Smith Manoeuvre

[rain111]

Any homeowner here using the Smith Manoeuvre technique? I am a fan of leverage investing. I do not own a home at the moment but when I do, I probably will set up Smith Manoeuvre on it. I totally bought his idea of retiring without the house paid off but owing a lot more investments instead.
In long term, a prudent leverage strategy almost always trump a non-leveraging one.

[mart242]

Care to elaborate? There's not much info on their website and I don't feel like paying 25$ for something that I might not be able to do..

[dgg]

there was a post about this a little while ago, i replied as i am currently doing a half smith manoevre, ie don't yet have enough equity built up in the house to make the leveraging worthwhile. do a search on my posts and it should pop up.

good luck.

[mart242]

never mind...

[SirloinofBeef]

Fraser Smith himself has answered questions posted here in great detail which I think is great. I read his book and will likely implement the method after seeking a FA, doing the usual due dilligence and excel number cruching. What I got out of the book was to convert your mortgage payments into a tax deductable loan.

In the end you've:
1. paid off your mortgage
2. have a tax deductable investment loan equal to the original value of the mortgage
3. own investments that have been compounding returns and/or growing for the duration of the mortgage payment period which *should* offset the cost of financing the investment loan thanks to time and the interest mail in rebate :) from point 2
4. risks include investment performace and interest rates which comes from leveraging

There are more points but the selling point for me was the ability to build a portfolio on the relatively cheap and early.

[fraser]

Fraser Smith himself has answered questions posted here in great detail which I think is great. I read his book and will likely implement the method after seeking a FA, doing the usual due dilligence and excel number cruching. What I got out of the book was to convert your mortgage payments into a tax deductable loan.

In the end you've:
1. paid off your mortgage
2. have a tax deductable investment loan equal to the original value of the mortgage
3. own investments that have been compounding returns and/or growing for the duration of the mortgage payment period which *should* offset the cost of financing the investment loan thanks to time and the interest mail in rebate :) from point 2
4. risks include investment performace and interest rates which comes from leveraging

There are more points but the selling point for me was the ability to build a portfolio on the relatively cheap and early.

Hi Sirloin,

Pretty accurate summary, thank you.

You are correct that the power of the strategy comes from recognizing that if you have a mortgage, you have already leveraged your position to get your house. The problem is that this large debt costs huge amounts of interest that is non deductible. Most people wish they could gather other assets, but usually are following the custom of getting the house paid off first so that they can then divert the former mortgage payment towards investment gathering. Of course that means they will lose 20 or 25 years of compounding time for the investments you have not yet purchased. The Manoeuvre allows you to convert the bad mortgage loan to a good investment loan. As fast as you reduce your first mortgage, you re-borrow that new equity and purchase investments of your choosing. Your debt will therefore stay level, but most will recognize that if they can handle a 200,000 mortgage debt today, then they should be able to handle a 200,000 investment debt a month from now, a year from now, or forever. If it's deductible, you will get a maximum tax refund cheque in the mail every year for the rest of your life, just like wealthy people do.

Not only do you start building your investment portfolio starting right now, the cherry on the top is that the interest expense on your investment loan is a tax deduction, and the tax refunds obviously are available to make your mortgage go down faster, which means you can borrow back to invest faster. Faster is better when you are talking about getting rid of bad debt, and faster is also better when you are talking about building your investment portfolio, and faster is also better when it means tax refund cheques will be getting larger as each year goes by until the mortgage has been completely converted to good debt.

Wealthy people have debt too. The difference is that they paid large sums of money to expensive lawyers and accountants to show them how to make their debt deductible. Now you can do the same. I strongly recommend you work with a financial planner.

To get the full story, download my PowerPoint slides from my website at www.smithman.net. There is no charge.

Hope that helps,

Best regards,

Fraser

[str]

The only potential problems with the Smith Manoeuvre is that legislation might change. For example, in Quebec (provincial tax) now you can only deduce the interests from declared gains on the loaned investment, which makes the Manoeuvre less interesting (but interesting nonetheless). If the federal government was to change the law to something similar, then you would only be able to reduce your taxation when declaring income from the investment, which means you wouldn't be able to profit from the short term tax deduction.

[Paksis]

Hi Sirloin,

Pretty accurate summary, thank you.

