As promised, I will be discussing my personal scenario regarding using the Smith Manoeuvre. The spreadsheet provided by Cannon_Fodder was a great help and reinforced in my mind the power of smart tax planning.
Anyways onto the good stuff. Spring is here which means my wife and I are on the house hunt. With this comes the opportunity to use The Smith Manoeuvre on our future home, but I would like to discuss some of the numbers that I came up with to make sure that they made sense. From the comments on the article "Anti-Smith Manoeuvre", it appears that some of you are better at analysis that I am. :)
Without further adieu, here are the numbers:
- Current Residential Home Value: $140,000
- Current Mortgage: $80,000
- Equity: $50,000 after Realtor fees.
- Cash Savings used: $20,000
- Non-Registered Portfolio: $40,000 (liquidate)
- Total Down Payment: $110,000
- New House (estimated): $275,000
- New Mortgage: $275k-110k= $165,000 (non tax deductible)
- New HELOC (@ 6%): [ ($275k x 75%) – $165k] = $41,250 (tax deductible)
- Total Debt: $206,250
- New Mortgage Payment (accelerated bi-weekly) @ 5.25%: $584.12 (not including property tax, insurance etc).
- Original Amortization: 16 years
- All tax returns will be applied to the non-deductible mortgage balance, which then again, increases the HELOC balance.
- All dividends will be used to pay down the non-deductible mortgage.
- HELOC interest payments will be capitalized. That is, the HELOC required payments will be paid by the HELOC itself. This will avoid using any of my own cash flow to support the investment loan. The spreadsheet will account for this.
- Assume that the LOC will be invested in dividend paying stock that provide an income stream of $1400/year (assume 3.5% average dividend yield). This equates to a $54 / bi-weekly period applied to the mortgage. This should be increasing annually but for simplicity sake, I will be keeping this constant.
- Assume that since I'm going to continue to max out my RRSP, I won't have any extra cash to pay down the mortgage.
- Marginal Tax Rate: 40%
- Average Investment Growth Rate: 8%
- Diverted Periodic Investments: $54
- HELOC Interest rate: 6%
- Mortgage Interest Rate: 5.25%
- Non-deductible mortgage will be paid off in 11.78 years instead of 16
- Investment Portfolio Value after mortgage is retired: $244,833
- Portfolio Value NET of HELOC: $38,583
- Investment Portfolio Value after 25 years: $908,640
- Portfolio Value NET of HELOC: $702,390
- This analysis shows the benefits of using the Smith Manoeuvre, not the down side. You need to be comfortable with leverage, especially the downside, before you even consider using this strategy.
- The Smith Manoeuvre will enable me to pay off my mortgage in 12 years instead of the stated 16 years with no extra cash flow out of my pocket.
- At the end of the mortgage term, assuming that I average 8% returns over the term, my portfolio value minus the loan amount will be approximately $38,000.
- It is very likely that we will be putting some of own cash flow/savings to pay down the mortgage. If we were to add an extra $100 to our bi-weekly payments, we would reduce the mortgage term down to 10 years from 12.