was only able to get prime – .65, but feel that I should have got prime -.75. My mortgage is 196k, and my LOC is starting out at $1. Should my LOC only be starting at $1? How will it be increased and by how much? The mortgage is a 3yr open term, with an amortization period of 35 yrs, so my payment is about $840.00 per month, which leaves me with $300-400 cash after all expenses. I am concerned about the LOC portion because I would like to move my car loan of $10k from TD to the Readiline LOC because of a lower interest rate. I would also like to use the LOC to invest Can this be done in my current position? I currently have about 8k invested with Questrade as well. Any feedback is appreciated.

  129. 170. Scott

    Forgot to mention following in my above post: This is my first home, my 10k auto loan is my only debt, and I am 25 yrs old.

  130. 171. DAvid

    Scott asks: “I just purchased a home for 245k, I put 49k (20%) down … My mortgage is 196k, and my LOC is starting out at $1. Should my LOC only be starting at $1? How will it be increased and by how much?

    These HELOC products begin at 80% of the value of your home, which is exactly where you are right now. The HELOC will increase by the amount of principal you pay each month. Your total available loan amount will remain at (Mortgage + HELOC) = 196K, unless you have your house re-assessed to a higher value. Manulife will allow you to have a CMHC insured loan (90% instead of 80%), but then you pay CMHC fees.

    … I would like to move my car loan of $10k from TD to the Readiline LOC because of a lower interest rate. I would also like to use the LOC to invest Can this be done in my current position?

    Not until you build more equity in your house.

    I currently have about 8k invested with Questrade as well. Any feedback is appreciated.”

    You could perform a Singleton Shuffle by cashing your investments, paying down your mortgage, and borrowing from the HELOC (now $8000 less capital gains taxes) to purchase new investments. See Smith Manoeuvre details for more info.

    DAvid

  131. 172. Chad

    Hi there,
    We have about 93K equity in our town house and a mortgage through Canada Trust at 4.1% that come due Jan 1/09.

    I have a secured line of credit through cibc for $32000 at 4.75%. Secured to the house. I’m using about 17000 of it for my truck.

    I don’t have much of a port folio, maybe about 7K of RRSPs through my work plan.

    Is the smith manoever for me, or will it not work b/c I don’t I don’t have enough equity with my secured line of credit? With the unstable economy and the market being so bad isn’t that cause for concern with this style of mortgage?

    Please help!

    Thanks, Chad

    I wan’t to consolidate my truck dept of 17K from my secured loc to my mortgage as well so I only have one payment.

  132. 173. Chad

    Hi there,
    We have about 93K equity in our town house and a mortgage through Canada Trust at 4.1% that come due Jan 1/09.

    I have a secured line of credit through cibc for $32000 at 4.75%. Secured to the house. I’m using about 17000 of it for my truck.

    I don’t have much of a port folio, maybe about 7K of RRSPs through my work plan.

    Is the smith manoever for me, or will it not work b/c I don’t I don’t have enough equity with my secured line of credit? With the unstable economy and the market being so bad isn’t that cause for concern with this style of mortgage?
    What would be the best style of mortgage for me? The Red Frog?
    Please help!

    Thanks, Chad

  133. 174. Ed Rempel

    Hi Chad,

    You did not tell us how much of this $93K equity is the 20% down, but if you have a securd credit line of $32,000 that is not fully used, then you have enough equity for the Smith Manoeuvre.

    The bigger issue is whether or not you have the temperament for leveraged investing. If you are nervous about starting, then perhaps it is not right for you. Leveraged investing should only be done as part of a long term strategy, in which case what happens in the first year is not significant. If you are trying to “time” the entry, then you will probably try to time future investments – which likely means you will invest very badly.

    An “unstable” market is exactly the best time to invest. In general, unstable vs. stable markets are irrelevant – low priced vs. high priced markets may be relevant. Do you consider today’s markets to be low-priced or high priced?

    We had not heard of Red Frog until you mentioned it, but a quick check on their web site shows it is a credit union mortgage that looks a lot like Manulife One, except there seems to be no mention of separate sub-accounts. Without separate sub-accounts, it is useless for the Smith Manoeuvre, since it is important to keep the deductible account separate from non-deductible accounts. It also seems to be completely non-competitive in mortgage rates, like Manulife ONE.

    If you still want to do the SM, you will need a readvanceable mortgage. The best products are with a couple of the big banks. We have a referral service called “Ed’s Mortgage Referral Service” that may be helpful for you. It is discussed in my article about the best SM mortgage on this site.

    Ed

  134. 175. M.Burns

    Hi all great discussion and very informative. I have 2 quick questions and by reading them you will probably figure out I’m new to all this.
    1. When you buy dividend paying stocks through a brokerage account and they are in a RRSP where do the dividends go? Do they mail you a cheque each quater?
    2. I like FT’s idea of doing the SM and investing in blue chip dividend paying stocks, so can you invest in DRiP’s when doing the SM? It seems like your investment would grow even faster if all the dividends were re-invested automatically.

    Thanks.

  135. 176. FrugalTrader

    M. Burns.
    1. Dividends within an RRSP are either deposited as cash in the RRSP or re invested. If you want them re invested, you will have to call the brokerage to set this up. Note that with the SM, any money put into an RRSP is not tax deductible.

    2. Yes, DRIP should be possible while doing the SM. Ofcourse, you’ll have to discuss this with a financial planner first.

  136. 177. cannon_fodder

    M. Burns,

    Eeehhhcellent!

    Actually, you may find that some brokerages (more likely the discount ones) can’t handle all cases of DRIP. If you are talking blue chips only, it should not be a problem. I have seen issues with BMO Investorline and some income trusts where they didn’t support DRIP which is a shame since some of the income trusts also give you a 3% or even 5% reinvestment purchase discount.

  137. 178. M. Burns.

    If I wanted to do a test DIY SM with my M1 account would I just withdraw say $10,000 and invest it in DRIP stocks then open a sub account to track the interest I pay on the $10,000?
    Can I claim the interest on my taxes every year?
    Can I do the same thing to top up my RRSP’s and also claim that interest?

    Thanks.

  138. 179. DAvid

    M. Burns said: ” If I wanted to do a test DIY SM with my M1 account would I just withdraw say $10,000 and invest it in DRIP stocks then open a sub account to track the interest I pay on the $10,000?”

    You should probably open a $10,000 sub account, and use that account to purchase the stocks. You might have trouble separating the the interest amounts if you have not created the sub-account first.

    “Can I claim the interest on my taxes every year? “

    You can claim the interest paid each year on that year’s taxes.

    “Can I do the same thing to top up my RRSP’s and also claim that interest? “

    You can’t claim interest on a loan to support an RRSP — you get the deduction when you purchase.

    DAvid

  139. 180. M. Burns.

    I am still reading the SM book and everything I can find online but I have a few more questions. In the book it talks about how you can lower the amoritization of your mortgage but in reality since your HELOC is growing at the same rate as the mortgage is decreasing your not really paying anything off faster.

    Do you keep this HELOC loan forever so you can use the tax deductable interest every year?

    Does it matter if your mortgage and accounts are joint accounts in both yours and your wifes names? Do you claim the interested deduction on only your taxes?

    In a true SM do you use all of the equity you have built up right away? For example house value $500,000 mortgage 350,000 so do you take out and invest $150,000 in the first year?

    Thanks.

  140. 181. DAvid

    M. Burns,
    Smith considers the Mortgage & HELOC to be two different loans: the BAD non-deductible, amortized mortgage, and the GOOD deductible, interest-only HELOC. Smith argues that you are indeed paying the BAD loan off faster, while building a portfolio greater than the value of the HELOC.

    Smith (and others) suggests keeping the HELOC for life, as the income generated should be greater than the interest cost each year. Ed Rempel states that in retirement, the interest deduction is pretty much the only deduction you will see.

    It should not matter that the accounts are joint, but only one of you can claim the deduction. The deduction should be taken by the individual with the higher tax rate.

    In a true SM, you use all the equity in the home. On day 1, you have a $550,000 home, having made a 20% down payment and a $440,000 mortgage. Your first months payment of about $2560, reduces your principal by about $740, which you re-borrow from your HELOC and invest. Wash, rinse, repeat.

    Since you have accumulated some equity in your home (about $90,000) you could consider immediately investing that sum.

    DAvid

  141. 182. Fred

    Ed:

    I have one question about SM practice:

    Assume I am doing SM at BMO Readiline ,What will happen if I want to change my house after 3 years?
    will I need close all mortgage and LOC and investment accounts ?
    If so ,I will get capital gain tax,or bad market may kill my investment account .

    IF I can get other SM mortgage for new house without touch my investment account,so I will use new LOC to replace old LOC account,is the new LOC account still tax deductible ?
    I just wondering about that,because the new LOC is to pay off old LOC, not for investment?

    Thanks lot.

    Fred

  142. 183. M. Burns.

    Thanks for all the great info just a couple more questions.
    1. If I invest in DRiP stocks and the dividends are automatically reinvested to buy more stocks how will this effect doing the SM? Are dividends considered ROC? and will that lower the amount of the investment loan that I can claim each year for my taxes?
    2. What is a margin call? If my home is valued at $300,000 and I have a mortgage of $200,000 with M1 what happens if real estate prices fall and my house is only valued at say $150,000?

    Thanks again.

  143. 184. FrugalTrader

    1. M Burns, dividends are not ROC. If you want to avoid ROC, I would avoid income trusts. Reinvested dividends are ok for SM.
    2. Margin call is if you have a margin account with your discount brokerage and has nothing to do with your HELOC.

  144. 185. M.Burns.

    What would happen though in the following situation. House is worth $300,000 and I owe $200,000 on mortgage. I get an M1 mortgage and they give me a LOC for $100,000 which I max out to do the SM. Lets say real estate market crashes and house is only worth $150,000, now my mortgage and LOC is worth more than the house what if anything would Manulife do? Would they want me to pay back LOC right away?

  145. 186. DAvid

    So, you present Manulife with the following info:

    You have a $200,000 debt to them,
    A home worth $150,000,
    A portfolio worth $100,000+, and,
    A regular paycheque of $XX,000

    I don’t think you need worry too much about them calling your loan. If you are still concerned about the leveraging at this point, possibly you would sleep better without leveraging.

    DAvid

  146. 187. M. Burns.

    I have no interest in mutual funds or having someone else set up the SM for me and would much rather do it myself. Where would I find a reputable accountant or financial advisor who understands SM and tax issues and who would work on an hourly basis just to go over my situation. I am in the Toronto area. I really don’t want a salesman who will try to talk me into buying their investments.

    DAvid would you provide this service since you seem to understand SM well and aren’t really trying to push it on anyone?

  147. 188. DAvid

    M. Burns,
    Sorry, but I am not a CFA, and therefore am only qualified to offer personal opinion, not financial advice.

    I think this also is telling on your do-it-yourself plan, as to date, you seem to be entering this project with little financial experience or knowledge. If you live in the Toronto area, there are a wealth of FAs available to you, including some who participate on this board. I am not certain that a FA would care to be in the position of offering the set-up of a SM, then allow you to manage it without their tutelage, only to have you return asking their help to untangle a mess in the future. In other words, if their hand is in it, they wish to ensure the plan stays on track through any changes in the economy that might occur.

    DAvid

  148. 189. Ed Rempel

    Hi Fred,

    There is no problem maintaining the SM with a new home, as long as you will have at least 20% down on the new home.

    When you move to a new home, you can just geta mortgage and SM credit line on the new home, just like you do with a regular mortgage. If you start with the SM credit line at the exact same value that it ended with your last home, then there should be no problem with tax deductibility.

    The issue is tracing the money. If you refinance a tax deductible credit line or loan, the new loan is also deductible, as long as you can trace it and do not mix it with any non-deductible loan or credit line.

    Ed

  149. 190. Jordan

    What happens in an inflationary environment when rates skyrocket? Answer: the Smith Manouvre falls apart. Can you imagine paying 10-12% in interest when markets only return 6-8%% over the long run?
    This strategy was developed in a low inflation bull market environment that ignores six sigma events like hyerinflation.

    Use at your own risk.

    Jordan

  150. 191. cannon_fodder

    Jordan,

    Wouldn’t you simply stop withdrawing from the HELOC? You have a choice to withdraw at 10% (even if your MTR is 40%) to try and earn 6%-8% or simply not touch the HELOC (or only enough to capitalize the interest).

    Another more drastic choice would be to sell off enough investments to pay down the HELOC to whatever amount you feel is palatable.

    There are choices and each circumstance will dictate which are more favourable.

  151. 192. Len

    How is the Smith Manouvre working for you all now that the markets have tanked?

  152. 193. FrugalTrader

    I will be doing another SM update at the end of the month. After today’s major sell off, my account is down 7% YTD.

  153. 194. Fratguy

    Jordan,

    What does it matter what percentage interest you are paying on your HELOC? At the end of the year, you will get all the money back in tax returns. If I have this idea wrong then someone please clear-up this confusion.

    Thanks!

  154. 195. DAvid

    FratGuy states: “If I have this idea wrong then someone please clear-up this confusion.”

    Let’s say you spend $5000.00 in HELOC interest to support an income producing investment. On claiming this on your tax return you will get a tax refund of the taxes you paid when you earned that money. So, if you are in the 30% tax bracket you will see a tax return of some $2100.00, and still be $2900.00 out of pocket. If the interest rate doubles, you have to pay $5800.00 out of pocket to retain the same portfolio. If your portfolio returns $3500 in income / growth annually, the lower rate makes sense, while the higher rate likely does not. It becomes akin to buying $10 bills at $20 a piece.

    DAvid

  155. 196. petr

    hello all i was planning on startine the sm/rempell max when my mortgage is up for renewal the end of this nov. My question is with the way the markets are would it be best to still go ahead or just go variable for a while until things are a little clearer/less volatile and then start then. Any input or advice back would be very helpfull thanks

  156. Hi Petr!

    There are two important things you should keep in mind. One is that the SM is not a short term thing you do, and later stop doing, but rather a long process, lasting ideally as long as you live, and during this process the market will go up and down numerous times. But as far as the value of your home and investments are concerned, they will go up in the long term. So, the market is down now, but it is an adjustment that will reverse and come up again.
    The other thing, coming from the first, is that for you, the SM investor it is a good time to start now, because the reduced market simply means that you are buying your investments at a substantial discount.

    Of course, you should take into account your temperament for risk and your age and other obligations, before deciding about the particular investment, but it is a good time to start investing, when the price of securities are cheap. Not to mention the tax benefit.

  157. 198. Fratguy

    David,

    Thank you for the clarification. I am planning to buy my house next year and implement the SM. I plan on investing the HELOC into Canadian dividend paying stocks due to the special dividend tax credit. Since the dividend tax credit calculation marks up the dividend income 145%, as my income increases from dividends, my tax bracket will increase as well. This will have a positive and a negative impact, Negative, in a sense that I will have to pay more in personal income taxes. The positive impact will be that since the amount of tax refund for HELOC interest is directly proportional to the tax bracket, the higher my tax bracket, the higher my refund amount. Am I on the right track here with my assumptions?

    Thanks!

  158. 199. cannon_fodder

    Fratguy,

    I went to taxtips.ca to run scenarios through their income tax calculator. It is a quick and easy way to figure out how much the SM will affect your tax bill. Unfortunately, it is not a linear equation because the dividend tax credits have a different rate than working income. That is why running through the calculator is helpful.

    For me, in a rough estimation, I get 80% of the benefits of dividends and only 60% of the costs for interest charges after accounting for taxes. Thus, if I could earn 3% dividends and my HELOC was at 4%, I would come out even roughly speaking.

  159. 200. Fratguy

    Thank you Cannon!

    On taxtips.ca, there is no field for the interest that is charged on the HELOC. Would I have to calculate it manually, based upon my tax bracket, and then apply it to the Other Deductions field?

  160. 201. xerox

    I have got all confused and need some help clarifying ..
    Here is my scenario

    Primary residence : Total value 375K
    Down payment : 100K
    Primary Mortgage : 275K
    HELOC a/c :

    Heloc gets credited with the principal portion of the monthly mortgage amount.

    Rental Property : Total Value 205K
    Down Payment : 42K
    Open variable loan for the balance.

    Now with SM , should I credit the monthly rental check into my primary mortgage a/c , have that credit my HELOC a/c , withdraw from the HELOC a/c and than pay of the rental property mortgage ?

    Am I on track for SM ? ..

    Please advise..

    Thanks in advance.

  161. 202. Guy Davis

    Great article and discussion. I have one question though after having read the SM book. Why borrow and invest the same amount as you are able to pay off the mortgage? For example, let’s say you can pay the mortgage down $50K a year. The SM would have you borrow that $50K and invest it.

    However, what is the downside of only borrowing $25K and investing that? For those averse to the leveraging aspect of the SM, this would seem a nice “dial” to adjust.

    Thanks in advance for any responses.

  162. Hi Guy!

    Indeed, those averse of debt and leveraging might do better just avoiding the SM.
    As to the dial, yes, you can choose the amount invested, but the reduction in the number of years, the value of tax refunds and the benefits of the strategy are directly proportional to the amount borrowed and invested. So, if you are doubling your investment, the house will be paid off twice as soon, the tax refunds will be twice as much and the profit will be double too.

  163. 204. FrugalTrader

    Guy, I am doing just that, borrowing less than my HELOC limit. I personally only purchase equities as they appear cheap not because I have cash available.

  164. 205. DLM

    Hello, so we just came across this SM in the last few days and are very interested.
    Here is our situation:
    We bought our house for 455,000 last year and put down 90,000 now we have a morgage for 360,000 with the bank at interest 5.4% 40 yr term

    We have an outstanding debt (between credit line and credit cards) of 80,000.

    Can you please tell us if the SM would work for us? we would like to incorporate all of our debt in our mortgage and then begin the SM,

    do we have equity in our house? (with the real estate market down the value of our house would be down too?) or does our 80,000 debt take cancel out our equity.
    We pay $2000/mth for our mortgage.

    We are wondering if we would qualify to use the SM?
    thanks in advance.

  165. 206. FrugalTrader

    DLM, a couple things:

    • With 80k worth of credit line and credit card debt, the SM would be the very last thing i would try financially. Your best bet would be to aggressively pay down debt.
    • Not only that, you would need to break your current mortgage to get a readvanceable mortgage which would be costly.
  166. 207. Mark

    @FrugalTrader,

    Before I ask you a question or two, I must first comment on this site and its associated posts. Excellent stuff! Learning lots and I will continue to read and contribute in 2009!

    My questions to you are related to my financial plan, and whether or not the Smith Manoeuvre would work for us:

    Our status:
    -Owe $260,000 mortgage
    -no credit card, car loan or other debts
    -have $40,000 (each) in RRSPs and contribute ~$4,000/year to them, mostly in equities since we are young and want to take advantage of dollar-cost averaging (certainly in this market).

    Our plan:
    -start buying Canadian dividend-paying stocks. We could likely save and invest ~$2,000/year in dividend-paying stocks
    -continue to pay-down the mortgage at an accelerated bi-weekly rate including some lum-sum payments in the process (up to $5,000/year).

    Our goals (15-20 years):
    ->$25,000/year income from dividend-paying stocks
    -paid-off house (worth ~$350,000)
    ->$200,000 each in RRSPs.

    Thoughts from you and others?
    Thanks very much for any advice and experience you have in using the Smith Man. As you can read above, we want to do a “little bit of everything” to decrease our taxable income, start building dividend-income and reduce mortgage debt.

    Good luck with your net worth and investments in 2009!

  167. 208. DAvid

    DLM,
    If you incorporate your debt into your mortgage you would end up with a mortgage of 100% or more of your house value. To engage in the Smith Manoeuvre, you need at least 20% equity in your home. I second Frugal Trader’s comment that the first step is to pay down your debt, and add that while doing so, spend some time gaining knowledge of financial opportunities. Once you are debt-free, except for your mortgage, you can then consider the opportunities offered by the SM.

    In the interim, take a day & read the book.

    DAvid

  168. Hi Mark!

    You could do the SM and would be able to benefit from it.
    But in your present situation it would be a slow start that will gather force in a couple of years.
    If you decide to do it, you have to redirect your RRSP contributions to the SM. It would do more for you there.
    Your accumulated RRSP however, must not be touched and has no role to play in the SM>

  169. 210. Mark

    @Sandor,

    Thanks for the quick response!

    I guess I’ll have to read more about the Smith Man. and learn how to use our home equity as leverage for the dividend stock investments.

    But to do the Smith Man., I assume you’ll need to be very comfortable with leverage (your house) and not in any rush to pay-off your mortgage debt?

    Doesn’t the Smith Man., force you to pay lots of interest on your mortgage and not so much on your principal? This equates to paying-off your house at a much, much later date?

  170. 211. DAvid

    Mark,
    There’s also an historic discussion on this topic at Canadian Capitalist’s blog. Just search for “Smith Manoeuvre”.

    DAvid

  171. 212. Ed Rempel

    Hi Mark,

    No, with the SM, the more principal you pay on your mortgage, the more you can invest and the larger your expected benefit.

    Ed

  172. No Mark.
    If it is done properly, your monthly payments will be less and the house paid off much faster.
    But indeed, you must understand and be comfortable with leverage and the idea very much includes the assumption that the “mortgage” principal won’t be paid off, instead it is invested for your benefit.

  173. 214. Mark

    @Sandor and Ed,

    Thanks for the replies.
    Given your feedback, I think I will do some reading on the SM.