You are correct that the power of the strategy comes from recognizing that if you have a mortgage, you have already leveraged your position to get your house. The problem is that this large debt costs huge amounts of interest that is non deductible. Most people wish they could gather other assets, but usually are following the custom of getting the house paid off first so that they can then divert the former mortgage payment towards investment gathering. Of course that means they will lose 20 or 25 years of compounding time for the investments you have not yet purchased. The Manoeuvre allows you to convert the bad mortgage loan to a good investment loan. As fast as you reduce your first mortgage, you re-borrow that new equity and purchase investments of your choosing. Your debt will therefore stay level, but most will recognize that if they can handle a 200,000 mortgage debt today, then they should be able to handle a 200,000 investment debt a month from now, a year from now, or forever. If it's deductible, you will get a maximum tax refund cheque in the mail every year for the rest of your life, just like wealthy people do.

Not only do you start building your investment portfolio starting right now, the cherry on the top is that the interest expense on your investment loan is a tax deduction, and the tax refunds obviously are available to make your mortgage go down faster, which means you can borrow back to invest faster. Faster is better when you are talking about getting rid of bad debt, and faster is also better when you are talking about building your investment portfolio, and faster is also better when it means tax refund cheques will be getting larger as each year goes by until the mortgage has been completely converted to good debt.

Wealthy people have debt too. The difference is that they paid large sums of money to expensive lawyers and accountants to show them how to make their debt deductible. Now you can do the same. I strongly recommend you work with a financial planner.

To get the full story, download my PowerPoint slides from my website at www.smithman.net. There is no charge.

Hope that helps,

Best regards,

Fraser


This is an idea for a small select few who can make it work, the rest will screw it up.

[rain111]

This is an idea for a small select few who can make it work, the rest will screw it up.

Care to elaborate why the rest will "screw it up"?

[fraser]

The only potential problems with the Smith Manoeuvre is that legislation might change. For example, in Quebec (provincial tax) now you can only deduce the interests from declared gains on the loaned investment, which makes the Manoeuvre less interesting (but interesting nonetheless). If the federal government was to change the law to something similar, then you would only be able to reduce your taxation when declaring income from the investment, which means you wouldn't be able to profit from the short term tax deduction.

Hi STR,

I suppose we always live with the possibility that the government will change the rules in anything that affects our daily lives. This is most unfortunate, because there is bound to be many folks who decide not to act in their own best interests because there might be a change in the future. The fact is that current Canadian tax law allows for the deduction of interest on loans made for purposes of investment to earn income, and it would be a shame if people avoided investing because there might be a change someday.

On the other hand, only about one third of the advantage of The Smith Manoeuvre comes from tax benefits. The bulk of the advantage comes from the fact that Canadians will use the equity generated in their home to borrow back to get it invested right now, on a monthly basis, instead of waiting to take out an investment loan secured by the house 15 years from now. Or, worse yet, taking a reverse mortgage at age 65 because they have not enough investments to provide income in their retirement. A reverse mortgage is the ultimate removal of the equity from your home, and it is totally avoidable if you are wise enough to make the equity work now instead of later.

So, if the government takes away deductible interest, which is one of the more hare-brained ideas ever dreamed up by Finance, Canadians will still be much further ahead to have implemented The Smith Manoeuvre to build their own personal retirement pension plan. In the meantime, you can have your own pension plan as well as excellent free tax refund cheques under current tax law.

Thanks for your comments.

Fraser

[Paksis]

Care to elaborate why the rest will "screw it up"?


You have to have the discipline to put the money where it is to go in the right percentages to the best investments. I've seen a number of people put the money into Uncle Ed's Condo Villa or exotic forex transactions, options, etc. etc. Lose the money and still have the debt. Not a good place to go. Human nature is short term for a lot of people, memory's are short and I just gotta have that wonderfull stock that's going to change the world. Remeber Nortel etc. etc.

For some it is a good idea, for other's not a good idea. Best investment in life is a pd up home. Not a 250,000 perpetual mortgage. Makes you a renter in life, not an owner. The people who think these things up are after the fee income associated with it, because your sure as hell not doing it for free. As soon as Canada Revenue changes the rules everyone disappears leaving the poor sap holding the bag. He/She is faced with financial devastion and the people who advised them into the mess are laughing all the way to the bank. Seen a lot of people take bad advice and then get shafted because of it.

Your Smith Manouvre might be fine, but might not. It depends. Markets can change, for real estate and for investments. If a person does this make sure you CYA, leave a healthy chunk of equity and hope like hell it works.

That's why far too many will "screw it up".

[gnunn]

Is this largely dependant on interest rates remaining low though? For example, carrying $200K of mortgage at 3.5% while investing the equivalent and getting a return of 7-8% is good, what happens when interest rates rise, does the Smith Maneouvre become less interesting the higher rates go?

[Agent_J]

Is this largely dependant on interest rates remaining low though? For example, carrying $200K of mortgage at 3.5% while investing the equivalent and getting a return of 7-8% is good, what happens when interest rates rise, does the Smith Maneouvre become less interesting the higher rates go?
also, what if the return % falls?