    By the way, what are the rates on a HELOC?

    If I can find a way to contribute more than a few thousand each year to purchase and hold stock investments – is the SM still valuable?

    Thanks again!

  174. 215. DAvid

    Mark,
    The more you pay on your mortgage, the more you can invest, the sooner you convert your loan to a deductible loan, and the faster your portfolio grows.

    HELOC are usually available at Prime.

    DAvid

  175. 216. Mark

    Hey David,

    More questions for you…

    Can the Smith Man. be used with a DRIP investment strategy? Or is it one or the other?

    I am strongly considering purchasing dividend-paying stock and then setting up directed reinvestment plans for those stocks. Those dividends would be reinvested in a non-RRSP account.

    Thanks!

  176. Bad news FT, most NEW HELOC are now at P+1 due to the recent credit crunch.

    From what I know, Scotia is still offering its HELOC at prime and maybe a few other mortgage firms. However, most financial institutions reviewed their variable rate policy (HELOC and variable mortgage rate).

    Thank god they can’t change existing contracts ;-)

  177. 218. Ed Rempel

    Hi Mark,

    There is no problem using a DRIP. It sounds like you are misunderstanding what the SM is, though. Using dividends from the investments is not part of the SM. Using taxable dividends can add to the SM, but it is only an optional extra. The SM is reborrowing the principal portion of each mortgage payment to invest.

    You mentioned trying to find a few thousand extra to invest. Paying that down on your mortgage and reborrowing will add to the SM, but with a $260,000 mortgage, you probably already pay down at least $8,000/year of principal that you can invest.

    Ed

  178. 219. DAvid

    The Financial Blogger said: “Thank god they can’t change existing contracts ;-)”

    Actually, I believe they can. My LOC rate was changed some years ago, fortunately to a lower premium over prime, and if I recall, my HELOC rate could also be changed by the bank with appropriate notice. If you review the Manulife One thread, you’ll find a bunch of folks upset over a change in the M1 rates.

    DAvid

  179. 220. Mark

    @ Ed,

    Good to know…there is no problem using a DRIP.

    No, I understand the logic behind the SM.
    Using a re-advanceable mortgage and the home equity you have, to invest in income producing vehicles; such as dividend paying stocks or rental property. As you pay the mortgage, the equity (home ownership) you have increases. So with every regular mortgage payment, you can invest the money the equity provides from the home equity line of credit.

    Yes, we have a $260,000 mortgage. We’re trying to pay another $5,000/year (lump sum payments) on top of our regular mortgage payments to decrease the amoritization.

    I am simply looking at the best way to continue this (pay down the mortgage) but also find extra monies (beyond saving and watching our pennies) to start a DRIP and invest in some dividend paying stocks for retirement income. We have another 20+ years until we retire :) No time to start planning like the present!

    Our status:
    -Owe $260,000 mortgage
    -no credit card, car loan or other debts

    Our plan:
    -start buying Canadian dividend-paying stocks. We could likely save and invest ~$2,000/year in dividend-paying stocks
    -continue to pay-down the mortgage at an accelerated rate with lump sum payments

    Our goals (15-20 years):
    ->$25,000/year income from dividend-paying stocks
    -paid-off house (worth ~$350,000)

    Thanks for all the feedback!

  180. Mark, the HELOC rates are slightly over prime now. The lenders no longer can afford to lend at prime. But prime being so low, this will not be a very onerous problem in the near future. Probably 4, 4.25 is what you can expect.

    Yes, the SM will work with stocks, but I personally prefer guaranteed segregated funds. If you invest in those there is practicly no chance of loosing, only gaining.
    In any case the SM is very valuable indeed.

    The reading is very much recommended.

  181. 222. Mark

    @Sandor,

    Thanks very much.
    I will likely do some much needed “Smith” reading over the next few months.

    Other than that, I can’t go wrong with the rest of my plan:

    -start buying Canadian dividend-paying stocks.
    -continue to pay-down the mortgage at an accelerated rate with lump sum payments
    -contribute to RRSPs.

    I’ll keep reading this post and associated comments.

    Cheers!

  182. 223. Newbie

    Is there any disadvantage to using the Canadian Tire all-in-one account with the Smith Manoeuvre? We have no debts other than mortgage and hope to pay in off in about 8 years.

  183. 224. Newbie

    Is there any disadvantage to using the Canadian Tire all-in-one account with the Smith Manoeuvre? We have no debts other than mortgage and hope to pay it off in about 8 years.

  184. 225. Baywen

    Good afternoon. I am involved in the real estate industry in BC as an unlicensed marketer of various developments. As a startup I have utilized credit card(s) to get myslef going over the past year.

    As I have not been making income tax deductions throughout the year (yes it was foolish, I know), I will have that to deal with as well.

    I have split my income with my assistant so that both of us have earned roughly $50,000.

    Currently I have roughly $20,000 in debt and with roughly $70,000 of room for RRSP.

    My mortgage is roughly $210000 with a home value of $425,000.

    As I have $18,000 coming into my pocket over the next couple of days, I am looking for some options from readers as to how I should proceed. Pay off dedt, do Sm in some fashion, RRSP’s???

    I am completely ignorant of the financial aspect of things and my advisor is not a hands on type of guy and is going to be replaced.

    Looking for genuine input.

    Thanks

  185. 226. Tony

    I first want to say I am so happy to find this site and so many intelligent people out here helping out investing rookies like me.

    I have two questions concerning tax deductability.

    1. If I use LOC to pay monthly mortgages and rental expenses such as propety tax, maintanance fee etc on my rental property, is the interest tax deductable?

    2. Last year I took out LOC from my then primary residence and used it as downpayment for a new house which I am living in right now and rented out the previous one. In this scenario, I see the only interest that can be deducted would be the mortgages that associated with my previous residence.

    However, could I still designate this rental property as my primary residence and consider the new one as rental property even if I am actually living in? What tax consequence would that be? Could I deduct intrest on LOC and mortgages on new house? will CRA disallow the deduction because it will be far more than the rent I received.

    This might not be much related to SM. However, I hope someone here can give me some insight about this matter.

  186. 227. DAvid

    Tony,
    Question 1: Yes you should be able to deduct those costs.

    Question 2: Yes, though you could re-mortgage the rental to it’s full value.

    Question 3: No. Else we could claim to still be living with our parents, while owning a rental in which we actually live. You are describing tax evasion, which is illegal, versus tax avoidance, which is perfectly legal.

    DAvid

  187. 228. Mark

    @DAvid:

    Quick follow-up question from Tony’s information: any LOC used to pay monthly rental mortgages & rental expenses have the interest as tax deductable?

    Thanks for the help,
    Mark

  188. 229. DAvid

    Mark,
    I an not a financial advisor, so you should confirm the information with a properly credentialed professional.

    My understanding is the the interest on a loan used to generate income is tax deductible. If you borrow to cover the legitimate expenses of that income generating property, the associated interest expense should also be tax deductible.

    DAvid

  189. 230. Tony

    David:

    Thanks for your advice.

    As for re-mortgage my rental property to the full value, do u think CRA will allow full interest portion of mortgages tax deductable? A sample to this would be: I have 200,000 mortage and 100,000 LOC on this rental, of which interest on mortgage is tax deductable while interest on LOC is not because i use it to pay as downpayment for the new residence. But if I re-mortgae the rental property, i.e, combine the old mortage and LOC into one single new mortgage, does this mean I can suddenly deduct all interest against my rental income?

  190. 231. Ed Rempel

    Hi Tony,

    No. If you add to your rental property mortgage money that was used for a different purpose, that interest is not deductible. There is a common misperception by landlords that they can increase their mortgage for a personal purpose and claim the interest, but you can’t.

    The tax rules in Canada are that interest deductibility is determined by the use of the borrowed money. So, David is correct that if you borrow to pay the expenses of the rental property, that interest would generally be deductible.

    Ed

  191. 232. Jason

    What are the implications for the SM if I were to buy a two unit building and rent out both sides, one tenant being my girlfriend?

    Any advice or opinions on the legal implications of this.

    Thanks

  192. 233. Jfriah

    Brilliant! First I’ve heard about this strategy. The next 1-3 years for me are all about restructuring and beginning to build my net worth.

    With mortgage coming up for renewal a year from now, looking forward to more reading. Tonight has already been a red-eye one from all the text absorbing!

    Thanks for the postings!

    onward and upward.

  193. 234. Bob

    hi ed,
    i have been following your posts on SM for a little more than 2 years..
    they are higly informative./educative..
    but i never got to implement SM because of the adverse opinion on Canadian Capitalist..

    anyways..has your opinion changed about leveraging given the current market scenario..are you feeling the heat from clients…have your clients been losing the same as market..or is your fund manager being able to mitigate the downslide.

    would the contributors here..who have been using a percentage as long term returns ( eg 8%, 12%…) ..still go about citing those percantages..

    thanks

  194. 235. Ed Rempel

    Hi Bob,

    Good question. 2008 was a very unusual year. I wrote an article that is coming shortly that shows how it compares to other bear market years.

    This has not changed our opinion about the long term benefits of leverage strategies like the Smith Manoeuvre. It has, however, emphasized how key it is that the SM must be a long term strategy.

    We have complete confidence that our “All-star fund managers” will still have good long term returns, including 2008. The high long term returns of the stock market include a lot of bear markets in history.

    There will be significant ups and downs, though. It is important with the SM to invest tax-efficiently and to make a reasonable long term return, which requires a high proportion of equities.

    We think of it as the “Owner’s Manual” for investing in equities and for the Smith Manoeuvre – you must be able to ride out the ups and downs.

    We had a client event a few years ago to which we invited 2 opposite fund managers – a top hedge fund manager and a top tech fund manager. The hedge fund manager talked about the importance of “Rule #1 – Don’t lose money. Rule #2 – Don’t forget rule #1.” Then he went on to show the math that you need a 25 % gain to get back even after a 20% loss.

    Then the tech fund manager stood up and just said that the math was right, and all he could say is that the markets do make this up all the time. There have historically been a lot more large gains than large losses, the largest gains tend to be not long after the largest losses, and the strong long term returns of the markets include past large down years.

    It was a very informative exchange.

    Long term projections are part of evaluating any strategy, but they should be conservative because of all of the things that can go wrong.

    The long term returns of various indexes including 2008 are still mainly between 10-12%/year, depending on which index and which period of time. Getting these returns can be quite challenging, however, especially with human emotions of investors, and returns do vary a lot with various time periods, even when you look at 10-year or 20-year periods.

    For us, a long term return of 8% still seems conservatively achievable with an all-equity portfolio of all-star fund managers.

    Ed

  195. Hi Ed!

    On the whole I can only agree with you. But in the details I could have a few quibbles with your caveats.
    I also have written about this a few months ago, but without the caveat of “all-star” managers and mysterious techniques.
    The general idea is of course, that during years of negative growth investing is just as rewarding as in good years, provided the investor will be around to reap the benefits when the market returns to growth.
    Perhaps it is not too immodest on my part if I recommend this article. It was originally a circular letter to my clients, but I thought it had enough general appeal to be shared with a wider audience so, I posted it on my website and that is where you can find it: http://www.falconaire.com/news.html

  196. 237. Brud

    I am thinking of implementing the SM and using the LOC to invest in Rental Property. Here is my situation and this is what I am thinking about implementing.

    I have 2 lines of credit $50000 unsecured, $59000 secured in a HELOC with $250000 mortgage. If I use the LOC to purchase a 2 apt Rental Property $250000 – $100000 down payment from LOC gives me a $150000 Mortgage. I claim the interest paid on the LOC and use the tax savings to pay down my main mortgage. Then If use the extra room in the LOC to pay on the Rental Mortgage, would this also be tax deductible?

    I know this sounds a bit complicated but I figure I am getting the best of both worlds, I have a rental property which will generate income, and I am changing my main mortgage to a tax-deductible one.

    This make sense to me but am I missing something, or is there something else I should be concerned about?

  197. 238. Luigi

    I do not think anyone should be capitalizing the payments as you describe. Seems to me the dividend paying investments must have a yield much greater than the carrying costs of the HELOC. In addition, there has to be significant protential long term capital appreciation for those investments.
    HELOC carrying costs should not be supported through capitalizing the payment or from personal cashflow.
    Therefore captial preservation and yield are the important ingredients for leveraged investing to work. If this cannot be accomplished with some reasonable consistency, don’t do it.

  198. 239. Brud

    Just wondering if anyone has any advice on my previous post?
    I realize that I need to see a financial advisor and I am seeing one this week , but I would like to have as much information as possible before proceeding.
    I just purchase Fraser Smiths book this weekend and am about half way through it, pretty interesting reading.
    I would appreciate as much info as I can.
    Thanks

  199. 240. Ed Rempel

    Hi Brud,

    It sounds like you are trying to do a version of the Cash Dam. If I understand you explanation, you are thinking of 100% financing your rental and then borrowing to pay the rental mortgage. That would work fine, but may not generate much of a refund.

    You may want to consider doing the Cash Dam. You can borrow to pay all your rental expenses on your credit line. Better would be a credit line linked to your mortgage.

    Then you can pay your gross rent down as an extra lump sum on your mortgage each month.

    This would have a much bigger benefit. It would pay your mortgage much more quickly (convert it to deductible as a rental expense) and generate much larger tax deductions than the “part Cash Dam” you are thinking about.

    Ed

  200. 241. Ed Rempel

    Hi Luigi,

    The biggest benefit comes from the long term compound growth of your investments. If you are taking dividends or income from your investments constantly, you are drastically cutting into your long term, compound growth.

    For example, if your investments grow by 10%/year, they will double about every 7 years, so after 21 years, you should get 3 doubles and your portfolio should be about 8 times your starting number.

    If instead you take a 3% dividend out each year, your investments should grow by 7% and will double every 10 years, so after 20 years you only get 2 doubles and your portfolio ends up at about 4 times your starting number.

    In short, taking the dividend out and not investing it cuts your future portfolio in half after 20 years.

    It is this compound grow that is the biggest benefit of the SM. The tax savings are a nice addition, but most of the benefit is from the compound growth.

    Also, relying on your investments to make all the payments is considered a more risky strategy.

    The reason that capitalizing the interest on the investment credit line works is because it creates steadily larger tax deductions,while allowing you to leave your investments grow.

    Of course it also results in compound growth of the credit line, but all of this is tax deductible annually.

    The key is not yield, but having a strategy to earn reliable long term growth with a reasonable risk level. It requires confidence in the long term growth of equities. Investing in dividend stocks is one reasonable strategy, but you cannot forget that you are still in equities – and probably not very diversified if you are focusing only on yield.

    It sounds like you are a very cautious investor and may not have the temperatment for the SM.

    Ed

  201. 242. Alex

    Brud, Ed,

    I am going to purchase my first home within the next 6 months and I am planning to implement the SM towards a rental property investment and then a second SM from the rental property towards a stocks portfolio.

    I’d like to use the available equity in my principal residence as a downpayment for a rental property and then take a second mortgage to finance the rest of the rental property. In this case, I should be able to claim 100% of the interests of the rental (borrowed downpayment + 2nd mortgage)

    I spoke to my mortgage broker yesterday and he was saying that there is a grey area and I might not be able to claim interests refund on the downpayment portion… He advised me to contact my accoutant about that.

    Do you think that there is a way to do it or is it going to be an issue with CRA?

    Thanks !
    Alex

  202. Hi Alex!

    As the Lipson Case made it aboundantly clear, if you take out a mortgage to pay a down payment on the second property, the interest of that mortgage would not be tax-deductible.
    However, if you take the down payment from a line of credit, then the interest will be tax-deductible.
    So, make sure that you will make at least 20% down payment on the second property, from your own money and the rest you can finance from a loan. This way you can take advantage of the SM.
    If the 20% comes from a HELOC on your own home then that would be tax-deductible too.

  203. 244. Ed Rempel

    Hi Alex,

    If you borrow for the down payment on a rental property, the interest is tax deductible against the rent, as long as you keep it separate from your main home mortgage and can trace that the money went to buy the rental. This is true regardless of whether this is a mortgage or credit line.

    The key issues for tax deductibility are the use of the funds and your ability to trace that the funds are used for that purpose.

    Ed

  204. 245. Tom

    Hi everyone,
    I’ve read Fraser Smith’s book and have done a ton of reading on this strategy, but I still can’t quite get my head around the “substitution of collateral” aspect.

    We currently own a two bedroom townhome in the Vancouver area. We already have the RBC HELOC and the balance is at $221K, house worth about $290K. Let’s say we started the SM today and in 5 years we wanted to upgrade to a $400K house.

    Am I right in thinking that we wouldn’t have the 20% equity available for the downpayment on our new house that would be required to still qualify for the HELOC? The funds would be tied up in the investment loan portion of the SM.

    Am I missing something?

    Thanks for your help!

    Tom

  205. 246. FrugalTrader

    Tom, as far as I know, you would have to make up for the difference in equity, unless your current house increases in value. As well, you would get a new HELOC for the new house that would simply replace the one you have now. A mortgage/bank rep would be able to explain the process better.

  206. 247. Ed Rempel

    Hi Tom,

    If you buy a larger home in the future, all you need to do is to have a tax-dedeductible credit line on your new home that starts with the same figure you end with on your existing home. For example, if you have built up a $50K credit line with the SM, just have your mortgage on the new home setup so that $50K of it is in a credit line.

    The concept of “substituting collateral” is just that you can refinance a tax-deductible credit line, as long as you keep it intact and separate from non-deductible debt.

    There might be an issue with having th 20% down. Normally, you gain equity because your home grows in value and because you pay down you mortgage. With the SM, you are readvancing your mortgage paydown, so you only gain equity from your home growing in value.

    Usually, the worst-case scenario, if you want to buy a larger home and don’t have enough equity to get the 20% down, is just that you either sell a bit of the investments to get to the 20%, or you can refinance the tax-deductible credit line as an invesment loan so that the credit line is freed up.

    Ed

  207. 248. Tom

    That sounds good – thanks Ed!

  208. 249. Sky

    Hi,

    Thanks for the wonderful article. I just bought my first home and am trying to determine if SM is right for me. If so, I have to go to a bank with a SM-friendly product.

    My question is, what if you want to move to a bigger house, say 5 years down the road? You will have say 200k mortgage left, 100k borrowed from LOC, and hopefully > 100k in investment portfolio. When you sell the old property and move to a new, more expensive property, will you have to sell your investment portfolio to pay off the LOC (because it is secured by your old property, which you just sold?) That would be bad because you will have to pay taxes on any capital gains when you sell.

    Thanks!

  209. 250. FrugalTrader

    Sky, that is a common question. As far as I know, you can obtain a new line of credit to cover your old one and still remain tax deductible. If the house is more expensive, then plan to have cash saved to make sure you have the 20% down.

  210. 251. cannon_fodder

    Sky,

    Check out this link where a lot of homework about SM-friendly mortgages has been done.

    http://www.myvirtualmortgagebroker.com/Smith-Manoeuvre-Mortgages-Smith-Maneuver.html

    They have a column about portability to a new home. I hope that answers your question.

  211. 252. Sky

    Thanks for the replies. Yes I’ve seen that table. That says the mortgage itself is portable, but I was wondering what I need to do with the LOC part.

    For personal reasons, I need to be doing my mortgage with HSBC ‘s EPM. However, to re-advance, I would need to do re-financing with the associated re-appraisal, legal doc, paper work, admin fee. Obviously it is not feasible to do that every month to increase the LOC limit. Does anyone know of a trick or some kind of workaround that will make it work with HSBC? Anything I can do to effectively have a readvancible mortgage?

    One option I know is to just borrow the entire amount with LOC. That way I can reborrow my principal to invest, but I would be paying a higher interest (P+1) than a closed variable (P+.5)

  212. 253. cannon_fodder

    Sky,

    You probably know more about this product than I do (for personal reasons if nothing else) but the way I read the table is that there is an appraisal fee sometimes and that is only when increasing the LOC, not readvancing. The $25 fee per readvance is quite a pain, though. I wonder if this is only applicable if you do it at a branch vs. online. I can understand perhaps a charge to do this if a live person is necessary, but if it is online they really shouldn’t have to charge.

    Instead of advancing the entire amount (if you didn’t feel comfortable) perhaps you do it annually instead. Unless you are purchasing mutual funds, there may not be enough principal paydown on a monthly basis to purchase stocks efficiently.

    Perhaps you could take 25-50% of your available LOC and invest it immediately, then readvance on an annual basis.

  213. 254. Sky

    Hi cannon_fodder:

    I may be confused, I thought re-advancing means increasing the limit on the LOC. Could you please clarify for me?

    If I understand it correctly (I do not work there), when you apply for the EPM with HSBC, you get a mortgage + a LOC with a certain limit. The problem is, as you pay down the principal in the mortgage, the limit on the LOC does not increase. You would have to re-finance to be able to increase the limit on the LOC, and that re-financing involves reappraisal, paper work, fees, etc.

    In this case, making investments annually instead of monthly will reduce the pain. However, if it involves re-financing, it would complicat things if the value of my property goes down (in which case I’m not sure if I still want to re-advance).

  214. 255. cannon_fodder

    Sky,

    They are two different animals. You can readvance without increasing your limit (assuming you haven’t already hit your limit).

    For example, let’s say you have a $400,000 home – you could get a $320,000 combined mortgage/HELOC. Let’s say the mortgage portion is $200,000 and you are left with a $120,000 HELOC. The $120,000 is your limit and can’t be increased at HBSC without the reappraisal rigamarole. (If you do it in 5 years you may find the bank is quite willing to do it for free if they think that you will tap into that new found credit.)

    Now, let’s say your first mortgage payment of $1,000 is made. Let’s imagine that your principal paydown is $300. Readvancing would mean you withdraw $300 from your HELOC. The limit stays the same it is just that you have now tapped into your HELOC.

    The next month let’s say you do this again – $1,000 mortgage payment, $302 principal paydown, $302 readvanced, $0.50 towards HELOC interest, $301.50 towards investments.

    Now, if HBSC really charges $25 every time you readvance then this would kill the SM process right away unless you took out substantial sums, say $10,000 at a time.

    Now, let’s say you instead decide to take out the full $120,000 right away. Then you would not be able to readvance until you went through a process to reappraise and (hopefully) get a higher HELOC limit. All that would happen then is you would paying your mortgage AND the interest costs on your HELOC which combined would likely require more cash flow (unless you came out of a much higher interest mortgage).

    I hope that clears it up for you.

  215. 256. Nikolai

    I have started implemented this strategy (well, better late than never and better at partially than not at all! ;) ). I have identified the non-registered investments I can sell to take advantage of the extra lump sum payments allowed in my existing mortgage contract, which I can re-purchase right away with the money taken from HELOC.

    I am wondering about the eligibility of a plain and stupid savings account. I have some emergency cash stashed at ING Direct earning peanuts (1,5%), but easily accessible. Potentially, I can withdraw them to reduce the mortgage balance and then borrow from the credit line and put back on my savings account. Currently the interest rate on my mortgage is higher than what I am paying for the HELOC so the savings are obvious. But here comes the question: would CRA allow to deduct the interest paid on the HELOC for this kind of investment? The investment does carry the interest so, technically, it fits CRA requirements.

  216. 257. Sky

    Thanks again cannon_fodder, that clears up things a bit for me. :)

    I think I undersatnd your example, but I guess my situation is a little different. Being a first time buyer, I only have enough for a downpayment slightly over 20%, say 100k in your example. I then would need to get a 300k mortgage, leaving a LOC limit of only 20k. I supposed that 20k will be used up quite quickly so I will need to readvance to get more. However, if I readvance without having paid down a substantial amount of principal, I can only gain a small increase in the LOC limit, making this method not practical.

    I’ve been trying to figure out ways to achieve the same effect as other banks with HSBC’s products. Using your example, one solution I thought about is to get a 320k LOC limit. 200k would be used to pay for the house instead of a mortgage, and there will be 120k left for investing. The 2 downsides to this solution are 1) your entire mortgage will be at P+1, which is more than close variable of P+0.5. 2) For tax purposes, I can prove I’m taking out money from the LOC to invest, but when I make payments to the LOC, I cannot prove if I’m paying down my investment loan or mortgage, if they are in the same account.

    With other banks such as RBC, BMO, TD, the LOC limit is increased automatically as the mortgage principal is paid down. The LOC can also be used solely for investing and make claiming tax reductions much simpler. I guess I really need a product like that to implement the SM. =T

  217. 258. cannon_fodder

    Sky,

    If you borrow the maximum amount from day 1, thus having a combined total of mortgage and HELOC to be 80% of the appraised value of the home, how does that HELOC balance compare to the projected principal paydown in the 1st year? If they are fairly comparable (which I suspect) then I can see your frustration.

    Have you used the spreadsheet I created to run through scenarios? You may find, if you feel confident about your potential investments, that the additional 0.5% on the mortgage and the inability to readvance during the term of the mortgage could be justified by being able to get into the market heavily at this point rather than doing it in dribs and drabs.

    Just heard on BNN today that one pundit is saying the S&P 500 could be up more than 80% in the next 2-3 years while another pundit stated we should probably retest the March lows.

  218. 259. Nikolai

    cannon_fodder,

    One of these pundits most likely will be right :) About a year ago some analyst we predicting oil at $200 this summer, others were promising the numbers as low as $40 by this spring :)

  219. 260. cannon_fodder

    Nikolai,

    The thing is, both of those pundits quoted today could be right!

  220. Hi Cannon!

    I would like to reassure you that CRA knows damn well of what they are doing. I know, because exactly based on the two cases mentioned in the article you recommended, they issued a position paper.
    Everyone flirting with the Smith Manoeuvre, should be familiar with this long and sleep-inducing text, called IT533, and which is available on CRA website with little trouble. I recommend in particular the most salient sections: 8, 9, and 10.
    This expose, based on the Singleton and Ludco cases, which it does mention by their names, the august agency explains how they consider the source and use of the money, and what the criteria are for tax-deductibility. They also quote the Supreme Court’s postulations verbatim: “…a reasonable expectation of making an income.”
    What is also relevant here is the fact that contrary to the prevalent belief so often written here by many, that only dividend investments are suitable for the SM, the fact is that dividend, equity, real estate, or the person’s own business are all equally eligible for our purpose.
    In fact, the ideal investment strategy would be the one that is diversified, as we all should have learned in Investing 101.
    However, the very same reasons explain why “risk free” investments, such as money market, or GICs would not qualify. This is also a tacit admission that these instruments actually don’t make money, they do not have a “reasonable expectation of making an income.”

  221. 262. cannon_fodder

    Falconaire,

    Thank you for the reference to the CRA site and that document in particular.

    I don’t believe I’ve ever read on here that people have claimed only dividend producing investments will satisfy the CRA test for eligibility. However, some people, like myself, have chosen this route. It is not as tax efficient as investing in equities which don’t provide income. For myself, I would have chosen this path to invest regardless of the SM structure.

    I don’t understand why “risk free” investments wouldn’t qualify. First, I think recent events have shown that some of these are not risk free, just low risk. Second, if they don’t have a reasonable expectation of making income, then why does the CRA expect you to declare it as income on your tax return?

  222. Well, Cannon, CRA is practicing the Catch22 in the case of guaranteed, “low risk” investments.
    Perhaps you know what I am about to show here, but it never hurts to recapitulate.
    Let’s assume that you buy a GIC for $100 and you make an interest return of 3%.
    The resulting 3% is fully taxable, that is why CRA expects you to report it. So, you pay 30-40% income tax on the $3 return, depending on your tax bracket:
    result: 103- (3×0.4)=101.80
    But then there is inflation! If you assume a 2-3% average inflation then you are also loosing 2-3 bucks a year from your capital:
    result: 101.8-2=99.8
    101.8-3=98.8

    Thus your GIC is constantly loosing money. Its nominal value remains, it may possibly be increasing slightly, but its real value is in fact shrinking.

  223. 264. cannon_fodder

    falconaire,

    But, interest rates would be a known entity (unless it is a variable rate product) while inflation is not.

    Dividends are not a known entity (as I know after buying some Teck.B shares) nor is buying an equity with the ‘hope’ that at some point it COULD provide income (unless some statement by the company specifically forbids it).

    Sounds like the government wants to have its cake and eat it, too.

  224. That’s right, Cannon.
    But to be fair, we must concede, that a no-risk investment should have a higher tax rate, than a high-risk equity investment and CRA, or rather the Tax Code, recognizes the difference.
    I am usually suggesting to my SM clients to divide their investment money between dividend and pure equity in a reasonable proportion, relative to their age. At the same time I do stay away from the riskiest, specialty funds, such as gold, or oil.
    Now one thing is left: the mention of guaranteed segregated funds. I know that some people dislike them, because of the elevated MER, but I like them, because the guarantee insures the capital, without saying anything about the returns. The extra MER is only 0.3%, which is refunded after 10 years and in my opinion, is a worthwhile expense to protect the capital. Therefore, although the prospect of losses are eliminated, the gains are still the same as the market might provide. So, they are fully eligible for the tax refunds.
    These are the funds I prefer to use.

  225. 266. Sky

    cannon_fodder,

    Thanks again for your reply. I’ve found a way to work with HSBC’s mortgage. Basically I just don’t always borrow the full 80% (meaning mortgage + LOC adding up to 80%). Instead, I would borrow only 75% – that way, I always have some room in my LOC and can readvance only when it is used up (every year or two). The SM is not supposed to be that rigid that I have to borrow 80% all the time anyway. In fact with a smaller amount invested, it’s a bit less risky too.

  226. 267. Ed Rempel

    Hi Nikolai,

    CRA would not be interested in whether you are saving money. The would look only at the credit line you borrow from and the savings account you invest in. If you cannot reasonably expect to make a profit when compaing the savings account rate to the credit line, then the credit line interest would only be deductible up to the amount of the savings account interst.

    This is not really the Smith Manoeuvre.

    Ed

  227. 268. Ed Rempel

    Hi Cannon,

    Why would you want to leverage into a “risk-free” investment? It is technically deductible, since it clearly produces income.

    While CRA does not explicitly look for an expectation of profit with leveraging, they have used GAAR in other areas to deny business losses when there is not a reasonble expectation of profit. So, it is reasonable to assume CRA may deny a loss when borrowing to invest in a risk-free investment.

    If it is a temporary position or a portion of a diversified portfolio, there is no problem.

    Ed

  228. 269. Ed Rempel

    Hi Sky,

    Yes, borrowing less than 80% can allow you to do the SM with your HBC credit line, or other non-SM mortgage.

    You are also right that borrowing up to 80% of your home value is not necessarily the best amount to leverage. An optimal amount should fit what you are comfortable with and achieves your long term goals. The optimal leverage amount could be lower or higher than the difference between your mortgage and 80% of your home value.

    Leveraging less is easy. If you want to leverage more, just use an unsecured credit line or investment loan for the difference. You could add one of these so that you could invest up to 80% – borrow up to 75% from your HBC credit line and the rest from an unsecured credit line or an investment loan.

    After all your efforts to make things work without an SM mortgage, I hope your reason for staying with HBC is a good one, Sky. Such as to support a family member or friend – not that someone has pursuaded you that it is too expensive to leave HBC or that your rate is too good to give up.

    Ed

  229. 270. Sky

    Hi Ed,

    I’m pretty happy that I found this solution. You are right on (1st reason) for the reason why I chose HSBC ;) If it wasn’t for that, it would be a much easier decision to go with either RBC or TD.

    Thanks for all those who have helped me in this site. This comment section is getting a bit long though… =p

  230. 271. cannon_fodder

    Ed,

    I wouldn’t want to leverage to enter into a ‘risk free’ investment. I was simply questioning falconaire’s statement that the CRA would deny it.

    If I remember correctly, I thought a judge weighed in on this issue and looked not at just the interest rate differential between the borrowing and investing portions but also took into account the marginal tax rate in allowing the deductibility. In other words, if your LOC rate is 3% and your savings account is 2% but your MTR is 40%, then the entire interest portion is allowed because you ‘net’ a positive 0.2% rate differential.

    If you don’t take into account the expectation of interest deductibility based on your MTR then perhaps one could understand allowing deductibility up to the investment rate, not the LOC rate.

  231. Hi Cannon!

    I admit the need for some clarification.
    However, before that let me suggest that it is a bit risky from a taxation point of view to base your returns on tax advantage alone. The lesson of the Lipson case and the purpose of GAAR in general is that if you have nothing eles to gain but some lower taxes that is a red flag and chances are your SM plan will be in shambles.
    The clarification I have to make is that using guaranteed investments can mean two different things. GICs, money markets and their ilk are guaranteed in the sense that their market value is guaranteed. These would not pass muster in the SM, because they can not be expected to make an income higher than the interest paid for the loan.
    On the other hand, guaranteed investment funds, the ones I favour, are guaranteed for the preservation of the capital, to a certain degree. At the same time, they fully participate in the market, unlike GICs for example, and have the reasonable expectation of increasing their value as the market is increasing. But of course they also carry the risk of loosing market value. For this eventualities the guarantee and the periodic resets provide a protection.

  232. 273. Ed Rempel

    Hi Cannon,

    I’m not aware of that specific ruling and it does not really make sense to me, since the MTR would apply every year to the savings account interest, as well as the LOC interest deduction.

    I agree, though. Claiming an interest deduction up to the amount of the interest earned would be safe.

    Obviously, that kind of investment would not be a smart strategy. Don’t you find it strange that there are various discussions about risk-free and low risk investments when the market is so low? Market low periods during recessions are usually the best times to invest.

    Ed

  233. 274. Lenny

    Anyone compared the SM to Tax Deuctible Mortgage Program (www.tdmp.com)?

    “The TDMP Setup fee is $2750 + GST and recurring Cash Management fees are $39.95 per month. These fees are 100% Tax Deductible and are funded from the proceeds of the plan so you are never out of pocket.”

    Seems pricey, although attractive to those who are not very comfortable managing the SM on their own.

  234. 275. FrugalTrader

    Here I am giving away info for free while TDMP makes a bundle for the same info! I think I’m in the wrong business! :)

    I’d be interested to see what investments TDMP recommends for the SM. IMO, the fees are expensive. Might be better to get a fee only planner to look at the leveraged portfolio.

  235. 276. cannon_fodder

    Lenny,

    Perhaps you would like to check out these threads:

    Specific discussion on TDMP
    http://www.redflagdeals.com/forums/showthread.php?t=564417

    Search for TDMP where you see a heated discussion on TDMP takes place almost 200 comments down
    http://www.canadiancapitalist.com/the-smith-manoeuvre-debate/

  236. 277. Ed Rempel

    Hi Lenny,

    I believe that the TDMP plan includes paying out monthly distributions from a mutual fund. The Smith Manoeuvre does not include these monthly payments.

    The issue is that you risk losing the tax deductibility of your investment loan over time.

    To make this clear, many mutual funds pay out monthly distributions of say 8% that are considered “return of capital”. This means they are giving you back some of your own money each month.

    This is paid out regardless of whether the fund made money. The 8% is not a return on investment – it is just giving you back some of your own principal.

    The issue with this when it comes to the Smith Manoeuvre is that, if you start with an investment loan, the loan becomes non-deductible over time.

    To make this clear, let’s say you borrow $100,000 to invest. Then you cash in the investment and spend the money. In this case, you can obviously no longer deduct the interest on the investment loan, since the money is no longer invested. CRA is always looking for the “current use” of the borrowed money.

    Receiving a ROC distibution is the same principal. You get 8% of your own money back. If you spend that or pay it onto your mortgage or any non-deuctible activity, then 8% ($8,000) of your original investment loan is no longer tax deductible. After 12.5 years, non of the loan is deductible any more.

    What is more is that it is up to you to calculate that. CRA does not do the calculations for you. They ask you for proof that the money was borrowed to invest and that the money is all still invested. You would need to do the calcualtions showing that each month, a bit less of the investment loan interest is deductible. If you can’t prove it, CRA may just deny it all.

    The original Smith Manoeuvre follows all tax rules. Versions that involve a payout from a mutual fund that is ROC are called “Smith/Snyer” and run into this issue with losing tax deductibility over time.

    Ed
    __________________

  237. 278. Nikolai

    Hi Ed,

    I may be wrong, but I believe that even in case of ROC the current market value of your units does not affect anything. It changes the ACB of the units, but until you realize the gain or loss – it is all virtual. The unit price may go up any time etc. You have to sell first, otherwise it is still the original amount invested.

  238. 279. Brendan

    What are the implications of money sitting idle in a broker account?

    For example, you transfer 5k into your broker account to buy 100 shares.
    While you are waiting the 3 days or so, the market blesses you with a drop, now your purchase is only 4800 dollars. This leaves you with 200 leftover. Will CRA nail you because the 200 doesn’t have an expectation of earning income? Do you transfer it back onto the HELOC? Do you leave it for a few months until you can purchase another round of shares?

    What about commissions? Yes they adjust your ACB, but can you use the HELOC to pay the commission (and remain deductibility), or would it be prudent to transfer the commission into the broker account from a bank account separate from the HELOC, showing CRA that the borrowed money did not pay for the commission?

    I am thinking now of using the SM to purchase stock through a DRIP plan, build up to 100 shares fee free, and then request a certificate and then use dividends to pay down the mortgage, and immediately repurchase more stock. No sense DRIPing into the plan when I can re DRIP into my mortgage and deduct the interest.

  239. 280. Ed Rempel

    Hi Nikolai,

    You are partly right. An ROC distribution means cash is paid out. This is why the book value is reduced. This is considered that you are getting some of your principal back for tax purposes, which is why any money borrowed to buy this investment would lose part of its tax deductibility. If you cash in an investment, you can’t expect to still claim an interest deduction for money borrowed to buy the investment.

    Otherwise, you are correct. There is no tax consequence from the investment itself from receiving the ROC distribution (other than the effect on the loan interest) until you either sell or you book value reaches zero.

    This is the “ticking time bomb” issue with ROC funds. You receive the distributions tax-free, but your book value is reduced. Once your book value reaches zero, the entire distribution is considered a capital gain. Then when you sell, the entire amount you sell it for is also considered a capital gain (because the book value is zero).

    For example, you invest $100,000 in a fund that pays out an 8% distribution. The distirbution is tax-free for the first 12.5 years. Each year the book value is reduced by $8,000 until it reaches zero. After that, the entire $8,000 you receive is taxable as a capital gain. If you sell after 12.5 years and the fund has maintained its value at $100,000, the entire $100,000 is a capital gain.

    If you borrowed the $100,000 to buy this fund, then the deductible amount of the loan declines to zero over 12.5 years, the same as the book value. At that point, none of the loan interest is tax deductible, but the full $8,000 distirbution is a capital gain. At that point, you are paying tax every year.

    However, it is hard to sell then, since the entire $100,000 would be a capital gain.

    Ed

  240. 281. Simon

    I don’t see why this is such a big deal or what this has to do with HELOC. It seems important to find an investment that has a return greater than the loan interest rate. Well if everyone could find an investment like that, wouldn’t everyone do it regardless of whether it’s HELOC or not?

  241. 282. FrugalTrader

    Simon, it’s not just a HELOC for this strategy, it’s a readvanceable mortgage which gives an increasing credit limit to the HELOC. The increasing limit provides increasing capital to invest with.

  242. 283. skywalker

    We are interested in doing the Smith Manouevre but want to work with a FP that has some experience doing it. I am having a hard time finding someone who has actually done it.

    I have found one person but there costs seem high. $2000 for the intial setup and then $75 / month to maintain the process and help us through i for the duration of the manouevre.

    I am nervous about being Auditted and making sure we get a good setup in terms of HELOC/Mortgage and making the process automatic, but should it really cost me this much to do it?

    Please advise, this person seemed leggit and well informed but once the cost was laid out I became concerned. As the person who is also handling the investment side of our SM wouldn’t they also get a cut of that with the management fee? Are the right to be asking this much money or is it a scam. Please remember I am not financially savy in terms of investing and tax laws.

  243. 284. FrugalTrader

    skywalker, the best thing you can do is find a good accountant to handle all the tax details of of leveraged investing, an financial advisor/planner who can put together a low cost portfolio that is based on your risk profile. Other than that, you’ll need a mortgage broker to setup the readvanceable mortgage for you.

    I would recommend that you pick up the book to get a good understanding of the concept and risks involved.

  244. 285. skywalker

    Frugal Trader,

    I have read the book, aware of the risks. What I want to know is should it cost me the fees I talked about to find a FP/Accountant to help set it up and make sure everything is above board?

    Thanks for the help.

  245. 286. FrugalTrader

    For the setup, it shouldn’t take anymore than an hour for an accountant to explain the basics of leveraged investing taxation. The FP, if he/she sells mutual funds should be free (they get paid by the MER/trailers/DSC), and the mortgage broker should be free as well.

    Best bet would be to contact a FP/mortgage broker who has experience with the SM. I can give you a couple of names, contact me via email by clicking on the “contact” button in the Nav bar.

  246. Hi skywalker!

    You are asking: “I have read the book, aware of the risks. What I want to know is should it cost me the fees I talked about to find a FP/Accountant to help set it up and make sure everything is above board?”

    Well, I am an advisor and I have done about seventy of them last year.
    Your dilemma is that if you do it alone, you take a high risk of failure, but at the same time you would not like to pay for the professional service, in your estimation the price is too high.
    A pressing dilemma indeed.
    However, I must remind you what is important: it is not how much you have to pay alone that matters, but also what is it you are getting in return.
    I personally find the $2000 setup fee reasonable, because you will earn that back in 3-4 months by doing the SM and from then on you will have profit. Provided the setup is good. On the other hand I find the monthly fee of $75 too much and unreasonable. Also, if you consider the future value of that $75 it is in fact nearly $20,000 assuming an 8% return on investment, in ten years.
    But your position, namely that you would not pay for a service that is doing a great good for you, is simply untenable. You just have to make up your mind: do you want the SM and its benefits, or would you rather keep the fee for yourself and either take the risk of messing up the SM and loose money, or do nothing and pay the Bank and taxes, as you are doing now.
    You should consider and understand that when an advisor undertakes a project for you he is taking on a lot of work and a great deal of responsibility on your behalf. In exchange for that fee he is making sure that the risk you would take alone will not occur and deploys his knowledge and experience on your behalf, providing you with a lot of money over the long term. Begrudging pay for work is not reasonable and if you go the cheap way you will have cheap results.
    If accountants were so good at this, they would have already converted everybody’s mortgage. In fact, accountants have the tendency never to look beyond their own specialities, they often have no idea of the possibilities, never mind the lack of experience. If you ask your accountant whether his mortgage is tax-deductible, likelihood is that it won’t be. Would you trust then your SM on the accountant who couldn’t even get himself rid of the onerous mortgage?
    My suggestion is that you should pay the fee as long as you are convinced, by figures, that you are getting value for your money.