[guest913]

The first thing that came into mind is "risk". I am not too sure what the Smith Manoeuvre is but it is risky to use your home equity as investment, especially on an investment that earns 7-8%. You would also have to keep in mind that interest income from investments are also taxed, some higher than others. (Capital gains vs. Interest Income).

For the average Canadian who do not have a background in Finance, this may not work. Even if you sit with a financial planner, they may not have the skills or time to fully plan the perfect investment strategy.

Is there any calculations that can show that the SMith Manoeuvre works? I would be very interested in taking a look at it.

[rain111]

The first thing that came into mind is "risk". I am not too sure what the Smith Manoeuvre is but it is risky to use your home equity as investment, especially on an investment that earns 7-8%. You would also have to keep in mind that interest income from investments are also taxed, some higher than others. (Capital gains vs. Interest Income).

For the average Canadian who do not have a background in Finance, this may not work. Even if you sit with a financial planner, they may not have the skills or time to fully plan the perfect investment strategy.

Is there any calculations that can show that the SMith Manoeuvre works? I would be very interested in taking a look at it.

Smith's book explains the math in details. Borrow the book from the library and read it and you will see.
In most cases, capital gain get taxed the least (50% of capital gain is tax deductible). Dividend next because of dividend credit. Interest income ( ING direct or GICs or bonds) is taxed at full.

In executing Smith Manoeuvre as well as any other leveraging strategy, by default it is risky. However, if you are willing to invest in a long term horizon, say 20 years, the risk will be considerably reduced.

Smith manoeuvre also works better for wealthier people because the tax refund they get back each year will be higher because of their higher tax bracket.

I have read through the book and I find no logical and mathematical flaw in this strategy. Undoubtedly there is risk but always remember, risk and return is proportional.

[grant]

the main point of this technique is only to "convert" your existing mortgage debt, not to increase it pursuing investment options.

So what's the risk, that rates will rise? So what, you'd still be paying those higher rates whether or not the interest is deductible.

[me!]

yeah, I've been contemplating making my mortgage a tax - deductable expense too, but I never got around to being fully comfortable with the math. The concept is really quite simple, and I know the basic concepts of it but never took that next step.

[cannon_fodder]

The risk is simple... if you borrow to invest, and the investments go down, you now have a portfolio worth less than you paid for it and you also have to continue to pay interest on a loan.

Over time you would expect that you should come out ahead, but there are no guarantees. Wasn't the Nikkei about 3 times its present value 10 years ago? Wasn't the Nasdaq 2.5 times higher 5 years ago?

I've looked at the PPT that Smith put out, and it obviously paints a pretty bright picture. There doesn't seem to be a balanced approach at what could happen if things take a turn for the worse.

I also thought it was a poor example when they had a family, I think "The Blacks" who supposedly had $50,000 in a GIC or CSB's as their rainy day fund. Meanwhile they have a $200,000 mortgage at 7%. It never occurs to them that putting the $50,000 against the mortgage is a guaranteed 7% after tax investment (which in their 40% tax bracket would be like a guaranteed 11.5% investment) Instead, through the magic of the Smith Manuevre, they cashed it in put it against the mortgage and then reborrowed it to invest it in some equities that don't pay dividends or income and expect to get a return of 10%.

It seemed to me, and maybe I'm the only one, that this family is pretty conservative but lo and behold they decide to go from a nice safe investment in GIC's and borrow money to invest in equities. I think a financial planner would question what changed them so dramatically.

Maybe I'm a little cynical rather than skeptical, but while the concept seems fine, the devil is in the details. If I am paying $800 every 2 weeks, and only $200 goes to my mortage, that means that every 2 weeks I'm supposed to borrow the $200 and invest it in something that preferably defers all income until I'm ready to sell.

Well, I am not going to buy stocks, because the commission would kill me at $200. So, does that leave me with a mutual fund? I guess so. And frankly, as you are starting out adding $200 here and $200 there, that makes sense.

The cynical part of me was triggered because Smith mentions over and over that you need a financial planner. A financial planner would make money on this manuevre. The bank makes money from this manuevre (they have you paying interest longer). Who ends up with all of the risk? You.
If the investments go down, does the bank make less money? Does the financial planner help you out? You are own your own.

I honestly think it is intriguing, but I would welcome some comments / debate on this. After all, anything that can help me be better off financially with an appropriate amount of risk, is worth looking at. One idea I'd heard of was that if you take this approach, limit your downside by investing in segregated funds. I've never looked at them for details on returns on how you can lock in returns, but that may be appropriate for this type of investing where you are borrowing.