  247. 288. Nikolai Grigoriev

    “if you go the cheap way you will have cheap results” – this is typical statement coming from the advisers. If fact, if you go the stupid way, you will have cheap results. If you go expensive way, you are not guaranteed to have good results either.

    Personally I would say that $2000 + $75/month (+ probably commissions and trailer fees that would account for other 1-2K/year) is not reasonable. In fact, there is nothing about the SM you cannot do yourself. The only questionable part is how to invest the money. If you cannot make your choice of investments yourself, then you may want to talk to a specialist. But please note: there is no specialist that will guarantee you anything!

    “when an advisor undertakes a project for you he is taking on a lot of work and a great deal of responsibility on your behalf” – this is not true. What responsibility they are talking about? The worst that can happen is that they will stop receiving their commissions and they will get an unhappy customer. Suing an adviser for inadequate performance of the investment portfolio is difficult, especially in Canada.

  248. skywalker,

    Nikolai is right: there is nothing in the SM that you could not do (and screw up!) yourself.
    Indeed nobody can guarantee results for you, but the difference is that the advisor is bound to do due diligence. Make every effort to help you succeed and find different ways and strategies to that end. None of which is available to you.
    That is the difference.
    If not for the lack of performance, then everything else the advisor can be sued for and they are sued often and successfully. But if you are looking for guarantees you won’t have that left to your own devices either.
    Your choices are simple: pay someone to do it for you, or do it yourself.
    I would like to know which of the two, Nikolai or you, would expect to have the better prospects of success.
    Hi Nikolai!
    Please, tell us how many SM did you do lately, is your mortgage tax-deductible and if so, tell us how you did it.

  249. 290. Nikolai Grigoriev

    Well, I cannot say I did a lot of SMs – I am not an adviser :) However, if my personal experience might be useful for someone, I do not mind to share (and get corrected, of course!).

    First of all, I am a newcomer to Canada (<6 years) and ~4 years ago my financial knowledge was limited to the interest paid on the bank account and term deposits :) We have a house for about 4,5 years and we have a fixed mortgage for 5 year term, the term expires next spring.

    In general my view on the family finances is quite simple. As long as we live within our means, we invest the rest for the future. The future is divided in two major parts: retirement and "something within approximately 4-5 years from now". We have no debt except the mortgage and the car loan, but the car loan is at 0%, I consider it a good loan for a good car. Thus, the only tax-inefficient debt was the mortgage.Even before I have learned about SM, I was trying to prepay as much as possible towards the principal of the mortgage as early as possible. I believed that what really counts is how much interest do you pay over the life span of your mortgage, I was not very concerned about the cash flow today. In other words, pay as little interest as possible and as little taxes as possible without going too crazy about chasing the last dollar :)

    About 3 years ago I have started do my own investments. I did work with an adviser at the beginning and he was a nice guy, but the conflict of interests (his commissions vs. the performance of the portfolios) was more and more evident so we have decided that our relationships has come to an end. Still, I am grateful to this guy because his lack of attention has stimulated my curiosity :)

    Once I have learned about SM idea I have decided that it is the way to go. Unfortunately, when I was buying the house I did not have any extra funds available, we barely had enough for the modest 10% down payment and for the initial expenses. I have started implementing the partial SM as follows:

    - within my mortgage contract I have right to prepay up to 15% of the initial amount of mortgage. With all extra payments we have made before 2008, effectively this amount is equal to ~25% of the remaining balance.
    - I have arranged a HELOC with the interest rate significantly lower than my fixed rate. The limit on the HELOC is set to the market price of the house, which is approximately 50% higher than the original mortgage balance. Not all the funds are immediately available, but when the mortgage balance goes down, the limit goes up.
    - I have started selling some securities back in May, using the proceeds to prepay the principal of the mortgage and borrowing similar amounts of money to purchase the investments
    - I purchased good dividend-paying stocks (no, I did not have MFC before Aug 6 but now I do ;) ) and ETFs. Some of them are the same I owned before. My transactions are very clear, I make a purchase and then transfer exactly the same amount from HELOC to the brokerage account. Thus it is very easy to track the money. Should I decide to sell one of these investments, I will put the entire amount of proceeds back to the credit line and then borrow again the new amount. All these transfers are electronic and instant, it costs me nothing but a couple of mouse clicks.
    - I do not use HELOC for anything else but the investments. Should I need a credit for something else, I have a non-secured credit line for that. Never used it so far.
    - By doing all this I have rotated about the quarter of the remaining mortgage balance to the tax efficient investment loan. My total amount of debt has not increased. The remaining mortgage balance is now less than 50% of the original amount.
    - As of January 1st 2009 I will be able to rotate another ~25%. And when the mortgage matures in a couple of months from there – I will be able to do more, but I am not sure I will have enough cash for that by that time. Depending on the situation I may prefer to fund our TFSAs in the beginning of 2010.
    - If I sign another 4 or 5-year fixed term with the same bank (I do not mind – they are as nice as bankers can be :) ), I will keep the ability to prepay 15% of the original amount every year, not counting the double payments. Thus, in 3 years I will be able to turn the entire mortgage in a tax-efficient loan. And I will be doing it in chunks so I preserve the flexibility. But I have not decided yet on the next mortgage term.
    - I try to make sure that the combined investment portfolios of my family (including RRSPs) are significantly more than enough to cover the entire amount we owe. Knowing this makes me comfortable.

    I am sure one could do better than that but I prefer the mechanisms that I fully understand and that are 100% under my control (except the market conditions, of course). I hope my strategy will prove to be successful long term, however, we never know. I invest with the hope to earn decent income while understanding the possibility of losing significant amount of principal on some positions. I believe if the market crashes completely so a well-diversified portfolio goes bust we will have more important things to worry about :)

    Uff, what a long post….Probably not very consistent but I tried to answer your question as clearly as possible.

  250. Well, Nikolai, I can only congratulate you for what you have done in such short time.
    Your setup is nearly as good as can be under the circumstances.
    Could it be improved? Yes it could be.
    Would it make a great deal of difference? No, it would only be small adjustments that could add some few percentages to the efficiency.
    If I may suggest an improvement, I would suggest to replace your mortgage with a line of credit. This would enable you to save and invest all the principal payments that you have to make monthly to your mortgage.
    The other thing you may want to consider is that if you do renew your mortgage, you would be better off by renewing only for one year term. Not only because short term mortgages often do better, but also because it gives more flexibility.
    Keep up the good work and best wishes to you.

  251. 292. Nikolai

    Yes, I will definitely think about what I can do with the mortgage next year. I was thinking about optimizing it this year, but the IRD penalty was too prohibitive and since I had less than one year before the end of term I have decided not to go this direction.

    Technically, I should be able to put the whole remaining mortgage balance to the credit line. One thing that is still not clear to me is how to use the same credit line for both mortgage (i.e. non tax-deductible loan) and a tax-deductible one. The calculations are relatively easy to do, my only concern here is how to correctly report it to CRA (i.e. to make sure they accept my calculations). Currently when using HELOC only for the investments it is pretty simple.

    Thanks for the comments!

  252. 293. cannon_fodder

    Nikolai,

    You would benefit from reviewing one of the articles at MDJ’s site where it reviews the various SM friendly mortgages. Some allow for multiple sub accounts so you can more easily separate an investment LOC from a car loan vs. a mortgage, etc., etc.

  253. 294. Vincent

    I just discovered your site days ago and I am eagerly reading through it since then! a very nice resource.

    I have been considering a Smith Maneuver for some time now and we will probably buy a house in the next 6 months and I’m still refining my strategy.

    Would a SEG fund offered by an insurance company be an investment qualifying my interest on the LOC to be deductible?

    SEG funds offers guarantees ranging from 75 to 100% of the capital at maturity for a relatively small deduction on your return. This can be part of a healty investement strategy.

    I will consult a CFP before implementing this but I am still confused by the information I get. Some will say that investments returning capital gains are NOT deductible, this would leave dividend paying funds? I am still not sure either if a TFSA account would qualify.

    Thanks to anyone who could enlighten me!

  254. 295. FrugalTrader

    vincent, it really depends on the distribution of the fund itself. If it returns a ROC, the deductible loan will slowly become non deductible unless you pay it down with the ROC. Ideally, the fund would pay dividends/interest only.

    Borrowed money put into a TFSA is not tax deductible.

  255. 296. Ed Rempel

    Hi Vincent,

    Seg funds can work fine with the SM, but the cost over time can add up. At .5-1%/year, if you calculate how much this reduces your returns in the long term, you may be surprised how much this can add up. If you make 7.5% instead of 8%, you lose 11.3% of your gain over 20 years.

    This is especially true because the benefit of the principal guarantee is questionable. The guarantee is only after 10 years and the major stock markets are very rarely down over a 10-year period. You would also need to keep the fund for the full 10 years.

    The odds are very high that your investment will be up after 10 years, so the only difference is the lower return.

    Investing for capital gains is fine. Your interest is still tax deductible. CRA is very clear in IT-533 that investments in mutual funds and stocks are fine.

    It does say that you need to have an expectation of income excluding capital gains, but then goes on to say that mutual funds and stocks are fine as long as their prospectus does not specifically disallow ever paying a dividend. We have never seen any mutual fund or stock with this clause.

    As FT said, the interest is not deductible if you invest in a TFSA.

    Ed

  256. Hi Vincent and Hi Ed!

    As usual, I beg to differ about the attractions of segfunds. In my opinion they are ideal for the purpose of SM, precisely because of their guarantees, by virtue of reducing the risk inherent in investing.
    Contrary to Ed’s assertion, the cost associated with those guarantees are not really too high. The ones I am using are charging 0.3%. This, added to the basic MER, would amount to 2.3-2.7% all told, well within the range that most mutual funds of comparable profile would charge, but with full exposure to market risk.
    I also disagree with the claim that most markets would customarily rise over ten years, therefore the guarantee is worthless. Although it is true that the markets do rise over the long term, but if they crash only once in that ten years, (a traditional occurrence), and the crash happens exactly at the time when you wish to liquidate, at the end of the period, then it really doesn’t matter how they had risen in the years before: you can still suffer a loss.
    The guarantee especially welcome in case there should be more than one contraction in the market: the periodic resets of your capital in its effect protects you from the volatility: in fact you can insure your gains, while reducing the risk of losses.
    The segfunds I am using refund the extra MER at the tenth year anniversary. It is true, that this is less money than the future value of the same amount would be, but the difference is the cost of protection.
    So, for example, if you insure $100,000 with the guarantee, it will cost you (0.3%) $300 yearly, or $3,000 over ten years. Had the same amount been invested at a 7% return, it would have earned $2,025. This is the opportunity cost of the guarantee. But if there were losses over the period, then this amount also would have been subject to those losses, so, this would be less too, while your capital would be safeguarded against those losses.
    It is also mistaken that you have to keep the fund for ten years in order to qualify for the guarantee. The only restriction is that you must remain within the same group of funds, i.e. stick with your investment company. Within the group of funds you can freely move your money from one fund to the other without any restriction. This enables you to balance and rebalance your portfolio according to your needs.
    The specific guarantees were introduced only 4-5 years ago, so in fact, so far nobody really has benefited from them yet. But suppose, they were in effect for ten years already, those trying to take advantage this last February, for instance, would have faced the 30-40% losses without it, or no losses at all with it.

  257. 298. Ed Rempel

    Hi Falcon & Vincent,

    Most people think the markets are far more risky than they actuallly are. This is why the benefits of seg funds are emotional – not financial.

    Let’s quantify this risk/return. We have the S&P500 total return by calendar year since 1871. It is the most broad-based index for which we have a long history.

    In that period, there have been 3 times when the S&P500 was down over a 10-year period. That is out of 129 10-year periods. Therefore, the S&P500 has only been down 2.4% of 10-year periods.

    Two of those 3 were during the Great Depression (1929-38 and 1930-39) and the other one was 1999-2008.

    The worst ever 10-year period was a loss of 1.47% comounded. This is a loss of 13.8% in total.

    If the seg fund has a higher MER of .5%, then the total cost over 10 years is 5.1%. If the index is down 13.8% and the cost of the guarantee is 5.1%, then the net gain from having the seg fund in the very worst 10-year period ever was a saving of 8.7%.

    So, with an investment of $100,000, in 3 of 129 cases (2.4% of the time), you would save money with a seg fund with the highest possible saving being $8,700. However, in 126 of 129 cases (97.6% of the time), the fund is up so you just lost the $5,100 cost.

    I realize this is over-simplified, since this is only calendar years, other indexes are less consistent, specific funds can be worse, and being able to switch between seg funds significantly increases the chance that you will be down over 10 years.

    However, many seg funds are balanced funds or even bond funds, which are laughable. Who would ever pay a seg fund guarantee fee for a balanced or bond fund?

    My point is that the risk is far lower than most people think and the cost/benefit vs. the amount you would save/lose is highly against you.

    Why do you think insurance companies offer them? They are taking on the risk but have a very high chance of making a nice profit.

    We think seg funds are okay if it means you would invest more in equities in your portfolio then you would otherwise or if market risk really keeps you up at night.

    The bottom line, however, is that the benefits of seg funds are emotional – not financial.

    Ed

  258. 299. Third World Charlie

    Where is Mr Smith after the market collapse?

    His ‘large portfolio’ is half the value but the loan (equivalent to mortgage) is large as ever. And to add insult to injury Mr. Smith has no taxable income so no tax benefits currently. Welcome to real world, Mr. Smith

  259. Mr. Smith is well above of the average mortgage payer still.
    He made a handsome down payment on the principal debt this year, like in years before, thus increasing the LOC money available for investing.
    The investments bought this year are at a very substantial discount, so more can be bought for the same amount of money than in years before.
    Mr. Smith is really enjoying the reduced monthly expenses.
    The eligible tax refunds are still coming, because they are not written off against investment income, but earned income, so, as long as Mr. Smith has a job and has a taxable income, he shall receive the refunds and can use them to pay down mortgage and re-borrow it to invest.
    But if Mr. Smith happens to be unemployed, then he is still benefiting from the lower monthly housing costs and can carry forward his tax deductions to next year.
    He is, by the way, walking around with a smug little smile on his face all the time, because while others are still groaning under the weight of the mortgage payments, he is making money by investing. His deposits in his investment account has returned 40-50-60% in the last five months, and his paper losses have recovered to about the same degree.
    We can safely say that Mr. Smith is better than ever.

  260. 301. Slava

    >> In that period, there have been 3 times when the S&P500 was down over a 10-year period. That is out of 129 10-year periods. Therefore, the S&P500 has only been down 2.4% of 10-year periods.

    It is not 129 of 10 year periods. It is 12.9 periods.

  261. 302. Ed Rempel

    Hi Slava,

    They are rolling 10-year periods ending at the end of each year – not rolling decades. That is why there are 129 periods since 1871.

    Ed

  262. 303. Aolis

    I’d like to clarify the issue by proposing three different scenarios.

    1. Do I try and take advantage of the tax deduction for investment loans without changing my monthly payments?

    You don’t put in any extra money, capitalize the interest and pay down your mortgage faster while building up a leverage portfolio. When the house is paid off, you can dispose of the portfolio as you wish.

    Given the very low interest rates right now and that you would pay 1% or more interest for the home equity line of credit than your mortgage, the tax deduction isn’t worth aiming for at this time.

    2. Do I borrow money to invest?

    Assume a 8% return on equities and a 6% interest rate, this could work out. Interest rates could also rise and squeeze out your profit margin. It might be hard to get a large unsecured line of credit from the bank but given enough time and a good relationship, you could work up to $30k or $50k. Both members of a couple could get their own loans. This credit limit is probably a good thing for most people to ensure they don’t risk too much as a proportion of their entire portfolio.

    RRSP and TFSA are a much better route for long term investing.

    3. Do I want to put my house on the line to get a better interest rate and/or a larger line of credit?

    Given the already low interest rates, you would probably get a 2% better rate. Given that you can do it without your house, is it really worth the risk? This is where the Smith Manoeuvre really confuses the issue between the first two choices. A tax deduction strategy becomes a leveraged investing strategy.

    The real catch to all this comes when the financial advisor proposing this plan starts suggesting investments that are profitable to themselves such as actively managed mutual funds. Suddenly, you are investing money that you didn’t have before and the advisor is making 1% of that each year.

  263. 304. Ed Rempel

    Hi Aolis,

    Regarding your 3 scenarios:

    1. Actually, the low interest rates make the SM more profitable. Your mortgage payment is the same either way. The only difference with the SM is whether or not you borrow back to invest. Therefore, your comparison is between your investment’s long term return and the investment credit line’s interest rates after tax. Lower interest rates make it more likely your investment return will be higher than the interest (after tax).

    2. Most people are not limited to unsecured credit line limits. Investment loans are available, usually with much higher amounts.

    Also, RRSPs and TFSAs are not necessarily better for long term investing. Leverage magnifies the gains and the losses. If you invest effectively for a long time frame and can tolerate the risk, leverage has a very good chance of making much higher returns than RRSP or TFSA.

    For example, if you have $4,000/year of cash, you could contribute it to your RRSP and get a $4,000 tax deduction. If instead you borrow $100,000 to invest @4%, you have payments of $4,000/year and have a $4,000/year tax deduction, but you have $100,000 in investments, not just $4,000.

    If the $100,000 makes a good return, then clearly I am way ahead (after interest costs and tax), and if it loses money, clearly I am way behind.

    The 25-year rolling returns of the S&P500 since 1871 have ranged between 5.0%/year and 17.4%/year. So, if you do this as a 25-year strategy, your odds are quite good.

    3. I agree that the SM can confuse the issue between a tax strategy and leverage. The SM is definitely a leverage strategy, so only those comfortable with leverage should do it.

    However, the 2% interest savings are normally worth it. You are going to pay the interest anyway (right?), so why not save the money?

    Regarding the advisor, in the end, the advisor must provide advice that is worth paying the cost. If you don’t think it is worth the cost, then DIY. The biggest benefits of working with an advisor should be:
    1. Creating a complete written financial plan so that you are doing the right strategies to get you where you want to go (very few people are), and so your overall finances are coordinated and structured for minimal tax. This also means you don’t miss opportunities, and aren’t indecisive or unclear on what to do.
    2. Helping you avoid the typical behavioural mistakes most investors make. Behavioural finance studies, such as the Dalbar study, show that the average investor loses 2/3 of their lifetime return because of behavioural mistakes.
    3. Investment recommendations that are better than what your would choose yourself. If the advisor recommends investments that beat the index by 2%/year after the MER and you would otherwise buy the index, than did the MER really cost anything?
    4. Being a financial resource to help you with any financial decision, such as restructuring debt, saving money on your mortgage, all kinds of tax saving strategies, cheaper insurance, etc.

    For a good financial planner, any of the first 3 should by themselves benefit you more than the MER.

    Ed

  264. 305. Aolis

    Hi Ed,

    The way most people describe the SM is to target a tax deduction by making your loan tax deductible. I wanted to make the distinction that it does not simply flow into a fully leveraged model.

    Leverage is not necessarily a good thing. Corporations might use it but they also go bankrupt all the time. Unlike a person, when a corporation goes bankrupt, the owners only loose what they invested and get to keep their homes for their families to live in. That is one of the principal reasons that people form corporations to run their businesses.

    You can hire an investment advisor for ‘fee-only’ instead of a yearly percent of assets. This gets the benefit of 1, 2, and 4 at a much lower cost.

    http://network.nationalpost.com/np/blogs/wealthyboomer/archive/2009/02/12/where-to-find-a-fee-only-planner.aspx

    As for 3, no one can pick investments that consistently beat their associated equity index by two percent. There is also no way for someone to prove they can. They can only show that they did well in the past.

    Instead, we as investors should focus on keeping down our investment costs and diversify our investments across many asset groups and many entities inside a group. A financial advisor that suggests otherwise has a serious conflict of interest with their own remuneration.

    Aolis

  265. 306. Ed Rempel

    Hi Aolis,

    I mostly agree with you. People should not do the SM just for a tax deduction. It is a leveraged investment strategy. The main reason people should consider the SM is if they need or want the extra growth as part of their long term goals.

    We consider it to be part of a retirement plan and is one of the options to consider for those who can’t or don’t want to invest enough to be able to have the nest egg they will need for the retirement they want.

    I agree that you can use a fee only financial planner (not a fee-only investment advisor). We considered going fee-only, but we found that most Canadians are not keen to pay fees and that people tend to see a fee-only planner as a one-time thing.

    From asking around, it seems that very few people that use a fee-only financial planner end up doing regular reviews of their plan or discussing on-going issues with their planner. If you call your fee-only advisor with a general financial question, you are on the clock. So, they only get a small bit of the benefit of having a financial planner.

    The fee-only planners we have also tend to be a lot like accountants – very conservative and use mostly just straight-forward strategies.

    We decided to go commission-based so our clients would work with us long term and so we are motivated to figure out the complex, creative and unconventional strategies. For example, we are not aware of a fee-only planner that does the SM.

    The other comment I have is that the index programming really has spread. Everyone that likes indexes always says no fund beats them consistently. Why is consistently important?

    If my fund beats the index by 5% compounded over 10 years after all fees but only beat the index in 6 of those 10 years, I’m happy with my fund manager.

    Believe it or not, it is actually hard to find a mutual fund that UNDERperforms the index consistently. Even money market funds beat the TSX about 30% of years.