Also, it might be prudent to invest in a mutual fund family that allows switching without generating a capital gain. This way if you feel it might be time to shift your asset allocation around because of certain economic changes, you can keep all of the income deferred.

[me!]

Yeah, that is where I had trouble understanding the logic of the "Blacks" too.

Okay, let's say you had 50K in mutual funds and cashed them out, paid off 50K in your mtge, and then borrowed money against your house to repay the 50K in mutual funds you just sold. You will have to pay interest on the 50K loan and that interest is tax deductible. Your house mtge is not really 50K less because although you decreased your mtge by 50K you have a new loan of 50K for the mutual funds you just bought (to replace what you just sold.)

I believe this is the basics of the smith manouevre.

[GabL]

AGF has a investment loan service (http://www.agf.com/static/en/products_services/1866.html), my friend told me about it. And I asked around and most people will answer, it is never wise to borrow to invest. Just my 2 cents.

However, if you're willing to take the risk, it seems a pretty good thing, as basically you don't need to pay much to get all those tax return benefit and as well the chances of the investment you bought goes up.

[rain111]

AGF has a investment loan service (http://www.agf.com/static/en/products_services/1866.html), my friend told me about it. And I asked around and most people will answer, it is never wise to borrow to invest. Just my 2 cents.

However, if you're willing to take the risk, it seems a pretty good thing, as basically you don't need to pay much to get all those tax return benefit and as well the chances of the investment you bought goes up.

IMHO It all depends on your risk profile. If you are willing to take risk, by all means, this is a way to get the snowball rolling sooner. The no-margin is a good option as it really gives you peace of mind.

[shocknawe]

I voted for Ernie Eves in the last Ontario election. He promised to make mortgage interest tax deductible.

Politics aside, this tax cut certainly would have been a nice alternative to the Smith Manoeuvre.

[me!]

AGF has a investment loan service (http://www.agf.com/static/en/products_services/1866.html), my friend told me about it. And I asked around and most people will answer, it is never wise to borrow to invest. Just my 2 cents.

However, if you're willing to take the risk, it seems a pretty good thing, as basically you don't need to pay much to get all those tax return benefit and as well the chances of the investment you bought goes up.

Yes, it is true it is never wise to borrow to invest. That in itself is a prudent move for most of us out there, but the point of the smith manouevre is to replace non-tax deductible loan with tax-deductible loan money. So theoretically, even though you are borrowing to invest, the amount of extra risk (WRT to money borrowed) stays the same.

[TrevorK]

Yes, it is true it is never wise to borrow to invest.

Wrong.

If I can invest, and am willing to take the risk, why not invest my loaned money (Which costs 4.25% interest) in an investment garnering 10-12%?

Again there's risk - but to some of us we can find some risk acceptable.

[me!]

Wrong.

If I can invest, and am willing to take the risk, why not invest my loaned money (Which costs 4.25% interest) in an investment garnering 10-12%?

Again there's risk - but to some of us we can find some risk acceptable.

Not everyone can find an investment that they are comfortable with to garner 10 - 12% coupled with acceptable risk .

the higher the ROR generally equates to higher risk.

Sure, if I could get a ror equal to or better than the interest rate on the loan,I would go for it, but that ain't always the case. You may be doing 10 -12% now, but 6 months from now, a year from now, it could be 1 - 2%. Then what?

[shocknawe]

Yes, it is true it is never wise to borrow to invest.
If this were true, many businesses would never be started.

[me!]

If this were true, many businesses would never be started.


that's why most people are not business owners and end up working for someone else for a paycheque.

[Mark099]

I have used borrowed money to invest for almost 10 years now. Yes, there are risks involved, but if you invest wisely the payout can be great.

Think of it this way...

Option A (borrowing):

You borrow $50,000 at prime. For simplicity, we'll say your monthly interest payment will be $200. It will actually be ~ $170.

Option B (invest monthly):

Instead of borrowing the $50,000, you decide to invest that $200 per month you would've paid to interest.

Again, for simplicity, we'll say you invest in a mutual fund that has averaged about 10% over the last 15 years. Granted, future performance is not guaranteed, but let's say it's safe to estimate an 8% return over the next 15 years.

After 15 years you would have...

Option A: ~ $165,000 minus the $50,000 = ~ $115,000 net (before taxes)

Option B: ~ $69,000 net (before taxes)

Now, to make it more complex. Since the $200 interest payment for Option A is tax deductible, you will get part of that money back. Say you get $75 of it back. So, what if you also invest that extra $75 per month on top of the $50,000 lump sum. After 15 years, Option A now becomes even better....