    We just need a fund that beat the index in the long run.

    In fact, mutual funds have a huge advantage over index funds in that they pay the full cost forever of a financial planner. If your mutual fund returns equal the index over time, you also get your financial planner and all his advice included for free.

    Ed

  266. 307. Aolis

    Hi Ed,

    I will grant you that mutual funds have done amazing things to get people to invest in stocks. Regular people will and do have “free” meetings with an advisor where they would not pay $100 for the same meeting.

    However, who decides what a financial advisor should get paid? The MER rates in Canada are very high compared to other countries. Great West Life sells an _index_ fund with an MER of 2.52%. And three quarters of these funds don’t do as well as their index.

    The alternative is a simple strategy of investing in four index funds (bond, cdn equity, us equity and intl equity). You save 2% just by doing that. But no one is going to make any money selling that.

    If I am paying a financial advisor, I expect them to point this out to me. I expect them to explain that chasing higher returns will cost me more and that it is much riskier. However, I’m not paying him, the mutual fund companies are.

    Aolis

  267. 308. Ed Rempel

    Hi Aolis,

    If I invest in a mutual fund that beats the index by 3-4%/year over long periods of time after the 2% MER with a risk similar or lower than the index, then how much has that fund cost me? Can you quantify a negative MER?

    Now if that fund also pays the $3,500 plan fee and $1,000/year review fee to my financial planner that I would have to pay if I did not invest with him, then have I not saved thousands?

    Many people have trouble believing that some fund managers can beat the indexes over long periods of time with lower risk because of superior skill, yet have no trouble believing that some people in other fields have have superior talent.

    Do you believe that Evgeni Malkin, Tiger Woods and Michael Jordan actually have superior talent over the average athlete? Why would you doubt there is similar talent in investing?

    The belief many people have in indexes is based on the Efficient Market Theory that hardly anyone believes any more. Most people, when they think about it, realize that there are all kinds of ways to beat an index.

    Here are a couple of easy ways an “All-Star Fund Manager” can beat your canned 4-index fund portfolio:

    1. Better allocation by investing globally and choosing a better allocation than the fixed 25% in each.
    2. Value investing. Most of the top investors are value style investors, which is also generally a lower risk style. Higher returns actually often come with lower risk.
    3. Equity investing. The 25% you have in your bond portfolio will likely underperform long term. Allocating 25% arbitrarily to bonds will likely reduce your long term returns by more than 2%/year MER.
    4. Owning some small or mid-cap companies. Top fund managers maintained their 10%+/year returns during the much talked about time from 1966-82 when the indexes made nothing (except their 5%/year dividends). This is partly because that was a great time for small caps, which indexes exclude.

    It sounds like you have not experienced good quality financial advice. Most of the benefits of a good financial planner are related to planning, not the investments. (See 304 above.)

    I think that it is better to focus on high quality advice and high quality investments, rather than free advice and cheap investments.

    Ed

  268. 309. finance

    Given the already low interest rates, you would probably get a 2% better rate. Given that you can do it without your house, is it really worth the risk? This is where the Smith Manoeuvre really confuses the issue between the first two choices. A tax deduction strategy becomes a leveraged investing strategy.

  269. 310. Ed Rempel

    Hi Finance,

    Sorry, I don’t understand your post. How can you do it without your house and what are the 2 options?

    Yes, the SM is primarily a leveraged investing strategy. While the tax deductions are cool, the real reason people should consider it is because it provides a way to invest long term for your retirement without using your cash flow.

    Ed

  270. 311. Andy

    Can I use the SM like this:

    I have revolving HELOC on principal residence and have 3 rental properties. I use the entire HELOC only for business and actually pay all rental property expenses out of the HELOC as well as putting all rent cheques into the HELOC.
    (I use it like a rental property chequings account)

    Can I simply start putting 100% of my rent cheques towards my principal mortgage instead (which increases my HELOC more than enough to keep covering expenses)?
    Essentially putting gross investment income into principle residence and paying 100% of expenses out of HELOC…

    If so, I can pay down $4000 on principle residence each month…..please say yes… I’m waiting to hear back from my accountant and thought I’d love to hear what you think.

  271. 312. FrugalTrader

    Andy, your strategy is called the cash flow dam, and as far as I know, it is a legit strategy.

  272. 314. Ron

    Andy
    This is what I am presently doing, and according to my accountant is is perfectly fine. I have one rental property (2 apt), I pay all my expenses from my HELOC and that same amount is taken from my rent received and goes directly on my principal mortgage. I keep whats left over for unknown expenses. Hope this helps. (I am presently in the market for another rental)

    Ron

  273. 315. rob

    HI Ed,

    i got a question about SEG funds…
    when i put in $100,000 ..they guarantee $75,000 after 10 years..or $100,000if i die earlier..

    if i withdraw a portion of prinicipal beofre 10 years, my guarantee stands correspondingly reduced/prorated..

    but what about the dividends…can i take away the dividends i receive every year from the fund & not lose the guarantee..

    $75,000 guarantee is it on the original $100,000 invested or the $100,000 plus all the dividends..

    thanks

  274. 316. barry

    I’m a bit confused hopefully someone can explain,

    With the SM if I keep investing money from my HELOC when will my mortgage actually be paid off?

    Wouldn’t I just essential have one giant HELOC and a big portfolio in the end?

  275. Hi Rob!

    Although the question is addressed to Ed, I attempt to answer, because he is not using them, as far as I know, but I do all the time.
    While not all companies have the same policies, they are similar in a general way. Indeed, the guarantee protecting your capital. If you have reduced your capital over the years, then the protected amount is what you have left in the account.
    However, many companies “reset” the capital value from time to time, even boost it by bonuses, so, in this case the earnings of the fund is attached to the original capital and protected accordingly by the guarantee.
    Most insurance companies reset every three years, but I use one that does it every year.
    The effect of these resets is very beneficial, because the capital thus “insured” is no longer susceptible to market fluctuations downward, while it is still fully benefitting from all market increases.
    The dividends are included in the resets, i.e. added to your capital, so, should you withdraw them, you would reduce the capital.

  276. 318. FrugalTrader

    Barry, that is correct. You will have one big investment loan and hopefully an even bigger portfolio at the end of it all.

  277. 319. Ed Rempel

    Hi Andy,

    FT is correct that the procedure you mentioned is called th Cash Dam. It is specifically allowed in IT-533. It is a nice addition for a rental property or non-incorporated business that allows you to convert your home mortgage to tax deductible more quickly because of your rental property or business.

    It helps rental properties, since real estate is generally only a good investment if it has a large mortgage. A paid off rental property normally makes less than a GIC and is fully taxable, but the Cash Dam lets you keep a large mortgage forever on your rental property.

    This thread is about the Smith Manoeuvre. The Cash Dam is a strategy that fits in well together with the SM. The expected long term benefit of the Cash Dam is relatively small compared to the Smith Manoeuvre, because it is purely a tax strategy, while the SM is both a tax and leveraged investment strategy.

    It is a simple tax savings, though. It is hard to understand why everyone with a rental property or non-incorporated business would not do the Cash Dam. All you do is change which account your rent and expenses go to and you get a bigger tax deduction.

    Ed

  278. 320. Ed Rempel

    Hi Barry,

    At the end of the Smith Manoeuvre, your mortgage is gone and replaced by a large, tax deductible credit line of the same amount – or most likely equal to 80% of your home value.

    We used to think that, before you retire, you could sell some of your investments to pay off your credit line and then go into retirement with the rest of the investments and no debt.

    But then we realized – it is good debt – you are actually better off having it than not having it (plus the investments). If you invest effectively, your investments should have a much higher return over time than the interest cost, especially after tax.

    So, keeping the investments and the loan right through your retirement is probably the most effective strategy, as long as you are comfortable with maintaining it forever. You can pass it on to your kids, together with the investments, and it will probably still be tax deductible to them as well.

    In addition, most people assume that when they are retired, they will be in a low tax bracket. However, many/most Canadians will actually be in higher tax brackets after they retire. When you include the clawbacks on the GIS, age credit, GST, OAS, etc., Canadians over 65 with a taxable income under $21,000 or between $31-105,000 are in a marginal tax bracket of 45-65%!

    So, the tax deduction from the Smith Manoeuvre interest might be a bigger tax advantage to you after you retire than before.

    Ed

  279. 321. rob

    hi Falcon..

    thanks to your reply…

    so if i invest $100,000 are not segregating funds guareenting that the capital will be woth atleat $75,000? i had thought so..

    from your reply(atleast my understanding)..is that seg funds say..capital $100,000 plus all the dividend reinvested for 10 years would be guaranteed for atleast $75,000.. not fair…

    example– i invest $100,000 no dividend the first year..if i withdraw $10,000(10% of capital) then my guarantee is also reduced by 10% & would not be $75,000..

    but what if in the first year dividend is $10,000 & i only withdraw the dividend of $10,000 & not anything from capital.. would the guarantee be reduced in this case too…doesnt not sound fair..

  280. 322. Barry

    Hey ED / FT

    To follow up so I take it another benefit is the mortgage is also turned into a bigger loan faster also because the interest is tax deductible?

    Also in theory I guess at anytime at the end I could sell those investments and pay down the mortgage so I own my home all out right?

    I’m one of those people who believe owning your home before you retire is a safe investment.

  281. 323. FrugalTrader

    Barry, yes, you can sell your investments at any time to pay off the investment loan/heloc.

  282. 324. Ed Rempel

    Hi Barry,

    Yes, you can pay it off any time. If you plan to keep it until retirement and then pay it off, that is a valid option. It is a matter of your risk tolerance whether you choose the safer option of paying off the SM credit line or the higher income option of keeping it right through retirement.

    Just to be clear, though, you should not go into the SM thinking you will just pay it off if you change your mind. It needs to be a long term strategy to be effective, because there will be down years. You should really only consider the SM if you can commit yourself to sticking it out for a relatively long time.

    I don’t quite understand the first part of your question, but if you take the tax refund and pay it onto your mortgage and reborrow to invest, then you will convert your mortgage to the tax deductible credit line more quickly.

    In practice, most of the time we actually use the tax refund for something else with our clients where we are looking at their entire financial situation. Considering all your financial goals, you may have more effective options for the refund, such as an RESP contribution or as part of an RRSP topup strategy, for example.

    Does that answer your question, Barry?

    Ed

  283. 325. Barry

    hey ed / FT

    That does answer my questions. Thanks for that. I’ll have to pick up the book.

  284. 326. Brendan

    Thanks for this super informative article and interesting blog! I’m about to embark on the SM journey.

    I’m wondering, though, can I apply it retroactively? I purchased a place witha friend and took possession in December, and had renters in by the end of the month. We set up a separate joint account and the income has gone into that account for Jan and Feb, and the mortgage payments have come out of the same account.

    I’m going to apply their rent cheques to my primary residence mortgage starting March 1, and then use my HELOC to pay the rental property mortgage. I’m assuming this allowable and that I can claim the interest on the mortgage *and* the interest on the HELOC (plus taxes, condo fees and repairs).

    Is this the correct strategy?

    What I’m also wondering is, can I use my HELOC to pay down my primary residence mortgage for Jan and Feb and claim that interest for the rental?

    Thanks again for an informative blog!

  285. 327. FrugalTrader

    Brendan, my understanding is that yes, you can use the HELOC to pay for the rental mortgage and both will be tax deductible. However, using the HELOC to pay down your principal residence will not be eligible for a tax deduction. Of course, it’s best to double check this with a tax pro as I am not.

  286. Hello,

    I was thinking about using the simth manouver and using the heloc to invest in another rental property. but my conclusion is that it doesn’t make sense to use the smith manouver to invest in rental property. does make sense for dividend stocks / reits etc. but not rental property.

    with rental properties you already have a HUGE arsenal of deductions that you will not see the deductions from your heloc for a very long time. with good accounting your rental properties will not generate any taxable income for a good 20-30 years, even longer if you grow your property portfolio and new properties are added.

    in the mean time, the simth manouver has increased your borrowing costs probably by 1% as the Heloc has a higher interest rate than the mortgage.

    your going to have to add a big time value on that 1% cause your not going to see its tax deduction take effect in a long time. maybe not even in your lifetime.

    FT I would like to hear your opinion on that?

  287. 329. FrugalTrader

    tsxcommentary, I think every situation is diferent. Not all rental properties are cash flow neutral at the end of the year. When I had my properties, I focused on purchasing properties that were cash flow postiive, so even after every deduction, I still had reported income. But yes you are right, a rental property already has a deductible mortgage. However, if you use a HELOC as the down payment, it would be deductible as well (AFAIK). Even though you would be 100% leveraged, 100% of the interest would be deductible.

  288. @Frugaltrader,

    but cash flow has nothing to do with taxable income :)

    if you have taxable income left over after deducting all the perks
    from car lease, gas, phone bill …. etc. you take CCA (capital cost allowance) ie depriciation on the building itself to bring the taxable income to NIL.

    so even with significant positive cash flow you’d be looking at tax defferal of 20 years. thats the beauty of realestate.

    the smith manouver is giving you more tax deductions great, but my beef with it is that it is not free. you have a higher borrowing cost. since the HELOC is going to have a 1% higher rate.

    its great if you have a source of taxable income you need to get rid off.

    if your rentals are creating taxable income for you, you need to change accountants, it would be much better than using the smith manouver.

  289. 331. Ed Rempel

    Hi Brendan,

    Yes, it sounds like you have the strategy right. However, you need to keep the Cash Dam credit line separate from the Smith Manoeuvre credit line, assuming you are doing both strategies, since they are different line items on your tax return.

    FT is right that doing it retroactively is questionable. You need to be able to trace money that you borrowed to pay the rental expenses.

    I did not realize you were also looking at the Cash Dam. It is a cool strategy with no down side, since it is purely a tax strategy. Basically it is restructuring your finances so you can claim an extra deduction.

    Of course the expected benefit of the Cash Dam is tiny compared to the Smith Manoeuvre, since the SM is mainly an investment strategy plus a tax strategy, while Cash Dam is only a tax strategy. It does not have an investment compounding for decades.

    Ed

  290. 332. Brendan

    Ed, it must be a different Brendan as I am not looking into a cash dam. I have no rental properties.

  291. 333. Ed Rempel

    Hi tsxcommentary,

    I’m not sure you understand the Smith Manoeuvre right.It is 100% in addition to whatever you do with the rental property. You can do whatever you want with the rental, and then on top of that you can do the Smith Manoeuvre.

    It is irrelevant how large rental deductions are, because Smith Manoeuvre deductions would be in addition to them. This is because the SM uses the portion of the mortgage that you are paying down with whatever mortgage payment you have. You reborrow that amount to invest.

    The issue with rental properties is that you can run into a tax problem once the mortgage is paid down. Then the rent is fully taxable. The SM allows you to maintain a mortgage and credit line that are always at 80% of the value of the rental property. That way, you always have a good deduction against the rent.

    The rental property can result in zero income on your tax return. but the Smith Manoeuvre normally gives you a refund, virtually every year. That is usually even true after you retire and start taking income from it.

    Your comment about not being able to claim the deduction on the SM interest for many year is wrong. You can claim it 100% every year against your salary and other income, whether or not you have investment income.

    Rent expenses are limited to the amount of rent claimed, but SM interest is not limited by investment income.

    By the way, your HUGE arsenal of deductions sounds like you are claiming way to many deductions on your rental. You can normally claim only a tiny portion of your car lease or other car costs, and probably none of your home phone bill. Car costs are limited to a reasonable amount for trips you need to take to the rental property. Your home phone bill is not claimable as a rent expense, since it is assumed you must have a personal phone. You should be careful in claiming too many rental expenses, since it is an easy one for CRA to catch. There are thousands of rentals in Canada and if you expenses are out of line with the norm, you are asking to be audited.

    The deferral effect of CCA is a lot like taking a ROC payment from a mutual fund. You avoid tax for the first few years until your book value reaches zero, and then you are taxed annually. However, when you finally sell, the rental property will then be 100% taxable (not a capital gain), while the mutual fund will still be a capital gain.

    Ed

  292. Hi Ed,

    Thanks for your comments.

    I understand you can claim a 100% tax deduction from the smith manouvre interest every year from the rental income on top of everything else you have there.

    however,
    since you cannot use CCA to create or increase a rental loss,
    To actually reduce tax from your salary from rental loss (line160), you need a lot of expenses, or low income from the rental properties.

    I’ll give a more specific example with easy numbers.

    we buy a property for 1 million at 5% cap rate, start off with 500,000 UCC
    use 800,000$ 1st mortgage @prime(2%) on the rental.

    option 1
    get a smith manouver loan for 200,000 @ prime(2%) +1.5%
    intrest on the smith loan will cost $3,000 a year more but all is deductable.

    option 2
    get the $200,000 from a regular 1st mortgage on your house @ prime (2%).
    the intrest here is not deductable.

    option1 tax:
    net rents: 1m *5% = 50,000
    1st mortgage intrest = 16,000
    smith intrest = 6,000
    your own expenses = 10,000 ( car, gas, cell phone, whatever)
    CCA = 18,000
    rental income = 0

    lets say we sell the property after 20 years

    thanks to the smith intrest, we saved $6,000 worth of CCA every year,
    which is equvalent to 120,000$ of taxable income 20 years from now.
    say at a tax bracket of 40% tax rate = $48,000

    however we had to pay $3,000 a year in higher intrest rate since the smith loan carried +1.5% rate than the non deductable mortgage. which adds up to $$90,000 in 20 years using a 4% time value of money.

    in this case the smith manouver cost us $42,000 (in future 2030 dollars), and reduced our cashflow by $3,000 a year.

    However smith will pay off if prime rates were higher.
    I wanted to point out that smith is not a win win win. the disadvantage here is because you already have tax deferral from rentals coupled with the 1.5% higher borrowing cost to set up the smith loan. you pay less tax, but you don’t see the tax savings for a while, in the mean time you are paying higher intrest costs.

  293. 335. Ed Rempel

    Hi tsxcommentary,

    Why are you calling the extra $200,000 the Smith Manoeuvre? Is that not just borrowing the down payment for your rental? I don’t see how this relates to the Smith Manoeuvre at all.

    Also, if you borrowed the same $200,000 against your home for the down payment on your rental property, it would also be deductible.

    Deductibility depends on the use of the money, not what you use as collateral.

    Ed

  294. 336. Brenda

    Is there something on this website that keeps trying to install a trojandownloader? I don’t have this problem on other websites. Microsoft Security Essentials is able to detect and remove this virus.

  295. 337. Ed Rempel

    HI Brenda,

    I’ve never had any problem with it. Perhaps you have a virus on your computer and by coincidence it opens up when you are on this site???

    Ed

  296. 338. lån penge nu

    I have read the book, aware of the risks. I may be confused, I thought re-advancing means increasing the limit on the LOC. Could you please clarify for me?

    Thanks for the help.

  297. 339. SMOO

    My wife is currently staying at home to raise our kids. Therefore, investment related income in her name is being taxed at a favorable rate.

    Borrowing under a HELOC, and investing in her name, would she still be able to deduct the interest expense, albeit at a lower tax rate? I’m thinking that our capital gains / dividend income will be below the amount where she would actually have to pay taxes (if that makes sense).

    Thanks, SMOO

  298. 340. FrugalTrader

    SMOO, you may want to examine that strategy. The interest deduction will be greater than any tax on the investment income (excluding interest). Check with your accountant, but it is usually recommended to claim the interest/investment tax under the higher income. As well, the more income your wife makes, the more the spousal amount tax credit is reduced.

  299. 341. SMOO

    Thanks for your comment.
    My concern is that if I borrow money (currently at 2.75%), and claim the deduction, I would also need to have the investments in my name. The capital gains would therefore be taxed under my tax rate, which I’d deem to be more than the interest credit.
    Alternately, if my wife made the investment, she’d have the basic tax amount where there would be no tax, and then any additional income over and above the basic amount would be taxed at a lower rate.
    Would it not make sense in that case to have it in her name?

  300. 342. FrugalTrader

    SMOO, capital gains are taxed @ 50% where the interest deduction is 100%. Here is more info on how the capital gains tax works.

    You would need to work through the numbers, but make sure to account for the reduction of spousal amount tax credit.

  301. 343. SMOO

    Thanks again. Will check it out and report back.

  302. 344. Ed Rempel

    Hi Ian,

    Yes, “readvancing” mens the credit line limit increases. This should happen automatically with each mortgage payment if you have the right type of mortgage.

    It is not an ordinary credit line. It is a mortgage linked with a credit line with a single limit for both. Therefore, when the mortgage is reduced by every mortgage payment, the credit line portion automatically has more room available.

    Does that clear up your confusion?

    Ed

  303. 345. Ed Rempel

    Hi SMOO,

    The Smith Manoeuvre should be setup based on a long term plan and long term expectations.

    FT is right that normally it is done with the higher income spouse, if one is not working.

    As an example, let’s say prime averages 4-5% and your investment averages 8-10% over time. With a capital gain, only half the gain is taxable, so that would be 4-5%, which is similar to the interest deduction.

    However, it is still a huge savings if you do it right. With tax-efficient investments or buy-and-hold, you can defer the capital gain for many years into the future, but you can claim the entire interest deduction every year.

    With good planning, you should be able to get refunds most years for your entire life and may not pay the capital gains tax until both your and your spouse are gone.

    With dividends, the tax rates are usually even lower than capital gains, depending on your tax rate, but you limit your investment choices, which could reduce your long term returns.

    The main savings with dividends are for lower income people, so you might think you can buy dividend-paying investments in your wife’s name. However,if the interest deduction is more than the tax on the investment income (most years), she would not be able to claim the tax deduction against other income like you can.

    Also, dividends affect various tax credits based on the grossed-up amount. In your case, your wife is not working so you can claim a tax credit, which will save you about of about 21%. However, any dividends your wife receive are grossed-up by 45%, so that effectively means you pay just over 30% on any dividends your wife receives.

    The other issue is the name you invest in. It is usually best to invest in joint names for estate planning purposes. You can then still choose to claim it on either one of you. However, the investments and interest deduction need be claimed on the same person(s) and whichever you pick in year 1 needs to be maintained as long as you have that leverage.

    Generally, our best advice is to claim it on the higher income spouse. With the investments, it is usually best to focus on the having the best investments based on risk/return and keep the tax consequences as a secondary issue.

    Ed

  304. 346. SMOO

    Ed,

    That was the best summary I’ve seen so far. My problem was that I didn’t understand the negative impact from investing under her name—I thought I’d be able to get some use out of having that 0.00 income for a change!

    Should be an interesting weekend thinking about this—cheers.

  305. 347. jim

    My wife and I have just purchased our first income property to rent. I am trying to get my head fully around how this can work for us. We have cash that can be used to pay for our down payment, but not sure how to go about doing it to take advantage of the taxes. Currently we have an outstanding line of credit for lets say 100,000, should we use our cash to pay off the LOC and then use the line of credit for the down payment? What I gather is by doing it this way, we can then claim the interest from the line of credit on our taxes. Where as right now by us paying down the line of credit, we can not claim the interest.

  306. 348. FrugalTrader

    @jim, afaik you can use the line of credit for the down payment on the house and claim the interest. One thing you want to do is to keep the investment line of credit separate from your personal expenses.

  307. 349. Nikolai

    jim,

    General rule is to use the cash to pay off the tax-inefficient debt first. Of course, this all comes to the end result, i.e. if you have high-interest tax-efficient debt it may be better to pay it off before paying tax-inefficient personal loan. Just do the math.

  308. 350. Ed Rempel

    Hi Jim,

    It sounds like you have it right. If you borrow from your credit line for the down payment, you should be able to claim the interest (as FT said).

    If you use your cash for the down payment, then your existing credit line is not deductible. If you pay it off first and then borrow for the down payment, then you have converted it to tax deductible. If you have the same credit line with an option between whether or not it should be tax deductible, obviously tax deductible is better!

    You need to keep it separate, though.

    Ed

  309. 351. Daps

    Can somebody please reply to let me know if first time home buyers with 5% downpayment are eligible for Smith Manoeuvre?

    Thanks

  310. 352. Jungle

    Dapps:

    No, you need 20% equity to qualify for a Home Equity Line of Credit.

  311. 353. cannon_fodder

    Since there was a question about the SM Spreadsheet I provided free to readers of this blog, I thought I’d pop my head in here.

    It was two years ago to the month that I embarked on the Smith Manoeuvre. I did sort of a quick start – I pulled out a large chunk of money and really didn’t put any more money into after that.

    Here we are two years later with the stock market not fully back to its peak and my mortgage will be discharged this year (I could do it right now if I wanted to) and our SM investment portfolio has doubled.

    Thank you SM!

  312. 354. Agie

    cannon_fodder:

    Can you provide some details of your pre-SM mortgage? Outstanding balance…years left, etc.?

    Also, did you implement the SM yourself? If not, who did you use?

    I’m happy to hear how well this has gone for you…particularly since we are about a month from implementing the SM ourselves…

  313. 355. cannon_fodder

    Agie,

    We had a normal BMO mortgage taken out in August 2003 for $305,000. Then in July 2008 we took advantage of the ability to renew our mortgage early. With Ed Rempel’s free service to work with banks on our behalf we secured a BMO Readiline mortgage at Prime – 0.75% and a HELOC at Prime.

    Our balance was about $118k and we had payments which suggested a 50 month period where the mortgage balance would be zero if nothing changed.

    We also got the bank to recognize the increase in equity so as to give us a total mtg plus HELOC of $423,000.

    I implemented the SM on my own working with Interactive Brokers because of their extremely low margin interest. By September I had pulled out about $300,000 from the HELOC to begin investing. In hindsight if only I had waited until March 2009 we would have been so much better off.

    As it went along there was a time where our investments were down almost 50% (ie in March). But I stayed patient and knew that I had purchased good companies that would reward me eventually.

    Not everything I bought worked out well – Manulife was one of the worst as it slashed it’s dividend and is a bit of a proxy on the TSX. But others compensated for that.

    All long term holdings I have are dividend payers and no trusts are in my SM portfolio. Our mortgage balance is now under $9,000 and our HELOC has grown to $378,000. So our overall debt has actually shrunk.

    Because we plan on retiring early by leaving Canada in a few years we will start applying our mortgage payments to pay down the HELOC. My wife would prefer to retire with NO debt whatsoever. Thus, regardless of ultimate efficiency we would try to retire the HELOC to keep peace in the marriage.

    Sorry for the long winded reply – it’s almost a guest post!

  314. 356. Jungle

    O my gosh Cannon Foder, $300,000 to start investing? I don’t feel so bad now, as I’ve started with $8k..

    Anyway, I am having trouble finding stocks with good prices. Did you just buy market price and use all the $300K at once?

    Congrats on paying more mortgage off early. To pay that much in that span is a big accomplishment.

  315. 357. Mick

    Need some advice regarding the SM strategy…here’s what i’ve got

    -Tax Free Savings Accounts: 7,500.00$*
    -Non-Registered Investment Accounts: 370,000.00$*
    -Registered/Retirement Investment Account: 27,000.00$
    -Cash savings: 25,000.00$
    -Cash chequing : 3,000.00$

    *(Blue Chip stock 6% annual increase, 8.5% Dividend return)
    ——————————————————-

    -Potencial of buying a house (family thing) for 100,000.00$ (appraised value 300,000.00$)

    My plan
    1. Buy the house
    -RRSP wrap : 25,000$
    -Cash saving : 25,000$
    -Mortgage 3.0%: (50,000$)
    -HELOC 3.0% : (300,000$ X 0.80 – 50,000$) = 190,000$

    2. Invest HELOC (Blue Chip Stocks)
    -HELOC Stock Value : 5% (annual return)
    -HELOC Dividend return : 5.5% (annual return)
    -HELOC interest : 5,700$

    BIG QUESTION ? : To sum it up…I want to invest the equity (80% – mortgage) in the house to received dividends for cash flow only (while not paying the HELOC interest, by capitalizing the interest, and getting a tax deduction on the HELOC interest). Don’t want to use the dividends or tax return to pay down mortgage. As anybody here ever done that!? I’m hoping to integrate this strategy in my porfolio…my goal is to live off dividends by age 30, can an HELOC help me do that?

    P.S Open to any advice, thanks in advance!!!

    Mick

  316. 358. Nikolai

    Mick,

    My $0.02.

    “my goal is to live off dividends by age 30″. Although it is a nice goal, I think realistically you need at least $1,5-2M to simply “life off dividends”. Strictly speaking you cannot find anything reliable enough that would give you more than ~5-6% annually. Even considering modest before-tax income of $80K (at age 30 you probably want slightly more) you would need around $1,3M.

    Unless you are active (and successful) investor, SM won’t magically pay off your mortgage. The primary point is to save on taxes + have additional flexibility.

  317. I have not heard about the Smith Manoeuvre before now, but thanks for the information. I like your post and look forward to read part two.

  318. 360. Ross

    I have a question, that I would like some feedback with…I am planning on doing the “smith maneuver” with a readiline mortgage from BMO. I have 80% equity in my home, and would like to use the funds to invest in dividend paying stocks. The rate for the interest payment on the mortgage will be 3.5%, and the dividend will be around 4-4.5%. My question is if that is enough of a spread to make it worth while, as far as the risks go? Thanks for all your help.

  319. 361. FrugalTrader

    @Ross, I can’t tell you exactly what to do, but a couple things to keep in mind. Although you are paying 3.5%, it’s tax deductible, so your real rate is after your tax deduction. One risk of your strategy is if interest rates rise. However, if you capitalize the interest, it should never affect your cash flow.

  320. 362. Steve

    How would an investment in a high yield bond ETF (i.e. CHB) fare under the SM scheme? Return seems good at over 7%, HEL cost of capital is now 3.5%.
    Appreciate some advice. Thanks.

  321. 363. Jungle

    That fund would be horrible, because it’s not tax efficient. Put that in your TFSA. However money borrowed for investments in registered accounts are not tax deductible. They have to be non registered. That’s why people use eligible Canadian dividend stocks, because they are taxed at a very favorable with the tax credit, compared to fixed income which is taxed very high.

  322. 364. Ed Rempel

    Hi Ross,

    The strategy you are talking about is not the Smith Manoeuvre at all. It is just ordinary leverage using the dividend to pay the loan interest.

    With the SM, you readvance the principal portion of each mortgage payment to invest and to capitalize the interest on the investment credit line.

    Whether or not you get dividends as part of the investment return is one of many factors in the investment decision. In general, receiving dividends reduces the long term return of the Smith Manoeuvre because of the “tax bleed” of annual taxes on the investment income.

    The long term total return of your investments is the critical factor, and having tax-efficient investments is a plus.

    The answer to your question is that the total return of the stocks should be much more than just the dividend, so if you understand the risk and will invest for the long term (especially during the inevitable bear markets), then the profit should be far more than the interest on the credit line – especially after tax.

    Ed

  323. 365. Ryszard

    In the article above you say “Your mortgage is NEVER paid off where you keep the tax-deductible loan (this can be a good thing)”
    What do you mean by that? Why the mortgage would never be paid off?
    I am confused.

  324. 366. Steve

    Never paid off because you’ve used your house as leverage for the home equity loan.
    Yes you might not have a fixed mtg any more, but you have a variable rate home line loan supporting your investment portfolio.

  325. 367. Nikolai

    Ryszard,

    It is not paid off from the mortgage perspective, you owe money to the lender. However, from your perspective it is “paid off” as long as your assets (bought on borrowed money) exceed your liabilities (the amount you owe). In hypothetical case when the lender demands the immediate and full payment of the loan you can sell the assets and generate enough cash to cover it, probably leaving you with a profit as well. At least this is the way I see the investment loan for myself.

  326. 368. Ed Rempel

    Hi Ryszard,

    The issue relates to the difference between good debt and bad debt. I agree with the last posts that your mortgage is paid off, but it is replaced by a tax deductible credit line from money borrowed to invest.

    The SM does not require any of your cash flow while you have the mortgage, but once it is paid off, you have to pay the credit line interest yourself. However, it is interest only and fully tax deductible.

    Your mortgage is “bad debt” that you should eventually pay off, but the investment credit line can be “good debt”. “Good debt” is debt that you are better off having than not having, because it was used to invest and the investments should make quite a bit more than the credit line costs after tax.

    It is “good debt” because it is reasonable to expect that you will make a significant net gain over time from keeping the credit line, assuming you are investing effectively.

    Ed

  327. 369. Ryszard

    Thanks guys for your comments.

  328. 370. Jeanette perreault

    With the new TSFA ACCOUNTS, how do you see using them in implementing the Smith Manoevre?

  329. 371. FrugalTrader

    @Jeanette, contributions to the TFSA with borrowed money are not tax deductible. So like the RRSP, I would not use them with the SM.

  330. 372. Nikolai

    @Jeanette

    I would not call TFSA new ;) In this ever-changing world something that exists for 2+ years is not new.

    Since SM is about making a loan tax-efficient and TFSA is about being tax-free the question does not make too much sense.

    I think the only thing to consider will be the return you can achieve on your money. Assuming you have a choice between paying off your bad loan (saving interest) and borrowing for investment (making $$$, paying taxes, deducting the interest on the loan from your income) vs. investing the same money in TFSA to make $$$. If you are genius investor and you can make very decent return, I think sheltering it from the taxes completely is better than saving on taxes. Otherwise – you need to do calculations. You can borrow to invest in TFSA, but the interest on this loan won’t be tax deductible.

  331. 373. Ed Rempel

    Hi Nikolai,

    We have found that the Smith Manoeuvre is almost always more effective than a TFSA. If you have $5,000, you could invest in an a TFSA. If you are doing the Smith Manoeuvre, you could instead pay the $5,000 onto your mortgage and the reborrow to invest. Which is better?

    In both cases, you can buy the same investment, so the investment return is the same.

    The difference then is that the Smith Manoeuvre also converts $5,000 of your mortgage into a tax deductible credit line. The interest on this credit line is tax deductible not only that year, but every year in the future that you maintain it.

    The partly offsetting advantage of the TFSA is that the investment growth is tax-free, while it is taxable with the Smith Manoeuvre. If you choose a tax-efficient investment, you can defer the tax far into the future, though, which minimizes the advantage for the TFSA.

    In short, the difference is mainly just the tax consequences. With the Smith Manoeuvre, you can create a tax deduction that you get every year for life. You will pay some tax on the investment growth, but it is possible to defer that far into the future.

    Ed

  332. 374. Nikolai

    Ed,

    While I do not disagree entirely, I still have a few points I would like to mention (at least this is how I view it personally):

    - depending on where do I get money for investments and where do I put them, I choose different investments. This is one problem I see with your analysis. When doing SM I invest using borrowed money. Thus, I am more concerned about the partial loss of the principal, not mentioning the complete loss. And, by the way, not all investments are eligible for the tax credit anyway. So, I can buy, say, Kraft Foods on the borrowed money as this is a well-known and quite stable company paying dividend. When investing in TFSA, I am not interested in a single-digit annual return. There is little point in investing in TFSA to earn a few % tax free. In order to really take advantage of TFSA, you need to make enough (if possible, of course). This implies higher risk.

    - with SM there is one additional risk to consider – the interest rate risk. It applies mostly if you intentionally keep your investments leveraged and pay only the interest. In case of rapid interest rate growth you will need more income from your investments to keep the balance positive. Again, this is not a show-stopper at all, this is just a risk factor to consider.

    - speaking of tax efficiency, again it comes to the choice of the investments. One chooses different investments for different situations, thus the end result may be different.

    Bottom line: I suggest people to do both if possible. If you think you can make decent money in TFSA, then absolutely – do TFSA in addition to paying off the debt. I try to make as much as I can in TFSA to withdraw some excess cash by the end of the year, then use this cash to pay off part of the mortgage, borrow the same amount for investments from HELOC and then replenish my additional contribution room in TFSA in the beginning of the year. So far it worked fine for me.

  333. 375. PC

    Hi Ed Rempel,

    Throughout this discussion on the SM, a few people had presented investment strategies that include Return of Capital (ROC). In some of the examples that our bloggers have submitted, you have dismissed some of these funds because you say that they are unsustainable and for some, it is probably the case. But some funds like the IA Clarington Cash Distribution Funds seem, at least in my mind, sustainable.

    Here is quick snapshot at one of them:
    The IA Clarington Cash Distribution Funds have distribution rate of ROC that varies typically between 5-9% with a NAVPS these days between $4-8. The funds have a compound annual return of 4-5% in the last 10 years. IA Clarington has been pretty good at maintaining their distribution rate at least since 2002.

    I think with these funds the focus should be on the cash flow it generates as oppose to the fluctuation in the NAVPS in the long term.

    Here is a scenario, to illustrate what I’m trying to say:
    Let’s say that you want to invest in one of those funds using some leverage. You invest $100,000 of your own money and get a 3 for 1 loan from B2B Trust (you pay back the interest only at prime +1% = 4%) so that you have $400,000 to buy units in one of those funds. $400,000 will get you 50,000 units at a NAVPS of $8.00/units. The distribution rate you get is $.061/unit/month = $0.732/unit/year which amounts to $36,600 in distribution per year (50,000 units X $.732/unit/year). In this example, the distribution rate would be $0.732/$8.00 (or $36,600/$400,000) = 9.15%. Not bad!

    Meanwhile, you will pay about $12,000 ($300,000 X 4%) in interest during that year. You will have to re-invest all of your distribution in the fund in order to be able to claim the full $12,000 of interest in your tax return year after year otherwise it will affect the interest tax-deductibility of your loan. The other interesting aspect of that fund, besides its tax-efficiency, is that it allows for monthly cash flow through return on invested capital without redeeming fund units or triggering capital gains. So in fact, what this means, is that you are increasing the total number of units invested in your portfolio by an amount equal the distribution rate (here by 9%) and thus benefiting from the compounding effect.

    You could do this for a number of years without affecting your adjusted cost base (ACB) if you are to re-invest all of the distribution into the fund. Your ACB will be reduced by the amount of any returns of capital not re-invested into the fund. If your adjusted cost base goes below zero, then you will have to pay capital gains tax on the amount below zero. You would also trigger capital gains if you were to sell any of your units (at the marginal tax rate at the time you selling them), but if you plan to retire in about ten years, you could just let them sit for a while and start cashing them only once you retire and when your tax bracket is much lower.

    Finally, the only time you should worry about the NAVPS, is when you are ready to start selling some of your units (ideally only once you have retired and thus are in a lower tax-bracket). The goal would be obviously to sell them at a NAVPS that is higher than you have paid for them on average over the last ten years as you were building up your portfolio.

    Ed, does this look like a sound investment strategy?

    Thanks

    PC

  334. 376. OttawaGuy2

    @ED your posing#333, last paragraph
    “However, when you finally sell, the rental property will then be 100% taxable (not a capital gain), while the mutual fund will still be a capital gain.”

    If I understand it correctly, it is taxed 100% now but you only pay tax on 50%. Am I correct?

    Example:
    Initial cost = $100,000.00
    Assume your claimed CCA (10 years or what ever time period) =$100,000.00
    Net cost = 0 (after above time period)
    Now you sold the property at price = $200,000.00
    Capital gain = $200,000.00
    Now you are taxed at 100% (i.e 200,000.00) but you only pay tax only on 50% (i.e. $100.000.00) of the gain because capital gain is taxed at 50%.of the gain amount.

    Am I correct?

  335. 377. Ed Rempel

    Hi PC,

    I just noticed your post. The problem with your idea is that whenever a ROC distribution is paid out, the price per share declines the amount of cash you receive. You don’t lose units, but the price/unit declines.

    Then if you reinvest, you have additional units (9% in your example), but they are worth 9% less for each unit, so your total dollars invested remains the same.

    Your strategy actually does nothing. The amount invested remains the same. Your ACB also remains the same.Nothing has changed.

    The only relevant figures in the strategy is the return on investment of the fund, the interest you paid on the loan and the tax consequences.

    In short the distribution is irrelevant.

    That is why you should choose your investment strictly based on the risk/return profile and how it fits with your goals. Any distribution has tax consequences, so it is best to try to avoid distributions as much as possible.

    The best case scenario is a 100% tax-efficient fund(s) with zero distributions of any type for many years – with the fund(s) also being the best choice based on risk/return.

    The big mistake is restrict your investment choice to funds paying a distribution.

    Ed

  336. 378. Ed Rempel

    Hi OttawaGuy2,

    No, your example is not correct. The CCA is “recaptured” first.

    You claimed $100,000 CCA in total, so the first $100,000 of the sale price is recaptured CCA which is fully taxable. Then you have a capital gain based on the difference between the $200,000 sale price and the $100,000 original price.

    Therefore, you end up claiming $150,000 income on your tax return ($100,000 recaptured CCA + $100,000/2 capital gain).

    The CCA in effect is a deferral, not a deduction.

    Whether or not it is worth claiming the CCA depends on your tax bracket in the years you claim CCA vs. your tax bracket on the recaptured CCA when you sell – plus the time value of money from getting your refunds each year and then paying it back later.

    If you sell after you retire and are in a lower bracket, then you benefit. However, if you have a large recapture plus capital gain, you could end up being in a very high tax bracket.

    In your example, you add $150,000 to all your other income for the year, so the recapture would be tax at the highest tax bracket. If you are in a lower tax bracket now, it might not be worth claiming the CCA.

    Ed

  337. 379. Howie

    Hi, I have a question. Let’s say I use the home equity line of credit (HELOC) to purchase a new house and use this new house as my primary resident. I then rent the house that I used for HELOC as a rental property. Do I get tax deductible on the interest of the HELOC?

  338. 380. Howie

    Quick question. If I own a house A and use the equity on this house A and get a HELOC loan to purchase a new house B. I then move to this new house B and rent out my house A. Is the interest on the HELOC loan deductible?

  339. 381. FrugalTrader

    @Howie, the interest deductibility of an investment loan depends on where you spend it. If you spend it on a principal residence, then it will not be deductible. More info here;

    Converting a Principal Residence into a Rental Property – The Solution!

  340. 382. Ed Rempel

    Howie,

    No, it is not deductible. The money was used to purchase house B, which is your principal residence.

    Which property that you use as collateral is irrelevant. Deductibility is based on what the borrowed money was used for.

    Ed

  341. 383. College_Chris

    Hey guys,
    General question about pre-preparing for a SM:
    I am graduating college in 18 months with a degree, and I plan to make about $50 000 a year pre tax earnings. I am planning on implementing a SM once i build up enough wealth to make a significant down payment on a house. I currently live rent-free at home. Depending on how much exactly i’m earning and how early I want my own a house will determine the length of time I invest before “cashing out” and making that down payment. My question is what is the best way to build this wealth. My current plan is to max out TFSA and RRSP, and contribute to a non registered portfolio, for about 5 – 10 years, focusing on more growth/equity mutual funds, index funds, and basically anything with a high return for a 5-10 year holding period. Also, would it be more wise to avoid withdrawing RRSP funds and instead use only non registered funds (and possibly TFSA funds) to make the down payment?