Option A: ~ $191,000 minus the $50,000 = ~ $141,000 net (before taxes)

So, again, you have invested $200 a month for 15 years. This is a total of $36,000. Which would you rather have? $141k or $69k?

Where this arguement might break down is when you have higher interest rates. So let's look at how high the rates have to be before this theory falls apart.

Let's say prime increases to 7.25% and your monthly interest payment increases to $300. Remeber, all of that is still tax deductible and you'll get about $125 of that refunded. You will still reinvest that refund. So for Option B, you are going to invest $300 a month for 15 years. The results are...

Option A: ~ $209,000 minus the $50,000 = ~ $159,000 net (before taxes)

Option B: ~ $104,000 net (before taxes)

Even at prime = 7.25% Option A is still clearly the best option.

What if prime is 10%? Your monthly interest payments would be $420. Still tax deductible and say $175 of that is refunded. Invest as before for 15 years in the same mutual fund that will get you 8% a year.

Option A: ~ $226,000 minus the $50,000 = ~ $176,000 net (before taxes)

Option B: ~ $145,000 net (before taxes)

Granted -- income taxes and fluctuating interest rates makes these comparisons less black-and-white. But it should be clear that the strategy can pay off even when interest rates exceed the rate of return on the investment.

Other uses for the bigger tax refund you will get...

1) contribute it to an RRSP
2) pay down your mortgage
3) pay down the line-of-credit or investment loan
4) 2 weeks in Disney World
5) pay down any credit cards or car loans

Yes, I hate to admit it, but last year's income tax refund went towards our trip to Disney World. This year's refund went to the mortgage.

[TrevorK]

I didn't check over your calculations, but I didn't see you mention this.

I assume you counted the monthly interest you paid out to the bank and deducted it?

[Mark099]

I didn't check over your calculations, but I didn't see you mention this.

I assume you counted the monthly interest you paid out to the bank and deducted it?

LOL! Of course, and to be really official you can ask the bank/cu for a statement of the interest paid for any given year.

[me!]

I have used borrowed money to invest for almost 10 years now. Yes, there are risks involved, but if you invest wisely the payout can be great.
Yes, you make some very convincing examples here that is very short, and right to the point, unlike Fraser Smith's Power Point presentation. It is much clearer now to me about re-investing the tax deductions or paying down the mortgage with it.

thanks for the clarity :)

[GabL]

Yes, you make some very convincing examples here that is very short, and right to the point, unlike Fraser Smith's Power Point presentation. It is much clearer now to me about re-investing the tax deductions or paying down the mortgage with it.

thanks for the clarity :)

It all depends on one's own risk tolerance. If you're a risk taker and you do your homework on the market, then sure this is a good way to save and make money! But if you're conservative and too lazy to do any research, then probably stick to the old way of paying your mortgage month by month will be the way to go.

I was presented the AGF investment loan from my friend a while back, and everything looks sweet. But just I'm not willing to take the risk (high interest rate, prime + 2.5%), plus I'm too lazy to track the investment, so I backed off.

[shocknawe]

Back on topic...

First of all, I haven't read the book yet but plan to. However, I've read some of Fraser's posts.

Can the Smith Manoeuvre be done as a DIY? Do I just go to the bank, get approved for an investment loan and ask them to forward my mortgage payments to purchase a mutual fund? I can just imagine the puzzled look on the mortgage or loan officer's face when I ask for this.

Or are there banks that offer, the "SmithMan" mortgage along side their other standard mortgages?

[me!]

I am not saying that I am too risk aversive or a risk woos. I have in fact paid for mutual funds via a line of credit before and written off the interest. I have also taken out a equity loan on my first house to buy my second house. I had to separate between the first morgtage and the equity portion of the mortgage by means of pro-rating.

for example, my first mortgage was 150K and my equity mtge was 75K. The bank rolled it into one mortgage ot 225K. So I had to create an excell spreadsheet of how much interest went to first mtge and how much went to equity mtge. 150/225 = 66.67% for non-deductible interest and 33.33% interest was deductible.

Every year I had to calculate how much interest was for each. I could find out each month how much interest I was paying, and then I just used the 33.33% ratio to make as deductible mortgage.

I did this for several years till I sold the ppty. Never was questioned by CRA

[nixx]

Back on topic...

Can the Smith Manoeuvre be done as a DIY? Do I just go to the bank, get approved for an investment loan and ask them to forward my mortgage payments to purchase a mutual fund? I can just imagine the puzzled look on the mortgage or loan officer's face when I ask for this.



I helped a few of my clients with this strategy but a "toned-down" version of it. We didn't use the full 75% of the equity because it makes most people uncomfortable, and some probably wouldn't be able to sleep at night if we did.