  342. 384. Ed Rempel

    Hi Chris,

    The quickest way to build up the 20% down payment may be to use a combination of RRSP/TFSA loans and non-registered savings. Using RRSP/TFSA loans may allow you to buy much sooner.

    For example, if you will need $50,000 to have 20% down, you may be able to get $25,000 from an RRSP loan and $5,000 from a TFSA loan, which would already give you $30,000. Then you need just $20,000 non-registered, plus of course enough to cover land transfer tax, legal fees, moving costs, furniture, etc.

    Most mortgage approvals allow you to qualify for a mortgage with about 30% of your income for the mortgage and 40% for all debts, so in general if your other debt payments are less than 10% of your income, it probably won’t reduce how much you qualify for.

    If you will be saving for 5-10 years, then it is probably best to use equity investments. That is enough time for the growth to benefit you, plus you need to learn about equity investing before you start the Smith Manoeuvre.

    Withdrawing from your RRSP under the Home Buyers Plan is fine. You will probably want to use RRSPs for part of your down payment, since the refund helps you save it faster.

    The cost to borrow from your RRSP is the return that you would have made if your money had stayed invested, which would be the same if you cash in non-registered investments instead.

    Some general advice is that, unless you will be buying in a year or 2, it is usually smart to have some long term savings as well, and not focus 100% on your down payment. This is less true if you will be doing the Smith Manoeuvre, since saving the down payment gets you closer to starting Smith Manoeuvre investments.

    My point, though, is that there is a huge long term advantage for you if you can build up some long term investments while you are young. It may be a while before you buy your home and you may end up meeting someone that does not want to do the SM. You don’t want to have a decade go by and you have no long term investments.

    Does that answer your questions, Chris?

    Ed

  343. 385. Limey

    If my wife had a limited company, could you take out a business loan to purchase my freelance business – then use the money she ‘gives’ me to pay off the mortgage – thus leaving my wife with a loan she (we) can write off?

    You could also swap out the wife for a college of mine who would be willing for me to purchase an agreed service or business exchange. I buy this off him for 200k and he uses that to pay off his mortgage. Then we do the same thing from his side and I use the 200k he gave me to pay off the mortgage.

    This is would be one total transfer of debt from a home mortgage to a business loan – its been used by several people I know in New Zealand. But I want to know if this would fly in Canada.

  344. This strategy sounds complicated and risky, though it could save a lot of money. I didn’t know it was possible to make a Canadian mortgage tax deductible. Thanks for the tip.

  345. 387. Ed Rempel

    Hi FinanceViking,

    I checked out your web site and noticed that you talk about the benefits of having the optimal amount of debt:

    “Debt should increase until the marginal benefits of the acquired assets, tax shield, and imposed fiscal discipline are equaled by the marginal costs of added risks to liquidity, solvency, and happiness.”

    The Smith Manoeuvre is essentially borrowing to invest for your future. The concept of the “optimal amount of debt” could apply to the Smith Manoeuvre.

    Why would you think it is “complicated and risky”?

    Ed

  346. 388. Bernard LeGault

    Scotia Bank HAS an automatic readvanceable Heloc… I Have one!

    It was pretty much unknown by my own banker but after a good search on his part he found the documentation to put every thing in motion…

    Basically, if your “Step” program is establish already it will cost aprox. $75.00 to “Title Insure” your Step Prg. before you are authorized to obtain a functioning readvanceable Heloc.

    If your financing (Or re-financing) has been insured at the origin by The FTC Titles Insurance Co. or “Stewart, Titles insurance Co. you can ask and get an automatic readvanceable Heloc inside your STEP products composition. (Minor paperwork to redo but no cost involved).

    Regards,

    Bernard L.

  347. 389. Steve

    You mention that The Smith Manoeuvre is used to buy income producing property.
    What if I bought a non income producing property using my HELOC? It is a vacant plot of land. Can I still deduct the interest?

  348. 390. Nikolai

    @Steve,

    Does your land produce any income? ;) If not, then from the tax perspective you cannot deduct the interest. It would be too easy ;)

    Even the possibility of selling your land later at higher price and generating capital gains from that does not count as “income generation”. CRA states the rules quite clearly.

  349. 391. bbtlova

    Hi FT and Ed,

    I am very happy to discover this website coz I have a question to ask and I hope you can give me some feedbacks -

    I own an apartment valued at $260,000, currently I have RBC Homeline and my HELOC room is about $35000 (@3.5%). I decided, for personal reasons, to move to a different place (a rental apartment with a better location for me) last June, and I rented my own place out to my tenants since then.

    Honestly I was not really thinking it through in terms of the tax implications. Now I realized I need to pay more personal income tax on top of my employment income (about $54000/yr). I would like to find out what you think is the best way –

    I talked to the RBC Financial Planner, he told me to kick my tenants out so I can move back, and then to max out my RRSP and TFSA if possible – but the thing is I don’t want to live there again. So, I talked to a friend who is in the financial advising business, and she proposed for met to take out the money in my HELOC and she said she can put them in dividend-paying profolio: she said I could deduct the carrying cost (i guess that’s the interest I pay for using the HELOC money to invest),and then with the annual dividend gain, she can pour it into RRSP so I can receive further tax deductions? I don’t really know if this is all true or doable. Does that make sense? What’s your advice for me? Thank you.

  350. 392. FrugalTrader

    @bbtlova, technically yes, you can take the HELOC, invest in dividend paying stocks, and deduct the interest. However, I will warn you to be careful in your investments. I would recommend against going with a dividend mutual fund as they often pay out return of capital, which can affect the tax deductability of your investment loan. Also note that if you want to use your HELOC to pay for itself, you’ll have to leave some space in there (ie. don’t invest the total HELOC amount).

  351. 393. aB

    Hello,
    Question about the tax deductability.
    If I try to make it as simple as possible and get a RBC Homeline HELOC, and an RBC Direct Investing Account. If I move say $100 from the HELOC, to the investment account, and buy a dividend stock, and leave $1 (whatever the remainder of HELOC deposit minus share price minus brokerage fees is). Then I get a dividend, into the account of $3. Apply $3 (dividend) to my mortgage.
    Does the CRA have a problem with that?

    (Something about mixing money, that left over $1 and the $3 dividend, that I am not sure of. [Can't deduct direct HELOC-to-mortgage interest.])

    Alternatively, I have some Computershare/CST DRIP/SPP going, if I apply the HELOC to those, through my normal checking account (where my salary goes as well) will I have a problem? or would I have to open another checking account (that only has the HELOC deposits) to be safe?

  352. 394. Ed Rempel

    Hi bbtlova,

    Since you started renting, your condo will be taxable. You no longer get the tax-free growth of your principal residence. This tax may not be much from year to year, since most condos don’t show much cash profit (and you can defer it by claiming CCA). However, the capital gains tax when you eventually sell it could be a larger number.

    I agree that it does not make sense to move back in if you don’t want to live there.

    The first question, then, is: Is the condo a good investment as a rental property? How does it compare to other investments with that money? If not, then sell it. If it compares well, then keep it.

    For example, if you sold it, you would clear about $75,000. You could invest that in equity investments and make say 8-10%/year average with minimal tax. Your net rent is fully taxable, but stock market type (equity) investments are taxed much more favourably.

    Since you ask about the best way, you could also take that $75,000 and use it for a 3:1 loan, so that you have $260,000 or $300,000 invested. That way, you would have a similar amount invested to what you do now, but instead of owning one condo, you could have $300,000 in the stock market, which has far higher growth long term. This would likely also solve your tax problem, since the tax savings from the interest deduction could be more than the tax on investment income.

    This is a similar to the “Rempel Maximum” strategy. It is a more aggressive strategy that can work extremely well if you have the temperament to stay invested in difficult markets. You should only do a strategy like that if you have a way to invest effectively.

    If you decide to keep the condo, then you could offset some of the tax by always keeping it fully leveraged. If you invest tax-efficiently so you pay little or no tax on the investments, then the interest deduction might offset the tax on your rent.

    The best way to do this is with some form of the Smith Manoeuvre. If you invest the $35,000 plus the additional principal from each mortgage payment, you can build a growing nest egg without using your cash flow, and also possibly offset your tax on the rent.

    Borrowing the $35,000, then investing in dividend investments and then using the dividends to contribute to your RRSP is not a bad strategy and should work. My general advice is that investments should always be chosen primarily because of investment value, not for tax savings.

    Therefore, I wouldn’t buy dividend paying investments just so you can contribute them to your RRSP. Find an effective way to invest. If that way includes dividends, then fine you can put those into your RRSP to offset any tax if you want. But the minute you buy your second choice of investment over your first choice because of a tax reason, you are almost definitely losing out.

    The dividend to RRSP would be minor anyway. If you receive dividends of 2-3% on your $35,000, that is less than $1,000. It could add up over time if you do it as part of the Smith Manoeuvre.

    Does that answer your question, bbtlova? That gives you a few options to consider.

    Ed

  353. 395. Ed Rempel

    Hey FT,

    Your comment about dividend mutual funds in not correct. They would never pay return of capital.

    Mutual funds, whether they are a trust or a corporation, will distribute only the net taxable portion of any investment income inside the mutual fund. Therefore, any distributions will not include return of capital.

    The exception is mutual funds with a fixed payout. The most common is a T8 fund, that pays out 8%/year to you in cash. It pays that amount, regardless of how much taxable income is in the fund, so that amount is usually almost all return of capital.

    However, with a mutual fund other than funds with a fixed payout, you should never expect any return of capital.

    Ed

  354. 396. Ed Rempel

    Hi aB,

    The issue with your questions is tracking. You can apply taxable investment income, such as the $3 dividend in your example, to your mortgage, but it needs to be the $3 you received. If you take that $3 and pay that onto your mortgage, that is fine.

    You are mixing it with the $1 of borrowed money, which you cannot pay down on your mortgage without tax consequences. But you can use the “flexible approach”, as discussed in Interpretation Bulletion IT-533 to determine which dollar is for which purpose. However, you must have clear tracking of it all.

    The same principle would apply to your second example. The HELOC money goes into your regular chequing account and then you would invest it directly from that chequing account. If you can clearly track this, you should be fine. The best way to do this is to invest the exact dollar amount you take from the HELOC each month – to the penny – within a reasonable time.

    Ed

  355. 397. SK

    Hi Ed,

    SM has been a fantastic read! I am wondering if I understand this correctly and I would like to ask your opinion on my take of SM on a rental property. (I feel anxious to apply to stock as I have less than stellar understanding of them.)

    My situation.
    I am a 33 year old single male living in MB.
    Recently moved from Toronto,ON.
    Had bought a condo to live in Toronto when construction completed but moved to MB due a better job offer.

    INCOME
    Salary 84k and going up annually until the max of 110k (5 years)
    Annual income at minimum in 2013 = salary+dividends=$91200 + OT pays

    ASSETS
    Car 7k
    TFSA maxed $25.5k
    RRSP $17k
    Cash $12k (as per the 3 month emergency fund, you will never know)

    PROPERTY
    Condo (completion date projected 2014) $560k in value
    (My cash of 160k is held by the construction company while construction is commencing)

    DEBT
    Student Loan $15k

    COST OF LIVING
    In avg $1800/month (includes all necessary living expense including car insurance, maintenance and gas. I know MB is cheap to live!)
    Entertainment $200/month

    Now here comes the question.

    Since I cannot get out of this assignment of condo and the real estate is fluctuating currently, I would keep it when the construction is completed. I would like to rent so that it would pay for the mortgage and condo fee. It is a possibility that it will also pay for the taxes if the price is right, but realistically the agent who would care for the unit will cost money and I do realize there may be a vacancy issues even with apartment rents are <1% available in Toronto. So I have decided to keep and rent the unit. (I would pay approximately $200 from my pocket monthly to keep the condo as a rental property until it is a such time that I can sell and at least break even, but hopefully with some capital gain after tax/fees.)

    Now that I looked at your SM strategy for rental properties, it seems the HELOC can be used to offset my $200 monthly I would have to pay out of my pocket if applied correctly. Especially the tax deduction I may benefit appears very attractive in my situation since I know it is a good property I would like to keep regardless. (I am confident that this property will not be swayed by the current grim outlook of the real estate bubble settling down in the next 5 years or so. I may have been reading outdated articles though.)

    Do I have any black holes in my understanding/theory? Am I missing something? Do you think I am a good candidate for the SM?

    Let me throw you a variable in my story. My parents are about to retire at age 64, and they would like to gift their savings to me before the age of 65. In this case I may end up with a small $200k condo in MB where I could comfortably live with much less monthly spending. (My current rent is $950/month, the new property I am looking at has all fees slightly less than $600 including fees/taxes/utilities/parking)

    Am I still a good candidate for the SM? How would you suggest I utilize $200k? (I believe a good place to live is just as important as investing and gaining money so that I can enjoy life. =)

    Do you believe other strategies are more appropriate for my situation?

  356. 398. R Allen

    A lot of people seem to be jumping on the Smith Manoeuvre band wagon, and I just wanted to give some words of advice.

    The Smith Manoeuvre is predicated on borrowing at low rate, using your home as collateral (HELOC) and investing these funds into dividend payings stocks, ideally to offset the interest payment on the loan and be able to claim the interest for tax purposes.

    This has been a great strategy for the past 40 years or so. Dividend stocks are closely tied to the BAA rated bond market. And as some of you might know, bonds go up when interest rates fall, and go down when interest rates rise. This is very likley to be what happens to dividend paying stocks. So now that rates are at a 40 yearl low, means bonds/dividend stocks are reaching 40 year highs. Following this manoeuvre goes completely against the old saying buy low sell high. A lot of people are going to get burned from this thinking they’re buying safe high quality stocks as interest rates begin to rise again in then 24 months or so.

    The way to think about this is as an opportunity cost. BAA bonds on average yield around 7.5% but currently yield around 3.5% so people have moved into dividend stocks for more income. But when rates begin to normalize and these bonds are offering 7.5% again, income investors are going to stampede out of their 4% dividend stocks and back into these 7.5% % bonds, I expect causing some major losses.

    But that’s not all! Becuase this system uses so much leverage you’re in for a double whammy. As interest rates begin to rise not only are your dividend stocks likley to underperform but the interest cost on your loan is going to rise, squeezing you even tighter and dragging your performance down even further.

    So by taking this on you’re opening yourself up to significant interest rate risk, which has done well for many investors over the years becuase for the past 40 years or so interest rates have trended downwards. But now that we’ve hit bottom, people are going to see what happens to bonds/dividend stocks when interest rates begin to rise again.

    I’m no financial advisor, but wanted to add my two cents regardless.

    Best of luck,
    Ron

  357. 399. florent

    Dear all,
    To illustrate many discussions, I’ve shared a complete cash flow analysis of the Smith Manoeuvre with Guerilla Capitalization – source code for the simulation is also shared as open source so that everyone can investigate different financial situations.

    http://theoryevidence.blogspot.ca/2014/01/the-smith-manoeuvre.html

    HTH,

  358. 400. SST

    Very nice!
    Good luck with your new website!

  359. 401. Carlos

    Hi Ed:

    I have been deducting for many years interest on a HELOC for I used this money to buy a rental property in USA. The time has come to renew my home mortgage and to get the best rate possible I’m tempted to blend the mortgage (185K) and Heloc (103K) into one mortgage. My question is if I do blend exactly 185+103 into one mortgage couldn’t I apply a ratio of 103/185 (~ 35.87%) to the interest every year and continue deducting this 35.87% of the interest paid?

    I read your previous responses and one said “…the new loan is also deductible, as long as you can trace it and do not mix it with any non-deductible loan or credit line…” pretty clear but wouldn’t there be enough paper trail to justify interest deduction of 35.87%? Please let me know your thoughts on this for I have heard that is quite possible but I’m not sure.

    Thank you in advance

  360. 402. Nikolai

    @Carlos,

    I am not Ed but I will share my opinion anyway :) I think you absolutely cannot mix tax deductible loan with regular one. You cannot do math properly in order to determine the interest cost. Also, this creates a natural conflict of interests. You want to pay off your regular mortgage as soon as possible. CRA wants you to pay off the tax-deductible loan as soon as possible. I think the only fair way to deal with it would be to pay only the interest, otherwise it will be hard to say where does the principal payment go. And CRA may say that you are trying to avoid taxes ;)

    I have solved the similar issue as follows: I have asked the bank (TD) to create two accounts for the same HELOC. Total limit is my HELOC limit, each account has its own limit. I use one account for investment loan, another one for my regular activity, whichever it may be (buying car, for example). This creates a clean separation between two loans and I can prove that every transaction for one of the accounts is strictly to buy an investment or repayment of the part of the loan after selling an investment.

  361. 403. Ed Rempel

    Hi Florent,

    Interesting and thorough analysis of the Smith Manoeuvre.

    I can’t help but notice that you have changed a few things from Fraser Smith’s original Smith Manoeuvre. Are these your ideas, or why did you make these changes from Fraser’s SM, Florent?

    For example:

    1. “The overall objective of the SM is to repay a home mortgage” is not part of Fraser’s SM. The objective is to build a large nest egg without using your cash flow. The purpose it to build a portfolio, not to reduce debt.
    2. You have changed paying off the credit line in retirement, while Fraser’s SM involves keeping the tax deductible credit line for life (or as long as you own your home). You are withdrawing extra money from the investments after retirement in order to pay off the tax deductible credit line. Incidentally, what to do with the tax deductible credit line after the mortgage is gone is an interesting topic. Keeping the credit line is the most effective strategy and provides the highest retirement income, while paying it off is a more conservative strategy. I’m curious why you assumed paying it off, Florent.
    3. You advocate investing in a dividend growth portfolio, which is not in Fraser’s SM. Fraser looked for tax-efficient growth, so there is no focus on a dividend portfolio. The dividends would obviously reduce the tax refund, and therefore the long term return of the strategy.

    I also have a few suggestions that may make your projections more accurate:

    1. Your assumptions on the interest rate on the HELOC at 3% is probably low. Even at today’s low interest rates, secured credit lines in a HELOC are generally 3.5%. We usually use 4% or 4.5% as a long term average interest rate on the HELOC.
    2. Your rate of return on the investments of 7% is quite a conservative figure (4% dividend plus 3% growth). The long term average of the stock market is 10-11%. It would make sense to make a more conservative assumption. Assuming a return of 3-4%/year less than the actual long term returns is quite a bit. This may or may not be overly conservative. We normally assume an 8% long term return with little or no dividends.
    3. All the readvanceable mortgages I am aware of in Canada have monthly compounding for both the mortgage portion and the credit line. Regular mortgages are usually compounded semi-annually, but mortgages within a credit line (readvanceable mortgages) are compounded monthly. HELOCs are compounded monthly, as well, since the interest is charged to you every month.

    Ed

  362. 404. Ed Rempel

    Hi Carlos,

    In general, you are correct that you could merge them and then prorate the interest. This does create risks (because you have to track it and be able to prove the figures), and also creates potential issues if you have any transactions other than regular payments. For example, if you have an additional prepayment, which part was prepaid?

    Nikolai is correct, though, that it is much better to have 2 separate mortgage portions within your readvanceable mortgage. Most readvanceables allow you to have multiple mortgages and credit lines within your overall limit. They would also be at the same rate and you should keep the terms and due dates the same.

    Having 2 separate mortgage portions has some distinct advantages:

    1. It creates a clear tracing of which is tax deductible and which is not. If you are ever audited, you will be glad you have them separate.
    2. It allows you to focus on the non-deductible mortgage. For example, instead of having them combined with a 20-year amortization, you could have a 30-year amortization on the tax deductible mortgage, so that you have the extra cash to have a 10 or 15-year amortization on your non-deductible mortgage. You can also make prepayments on the non-deductible mortgage only.

    Note all this assumes that you want to convert your tax deductible debt back into a mortgage. The advantages are that you are reducing it and that you save interest (mortgage rate vs. credit line rate). The disadvantages are that your payment is higher, since you are paying P+I, and that you are reducing your tax deductible interest.

    Ed

  363. 405. florent

    Hi Ed ,
    the Smith Manoeuvre, to me, is another financial strategy to increase wealth, and as such it has multiple variations, some of which I mentioned at the end of my post.
    I have thus elected to detail what I have implemented for myself, thus what I have defined as most appropriate for my situation after analysing different cash-flow scenarios.

    I believe the objective of the SM is to transfer a non-deductible debt into a deductible one while increasing wealth without adding further financial burden. Whether or not one is willing to clear that debt over time is another matter, from my POV, that relates directly to risk appetite. The objective is financial autonomy, and to me owing money to the bank with my primary residence (main home) as a collateral was not ideal – So I’ve balanced out “highest retirement income” with personal considerations. Should I do another SM with, hopefully, a secondary home (cottage) then I may change my POV.

    So I want to secure my primary residence quickly, that is quickly repaying my mortgage so that if things go south I’m the owner of a house I may sell to clear some potentially troubling debts, or if it goes way up north (like a house bubble), I can cash in eventually.