The Smith Manoeuvre is not a task you should tackle yourself unless you're very knowledgeable in investments & taxation and how they inter-relate. This should be left to a professional who knows how to do it properly for you. Trust me, the banks are the last place you want to go to get advice for this because most of the departments that you need help from don't even work with each other; mortgage & investment depts, not to mention they don't have an accountant you can consult. Plus majority of them are just transaction takers, they don't give advice if any at all.

If you're really interested you should consult an independent financial advisor that works closely with his/her own team of accountants and mortgage brokers. Getting proper advice from professionals who have done it before is the way to go. If you needed your car engine to be re-built you would go to a mechanic, right? If you need financial advice then shouldn't you goto a financial advisor?

[rain111]

BMO Readiline is just the right product to execute this strategy.
http://www4.bmo.com/personal/0,4344,35649_2835404,00.html

[shocknawe]

This should be left to a professional who knows how to do it properly for you.
Does the Smith Manoeuvre recommend that you use a professional to execute this strategy?

I went to the public library to borrow the book but it was out on loan.

rain111, the BMO product looks like a typical HELOC. I am thinking that you need to exclusively use this line of credit for investment purposes just to keep a clean money trail.

[rain111]

Does the Smith Manoeuvre recommend that you use a professional to execute this strategy?

I went to the public library to borrow the book but it was out on loan.

rain111, the BMO product looks like a typical HELOC. I am thinking that you need to exclusively use this line of credit for investment purposes just to keep a clean money trail.
Hi shocknawe,

Yes it does look like a HELOC but if I'm not mistaken, traditional HELOC requires you to reapply again and again if you want a higher limit. This Readiline thing will automatically up your limit once you have paid off more your mortgage.
Correct me if I am wrong.

rain111

[Neil]

Over the last couple of years or so I've tried making these strategies work, but ran into a lot of practical limitations.

One was getting a readvanceable loan. (The BMO Readiline was not available.) I checked every lender in my jurisdiction but nobody could give me all three of these features:
- open, variable
- low rate
- free readvances

I could find lenders to give 1 or 2 but never all 3. The lender with the best rates & policies still wanted $100 per readvancement, which kills the deal. Getting the best rate means locking in and restrictions on repayment & readvancement. I could not find one loan that would meet all 3 criteria.

Second challenge was on finding a suitable investment. Guaranteed investments give negative net return after inflation, and investments with better potential generally don't allow small weekly or monthly purchases. The only possibility for a better potential investment of small regular amounts is a mutual fund. Which leads to the third challenge I ran up against....

I consulted an expert at CRA. This is a woman that all the toughest questions get escalated to after several other departments and levels are stumped. She is not bureaucratic either and is quite willing to share honestly how the rules can support a taxpayers right optimize their taxation.

Anyway, she explained the rule of being able to deduct loan interest must be for an investment that is producing or has the reasonable expectation of producing current income itself. So in other words CRA lets you write off the interest expense but only on the presumption that it will be at the same time as you are paying income tax on the investment's income. The wording is on available on the internet and when I read it I reach the same interpretation. I believe there are specific conditions mentioned for equity mutual funds.

Very few typical mutual funds would meet such a criteria since they generally aren't producing current income. Those that do produce current income have a low rate of return that also kills the deal.

You could still record your borrowing interest expenses over time and try to claim that as ACB (adjusted cost basis?) when you sell your mutual fund units. It might work, but it could also be a challenge, especially if you don't sell your fund units for years or decades.

I'm aware this idea of writing off investment loan interest may have been challenged in the tax courts and some taxpayers may have won their cases. But personally I am hesistant to open myself up for a battle with CRA that I may or may not win.

Lastly this is an aggressive leveraging strategy. Leveraging multiples your potential upside but also your potential downside. It's absolutely dependent on getting OK investment performance. From the globe and mail site today here are their numbers:

Canadian Equity mutual funds
5 year group average = 3.78%
5 year index average 1.74%.

That means someone doing this maneuver 5 years ago using typical Canadian equity mutual funds would not have made out that well. After inflation that's zero return, meanwhile you've been paying borrowing costs the whole time.

I'm aware these approaches have merit and in cases where all the factors can come together it can work. I know people in Vancouver that have found suitable loans, plus lenders and investment advisers that understand it, and lastly they are willing to attempt the potential challenges and complexities of trying to claim the CRA deductions.

In my jurisdiction & situation however I found a pure Smith maneuver wasn't feasible.

Instead I just apply similar principles as I have in the past:
- avoid and quickly repay all debt higher than about prime + 1%
- get as many low-interest loans as possible, and make as many of them 'interest-only' repayment terms
- channel the amounts that would have gone towards principle repayment into an investment
- segment the loans so it can later be proven a given loan was strictly for investment, not a mix of mortage & investments
- accelerate and use windfalls to pay down non-deductible loans first.

[Neil]

I am not saying that I am too risk aversive or a risk woos. I have in fact paid for mutual funds via a line of credit before and written off the interest. I have also taken out a equity loan on my first house to buy my second house. I had to separate between the first morgtage and the equity portion of the mortgage by means of pro-rating.

for example, my first mortgage was 150K and my equity mtge was 75K. The bank rolled it into one mortgage ot 225K. So I had to create an excell spreadsheet of how much interest went to first mtge and how much went to equity mtge. 150/225 = 66.67% for non-deductible interest and 33.33% interest was deductible.

Every year I had to calculate how much interest was for each. I could find out each month how much interest I was paying, and then I just used the 33.33% ratio to make as deductible mortgage.

I did this for several years till I sold the ppty. Never was questioned by CRA

Can you elaborate on:

#1 - how you deducted the interest, ie: what schedule or line of tax return?

#2 - what investment vehicle?

[Neil]

I refreshed my research on this. It seems the 2005 budget threatened to close the door on investment borrowing deductibility. But some are speculating that the government may back off from that stance. Bottom line is it is certainly a gray area at this time.

Here's an interesting article I found from a mutual fund company:

http://www.aimtrimark.com/AIM/Resources/Taxes/Tax_Bulletins/TBMITDE.pdf

[NoahVail]

Thanks for the article Neil, here's another (not advocating AIC, it's just that they've put together a lot of relevant info on the subject):

http://www.upvest.com/investor/index.asp

I couldn't discern from your post whether you had tried for a pure BMO Secured LOC (prime, interest only, fees waived) that seems to be the most effective vehicle for this methodology. I noticed that TD is currently waiving all the appraisal and legeal fees as well.

TD index e-funds might be a method to both acquire the income generation and the no-cost monthly purchase plan you're looking for. Distributions are annual (December) and while I automatically re-invest mine, they could be distributed as cash (income). As long as you stay with the e-series, MERs are quite low. At some point it when your accumulations arrived at board lot volumes, you could move the board lot portion of them into an EFT which have even lower MERs and the difference would cover the initial EFT discount broderage commission.

I'm interested in your CCRA conversation as the info I recieved stated that distribution generating index funds would meet the CCRA interest deductability requirements. Did you sense that this might not be the case?

Cheers.

NoahVail

[me!]

Can you elaborate on:

#1 - how you deducted the interest, ie: what schedule or line of tax return?

#2 - what investment vehicle?
well, i haven't done this in a while, but it is in the section where you have carrying charges and interest expense. I think it is line 221 or something like that. But you have to fill out a separate schedule 4.

I put down for the explanation: Interest expenses incurred to purchase mutual funds in one example, another one I used it for interest expenses to purchase rental property, or something like that.

[Neil]

Thanks for the article Neil, here's another (not advocating AIC, it's just that they've put together a lot of relevant info on the subject):

http://www.upvest.com/investor/index.asp

I couldn't discern from your post whether you had tried for a pure BMO Secured LOC (prime, interest only, fees waived) that seems to be the most effective vehicle for this methodology. I noticed that TD is currently waiving all the appraisal and legeal fees as well.

TD index e-funds might be a method to both acquire the income generation and the no-cost monthly purchase plan you're looking for. Distributions are annual (December) and while I automatically re-invest mine, they could be distributed as cash (income). As long as you stay with the e-series, MERs are quite low. At some point it when your accumulations arrived at board lot volumes, you could move the board lot portion of them into an EFT which have even lower MERs and the difference would cover the initial EFT discount broderage commission.

I'm interested in your CCRA conversation as the info I recieved stated that distribution generating index funds would meet the CCRA interest deductability requirements. Did you sense that this might not be the case?

Cheers.

NoahVail

I was given a bulletin that mentioned specifically mutual funds and how you probably couldn't deduct the borrowing costs to buy them because they are investments that just accrue capital value and don't pay current income.

But I just went on the CRA site now and looked at another bulletin that seems to suggest you can, although the message is mixed. Here it is:

http://www.cra-arc.gc.ca/E/pub/tp/it533/it533-e.html

Under the section "Borrowing for investments including common shares" they say:

"Normally, however, the CCRA considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that there is a reasonable expectation, at the time the shares are acquired, that the common shareholder will receive dividends."

and "These comments are also generally applicable to investments in mutual fund trusts and mutual fund corporations."

But in example 8, it's a person buying common shares in a company that does not pay dividends. In such a case they say " In this situation, it is not reasonable to expect income from such shareholdings and any interest expense on money borrowed to acquire R Corp. shares would not be deductible."