    Although I do not advocate for anything, but simply present what I’ve implemented for myself, dividend growth portfolio was indeed the vehicle of choice considering it brings additional cash to the table to aggressively attack the mortgage without requiring significant involvement in terms of portfolio management. Kindly note that my objective is for the SM to quickly repay my house, then clear the HELOC debt, at which point anything is possible, the easiest way being signing off to DRIPs to prevent dividend taxes. I’m not advocating for this particular variation of SM, it simply is what I believe to be the most suited in view of my financial situation and risk appetite.

    As per the projections, I have made the software source code available as open source for everyone to modify, and study under different financial situations. I do agree with your long term average interest rate, although I’ll make that parameter dynamic in the future, yet I’ll stick with my conservative portfolio returns ;-) Better be surprised than sorry.

    One last thing: I disagree with the following comment “HELOCs are compounded monthly, as well, since the interest is charged to you every month.” – I may mistaken, but HELOC are not compounded, they are simply subject to daily interests, even though such must be paid monthly (at minimum). You can repay part of HELOC at any point in time during a given month and that will directly affect the amount of interest the bank asks you to pay once a month …. that’s the very interest in splitting your mortgage right away between a HELOC and a mortgage so that you can use your monthly paycheck to directly attack the HELOC … although one must do the maths to define how much mortgage/HELOC should be used to be sound in view of both interest rates … And wait, no this does not impact the SM long term … if your mortgage is less, you will repay it faster, at which point you may directly invest your money into your portfolio, without owing nothing to anyone. That is the subject of my next post probably.

    Cheers,

  364. 406. Nikolai

    @florent,

    “he easiest way being signing off to DRIPs to prevent dividend taxes”. I believe DRIP does not change anything from tax perspective. The way I understand it – it is only a method of automatically using your dividend payments to purchase additional units of stock without commissions and, possibly, at small discount. And whatever dividend you receive – it is taxable regardless of how you use it, DRIP or not.

  365. 407. florent

    @Nikolai
    … and you are right ;-) I meant SDP, such that using dividends to attack the debt during the SM (mortgage and HELOC), and switch to SDP to avoid dividend taxes once debts are cleared.

  366. 408. SC

    Hey Everyone,

    Great discussion here. I have learned so much from reading these comments!

    I just have a few things I am not clear on I am hoping could get cleared up.

    1. I am going to withdraw money from my HELOC to my brokerage account (questrade) and going to buy individual stocks. What happens when the price you buy it at doesn’t exactly add up to the amount w/d from your HELOC? Say I withdraw $1000 to my questrade account and buy 10 shares of X at $99. I will have $10 left over. Is that $10 still tax deductible? Do I just use the extra cash sitting in my account to for my purchases for the next month?

    2. What do I do about trading fees? If I buy 1 stock a month ($4.95 fee) should I deposit $4.95 from my checking account so I am not using money from my HELOC for the trading fee?

    3. I want to capitalize my interest. So I am going to set up automatic payments from my checking for the interest payments on my HELOC. Do I just withdraw whatever interest is paid from my HELOC to my chequing the day after it gets taken out? Does this work?

    Thanks!

  367. 409. Nikolai

    @SC

    1. You cannot deduct the interest from a loan that is not used for investment purposes. Or used to invest into something that does not qualify for the tax credit. Thus, your extra cash will not qualify. Solution? Do not withdraw $1000. Get a margin account. Buy whatever you need to buy and then withdraw exactly the amount you need.

    2. Yes, you cannot use the HELOC money to pay for your commissions.

    3. I am not sure what exactly are you trying to achieve. You have the interest charge – you need to pay to your HELOC before due date. I think it depends on how much time do you want to spend on doing the math every month. Me, personally, I have set up automatic payment from another account that pays for the interest. Plus I transfer all Canadian dividends straight to my HELOC. US dividends – I keep them as USD (to provide me a modest source of USD income that I can spend in USD directly) but I pay “myself” the fair equivalent of these dividends. I send the dividend payments to HELOC primarily to make sure I do not miss ROC distributions. Some of my investments pay mix of dividends, capital gains and ROC and often you do not know until next year the exact ratio. So, as long as I do not need that extra income I just simply send it all to HELOC.

    3.

  368. 410. SC

    Thanks a lot for the reply Nikolai, that really helps me out.

    Would there be a problem if I use my existing unregistered brokerage account to make my investments? I won’t be putting any other money into that account (just HELOC transfers). I will keep track of it diligently. Or is it better opening a brand new account?

  369. 411. Nikolai

    @SC

    I think it does not matter which unregistered account you use, I believe CRA does not mandate a particular method of bookkeeping for this tax credit. Also there should be no problem with mixing up your borrowed and other investments on the same account – as long as you can easily track them when needed. I assume you are not going to trade like crazy, so there will be not too many transactions there. I think the key is the ability to easily trace the money going FROM the HELOC, not going in/out your brokerage account.

    Just a question of discipline. If you want to be perfect, get yourself an Excel spreadsheet. Do a table like this:

    security, date_purchased, purchase_price, commission, borrowed amount, date_borrowed, transaction_number, date_sold, sell_price, sell_comission, ACB, gain(loss), amount_paid_back_to_HELOC

    Every time you buy something and you intend to pay for that transaction with the borrowed money – you put a new line there. Every time you sell the security – you complete that line, calculate your gain/loss. At the end I always pay back to HELOC the amount equal to my cost base (or lower if I sell at loss). The profit goes somewhere else – depending on my needs.

    I think the only situation when you might want a separate account is when you want to use your own money AND the borrowed money to purchase the same security. But even in this case it is not strictly needed (because you can still easily calculate your interest). And, if you think about it – why would you do that if you can buy the qualified investment and get the tax rebate? You can always use your own funds to buy something else that does not qualify for the tax credit – such as a pure growth company that does not pay dividends at all.

  370. 412. Ed Rempel

    Hi Florent #405,

    Your strategy sounds like it makes perfect sense for you – but it’s not the Smith Manoeuvre. There are 7 categories of Smith Manoeuvre strategies I have seen so far. You should name your own strategy, the Florent Manoeuvre, similar to the SM, but focuses on paying off debt instead of building wealth, and focuses on dividend growth stocks instead of tax-efficient growth.

    Credit lines are compounded monthly. Compounded refers to how often the interest is charged. When it is charged, you have to either pay it from your cash or add it to the credit line and then pay interest on the interest as well. If a credit line was daily compounded, you would have to pay it every day.

    Readvanceable mortgages are all compounded monthly, as far as I know.

    Ed

  371. 413. Ed Rempel

    Hi SC #408. I have a different answer for you. Your interest deductibility should be fine with small or temporary cash holdings in your portfolio. Using borrowed money to pay the commissions is also fine, since they are part of the cost of investing.

    I would suggest to have a separate account only for leveraged investing. Keep it separate from an account to invest your own money. Then fund the leveraged account from your HELOC. If all activities in that account are investment-related, then the interest stays tax deductible. You can hold whatever cash balance makes investing sense and pay investing costs from within the account.

    You can also capitalize your HELOC interest. Just refund to your chequing account the exact amount charged to you for interest – to the penny. That way, you could prove to CRA if necessary that all amounts borrowed from the HELOC either went to investments or to pay the interest on the HELOC.

    I hope that’s helpful.

    Ed

  372. 414. Nikolai

    @Ed,

    I am not a certified accountant, just an amateur and I respect your opinion…but I am not sure about this statement below. Maybe it is “the letter of law vs. common practice”?

    >> Using borrowed money to pay the commissions is also fine, since they are part of the cost of investing.

    From: http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/ddctns/lns206-236/221/menu-eng.html

    “You cannot deduct on line 221 any of the following amounts:

    brokerage fees or commissions you paid when you bought or sold securities. Instead, use these costs when you calculate your capital gain or capital loss. For more information, see Guide T4037, Capital Gains; and

    Please correct me if I misinterpret that statement.

  373. 415. Ed Rempel

    Hi Nikolai,

    You cannot deduct commissions on line 221 (carrying charges), but you can deduct interest on money borrowed to pay commissions.

    The point of the CRA section you quoted is that commissions are part of the calculation for capital gain/loss on your investment, so you cannot claim commissions as a carrying charge. If you claimed commissions as a carrying charge, then you would get a full deduction, but since you can only claim them as part of the gain/loss calculation, commissions are really only half deductible (since capital gains are taxed at 50%).

    That CRA quote does not refer to interest borrowed to pay commissions. It refers to the commissions themselves.

    Does that make it clearer, Nikolai?

    Ed

  374. 416. SC

    Thanks Ed and Nikolai. This clears everything up for me.

    After reading through all of these comments and then having Ed respond to me I feel like I got a response from a semi-celebrity.

    I am going to be withdrawing from my HELOC to a new margin account that will only have my HELOC money in it. I am not going to worry if I carry a few extra dollars for the month if the purchase doesn’t exactly equal what I withdrew. It will just roll into the next months buys.

    Thanks,

    Spencer

  375. 417. florent

    Hi Ed #412,
    indeed you’re right on the ‘HELOC are compounded monthly’. I went back to the definition of ‘compounding’ so thanks for taking the time to improve my ‘financial semantic’.

    As per name convention, I use ‘Smith Manoeuvre’ for anything that ‘support the conversion of a bad debt into a good debt based on the ‘borrowed money for investment’ principle. Is there a more generic name for this (like ‘cash damming’ is for involving non-inc business expenses) ?

    Hi SC #416,
    Mind the cost of ‘broker fees’ Vs amount of re-advanced capital effectively invested, balanced with the fact that interest deduction happen only when such re-ad capital is invested.

    My point is: if your mortgage is set-up for bi-weekly payment, and let’s say you re-adv 300$ every two weeks, a 7$commission on the broker side is 2.3% fee on your capital to take into account on top of everything else. Yet, if you decide to aggregate some capital (let’s say 5000$) to invest to neglect the broker fee, you cannot deduct interest on those 5000$ until they are invested but you’ll have to capitalize interest to cover what has been invested already.

    That’s the subject of my next post and it’s worth understanding this prior starting the SM.

    happy SM.

  376. 418. Nikolai

    @Ed,

    Yes, I think you are right, I was mis-reading this statement. Indeed, they are talking about what you can deduct – not only the interest. So, among the things you can deduct there is the “interest you pay on money you borrow for investment purposes”. And you cannot deduct the brokerage fees from your income, that’s clear. But they do not specify exactly if the cost of “investments” may or may not include the fees you pay to acquire them. So, I guess, this can be interpreted any way. But in practice…you borrow 10K to buy stock and pay, say, 10-20 bucks in commissions. 20 bucks at 3.5%/year is about $0.7 of interest. Which is, depending on the tax bucket, few dozens of cents in taxes. I doubt CRA will argue about it anyway comparing to $350 deduction for the interest paid on these $10K :)

  377. 419. Mansbridge

    Question re: capitalization of interest. The interest on the interest should be taken into account too, right? That will add up over time, making the breakeven point harder to reach.

    Say HELOC is a 3.5%, but if you capitalize the interest, you have to pay the interest on the interest eventually, so it’ll cost you (in reality) something like 3.51% (just guessing) a year effectively (pre-tax deduction)?

    I think I just wanted to point out that you’re not only paying the HELOC rate, you have to account for the costs that come with capitalization of interest.

    Let me know if I’m confused…

  378. 420. Ed Rempel

    Hey SC. SEMI-celebrity?? :) Thanks, but I’m just a guy trying to help. Your strategy is fine for tax purposes.

    Ed

  379. 421. Ed Rempel

    Hi Florent.

    The generic term is “borrowing to invest” or “leverage”.

    The Smith Manoeuvre is a specific strategy involving borrowing to invest bit by bit (usually) against your home, capitalizing interest, and tax-efficient investing. There are many ways to do it, though. I’m aware of 7 categories of strategies that are versions of the Smith Manoeuvre.

    Ed

  380. 422. Ed Rempel

    Hi Nikolai,

    Brokerage fees are part of the cost of buying and selling stocks. The fees to buy are part of the book value, and the cost of selling is part shown separately on your tax return along with the proceeds of selling.

    Both reduce your capital gain or increase your capital loss. Essentially, they are half deductible. However interest on brokerage fees is deductible as part of borrowing to invest.

    Ed

  381. 423. Ed Rempel

    Hi Mansbridge. Your point is accurate. The growth of the investments also compounds, as long as you leave it invested.

    The effective compound interest rate is a bit higher than the nominal interest rate, but the effective compound return on your investment should also be a bit higher than the nominal growth.

    Ed

  382. 424. Brandon

    Would it be a good idea to invest into your TFSA while using the smith manoeuvre or would there be any negative tax implications?
    Thanks!

  383. 425. Mansbridge

    Ed,

    Sorry, I don’t quite understand… how does the investment compound if you’re only in it for deferred capital gains (tax-efficient investing)?

    Brandon,

    the interest incurred cannot be deducted if you use it to invest under a TFSA/RRSP setup. only non-registered accounts

  384. 426. Ed Rempel

    Hi Brandon,

    Mansbridge is right. For the interest to be tax deductible, you have to invest non-registered. The investments have to be in a taxable account. You cannot invest this in TFSA, RRSP or any other registered account.

    Ed

  385. 427. Ed Rempel

    Hi Mansbridge,

    When you invest tax-efficiently, your money all stays invested and growth compounds. Multiple-year growth rates are normally quoted as compound growth figures.

    For example, if your investments grow 10% this year, then next year the growth will be on the new, year-end value.

    This is in contrast to receiving dividends or other investment income, unless you reinvest all of it.

    I’m not sure I fully understand what you are asking. Does that answer your question, Mansbridge?

    Ed

  386. 428. david

    Hi Ed,
    Would you claimed, under CRA ‘expenses on money borrowed for investment’ the Guerrilla Capitalization component of the manoeuvre (which does not contribute to investment per say)?

  387. 429. Ed Rempel

    Hi David.

    Yes. The tax rule is that if interest on a loan is deductible, than interest on the interest is also deductible. The Guerrilla Capitalization is also claimed as a carrying charge for interest borrowed for investment. It is compound interest and referred to in IT-533.

    Ed

  388. 430. SC

    Hey Ed,

    I have started the SM and have run into something I didn’t see coming. For my HELOC from Scotia bank the minimum payment is the greater value of the interest or $50. As I an just starting out ($5k on the LOC at the moment) my interest from last month was $14. But the minimum payment for my LOC is $50 as the interest for that month was less than that. Have you run into this before? Can I just withdraw and deposit $50 from my HELOC, but obviously only the $14 is tax deductible. Is there any other issues I would be running into with this? It will happen every month until my interest per month gets over $50.

    Here is the statement from Scotia on this:

    Interest-only minimum payment will be the greater of the interest portion only of the outstanding balance on your statement, or $50, subject to your minimum payment being no more than the outstanding balance on your statement.

    Thanks for the help!

    Spencer

  389. 431. k

    Hi SC,

    I’m planning to do the smith maneouver at Scotia bank too. Hopefully Ed can confirm this, but its my understanding you can just withdraw and redeposit the $50 into the heloc.

    Mind if I ask how you have the cash flow setup?

    I’m planning to transfer directly from my HELOC into a Scotia itrade account. The interest payments will go from the HELOC to a savings account and then back into the HELOC. Is this similar to your setup?

    Thanks,

    Ken

  390. 432. Ed Rempel

    Hi SC & K,

    Yes, that is a strange quirk of the Scotia STEP. You can just capitalize the entire $50, though. Take the entire $50 payment back each month, as you suggested. That should maintain our tax deductibility.

    In general, we find it more complex to do the SM at Scotia compared to most other banks. Scotia seems to have various version of the STEP that work differently. Some have the $50 fee, restrictions on automating, readvancing only once per month – all of these seem to apply sometimes and not others. We have not quite figured out which. It could be the source (broker vs. branch). Someone told me that Scotia has been rolling out a new Step and doing it one branch at a time.

    If someone knows why Scotia has different versions, we would like to know.

    Ed

  391. 433. SC

    Hi k,

    My cashflow setup is similar to yours and very simple. I withdraw from my HELOC directly to my unregistered Questrade account. This account is only used for the SM so there is never any doubt where the money came from. To pay off my HELOC interest, I withdraw the money from my HELOC to my TD checking account and deposit the exact same from my TD account to my Scotia HELOC. Pretty simple.

    Ed,

    That is what I thought. Thanks for confirming!

    Spencer

  392. 434. lw

    Hi Ed
    How does this work??? I just got 20% finally in equity and my mortgage is up for renewal. I also already have questrade rrsp account. I have a 340k mortgage left.

    So I should try and get a readvancable mortgage and use the loc and buy like…Facebook or Apple stocks?

    Pay the month interest from my checking and then take it right back out and what happens if I give up and sell all my shares? Do I pay cap gains? ?

  393. 435. Ed Rempel

    Hi LW,

    I think that the Smith Manoeuvre is not right for you. It is a risky strategy, since it involves borrowing to invest. If you don’t know what you are doing, then this is too risky for you.

    I won’t recommend specific stocks, but borrowing to invest in only 2 stocks (both technology) is not a proper portfolio. If you are the type of person that will give up and sell your shares, then the Smith Manoeuvre is too aggressive for you.

    The Smith Manoeuvre is a leverage strategy that can work extremely well for the right investor that stays invested long term. Interest rates are low and borrowing to invest in a solid equity portfolio for the long term can be an excellent way to build wealth over time. However, no matter what you invest in, you will have periods where your investments underperform and periods that your investments go down. If you are the type of person that will dump your investments the first time they are down, then borrowing to invest is a bad idea for you.

    In your case, I would suggest to stick with your RRSP investments, for now, until you find a way to invest for the long term that you will still be confident in after a large decline. If you borrow to invest and it drops by 40% and you sell, then you should never have done the Smith Manoeuvre. You need investments that, after they fall by 40%, you have no hesitation in continuing to hold and adding more money to, because you have complete confidence in your investments. Until you are at that point, I would suggest that you avoid the Smith Manoeuvre.

    Please don’t take offense, but we have done the SM with many clients and see both how effective it can be an how damaging it can be. You need to be the right type of person for the SM to work well for you. I hope this is helpful for you, LW.

    Ed

  394. 436. Nikolai

    @Ed,

    Very well said. SM requires some investment skills. Your own (if you invest in stocks and ETFs) or someone’s else (if you invest through actively managed mutual funds). Unless you are comfortable investing in stocks yourself without SM, you should not do SM with the stocks.

    If you are brave enough then you can start with the mutual funds and then slowly (over years!) move into stocks. But even the mutual funds are not guaranteed investments and the income from really guaranteed investments cannot justify the troubles going with SM. To me the mutual funds (I am talking about the actively managed ones) are even less transparent when the stocks and not flexible enough. Not to mention that often SM requires some lump-sum investments and this is another problem when it comes to the mutual funds. It is much easier (again, if you have enough experience) to find some qualifying stocks to invest in a couple of days then to find a suitable mutual fund.

  395. 437. Ed Rempel

    @Nikolai,

    There is one more step in the progression you mentioned. The route I have seen people go through time after time is that they start investing with mutual funds such as bank funds, because they are easy.

    After a while, they want to do something more and start picking their own stocks. Sooner or later (sooner if they are lucky), they realize they are underperforming by picking their own stocks.

    Then they move up to finding top investors to invest for them, and go back to mutual funds. But this time, it is based on having a top fund manager.

    It’s a lot easier to feel confident in 3-5 top fund managers than the management of 20 or 30 stocks.

    I don’t really understand your comment about lump sums. If you have a lump sum to invest, mutual funds are more flexible because you can invest any amount any time. You don’t have to worry about lot sizes and and buying 100 shares per stock. Just invest the exact amount of dollars you want to invest.

    Ed

  396. 438. on the fence

    I think it might be the right time to start SM now, especially if you have already a good chunk of equity in your home..

    The market is all time high, interest rate is low.

    A significant market correction is broadly anticipated, which would result in building up part of the the investment portfolio at a discounted price, at the early stage. The investment portfolio started at discount price would provide great long term benefit.

    How long can be cash parked and accumulated on a SM investment account – with the purpose of deferring stock, etc. purchase at the time when the market drops?

    A market crash might also put pressure on trying to keep interest rate low, as a monetary policy tool.

    What do you think?

  397. 439. Ed Rempel

    Hi On the Fence,

    I think you are missing the point by trying to time the start of the Smith Manoeuvre. Timing the market short term is a mugg’s game. The Smith Manoeuvre must be a long term strategy, which means you will go through multiple booms and busts. If the strategy makes sense for you, just start when you are ready regardless of where the market is.

    The market is at an all-time high, but that happens in almost 2 of 3 years. The market is fairly valued, not at a bubble price. It goes up 3 of 4 years, so up is more likely than down. Especially now when everyone is predicting a market correction. Whatever everyone is predicting is unlikely to happen. Remember – “the masses are always wrong”.

    Bottom line, you’re probably wasting your time waiting for a market crash.

    To answer your question, there is no limit of to how long you can sit in cash and still have the money you borrowed stay tax deductible, as long as you can track it. It’s a bad idea, though. Why borrow money at 4.5% and then just park it in cash? While waiting for a crash, you’re losing money.

    Ed

  398. 440. on the fence

    @ Ed Rempel. Thank you Ed.

    I agree with you about the long-term nature of the investment.

    The “timing for crash” is an extreme scenario, of course.

    The core of the question is that (if I am correct) since you have to make the mortgage payment and the investment portfolio contribution from the HELOC account on the same day to be able to claim tax refund, I was wondering if there was any time limit rule, in terms of making an actual investment product purchase from the cash, deposited from HELOC to the investment account, in order to stay qualified.

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