I guess one thing a person could do is find a mutual fund that has a track record of paying dividends.

[rain111]

http://www.dividend-growth.org/

Best site run by an amateur about DIY investing in dividend fund. have a monthly email report to subscribe for free. Excellent stuff.

[grant]

In my jurisdiction & situation however I found a pure Smith maneuver wasn't feasible.

Well the scheme you were describing isn't a "pure smith maneuvre"...

The basic premise is simply to make the interest deductible without buying new investments.

What you are describing is trying to make a profit off your home equity.

[shocknawe]

The basic premise is simply to make the interest deductible without buying new investments.
I thought that the Smith Manoeuvre involved building an investment portfolio with periodic investment purchases. Over time, the mortgage loan gets converted into an investment loan slowly transforming loan interest into tax deductible interest while your net debt remains the same.

This is what I understood from Fraser's posts and the slides on his web site.

[grant]

The point is to convert your existing mortgage into a tax-deductible loan- NOT to be a money-making scheme.

Investment portfolios are one way to do this. If you happen to already have an investment portfolio the size of your mortgage, it maybe the most convenient way.

But someone who increases their borrowing to buy an investment is off in uncharted waters and missing the point of this technique.

[shocknawe]

Neil's post is consistent with how I think TSM works. What part of it do you consider as the "money-making scheme" and how is it inconsistent with TSM?

The TSM does suggest reborrowing and constantly increasing your investment loan while decreasing your mortgage loan. However, your net debt remains the same.

[me!]

the way how the investment grows is by compounding the ROR in the investments and by infusing more funds into the investment by the tax savings of the tax that you will get back by making your "mortgage tax deductible". therefore, as the sm suggests, it may not be entirely monetarily wise to pay down your mortgage, because you want the keep the interest tax deductible as long as possible.

[grant]

Neil's post is consistent with how I think TSM works. What part of it do you consider as the "money-making scheme" and how is it inconsistent with TSM?

The part where he says he cannot find a suitable investment.

[temporalillusion]

BMO Readiline is just the right product to execute this strategy.
http://www4.bmo.com/personal/0,4344,35649_2835404,00.html

They just gave me prime - 0.5% on this product! Fully open revolving LOC at prime - 0.5% sounds pretty good to me.

I had no idea this was actually a "Manoeuvre", I first did this years ago when I got a condo.

Going to do it again on the house I'm currently building.

[Tiberius]

Hopefully this is a relatively simple question to answer...

How do you go about getting a loan/line of credit/whatever to use for investment purposes... and then, how does this reflect on your taxes? (i.e. what form / line number do you fill in on the tax form to have the investment loan be tax deductable?

Is there anything specific that you have to do with the loan/loc to have it be eligible to be deducted as an investment loan?

Any insight is appreciated!

[grant]

Tiberius if you can't figure out how to do your taxes, you should hire an accountant. Not to be sharp, but if you need answers to the basics like this on RFD, you're asking for a lot of trouble from CRA.

Any loan interest is tax deductible if the loan was borrowed to purchase/fund a profit-generating endeavor, eg., invest in your business or purchase stocks.

[Tiberius]

Hi grant,

I have no problems doing my taxes on my own - and they aren't always straight forward. ;)

I was only asking this question to see if there was specific guidance/knowledge available from people here to give me a "head start" on this particular topic. If I don't find that knowledge here, I will find it elsewhere and be just fine. :)

My question mostly was based on not knowing if things need to be documented in a certain way - to "prove" the funds went into investments. If there is a specific way to do things that avoids any "issues" that might arise, I would prefer to learn from other people's experiences... know what I mean?

[grant]

You do not include with your tax return a paper trail, but make sure you keep it in your files in case of audit!

Personally I have a copy of my cancelled cheque made out to my investment broker, for the exact same amount as my mortgage funding.

[chrishall1]

THINK..........There is one person who benefits from this move and its not you. In a perfect world you could benefit from it. However, you have to have some good disposable income to join in this Manoeuvre. If you perform this technique you will stimulate the economy on your own. Just think of all the investment fees/expenses you can encounter.
Unfortunately we all make the fatal mistake of thinking a house as a place to live and not, an investment. Or rent out 3/4 of your house and have someone else pay your mortgage. We all stimulate the economy and the Smith Manoeuvre is just another vechile to maximize your "economy stimulating potential". Here is the kicker you have to pay $25 for the advise.
Yes, if you are in a 50% tax bracket then you can afford to perform this technique and you don't really need to because you have offshore accounts set up.
For the average joe earning $30 - 50 thousand dollars a year you are out of luck. Work your butt off and pay down your mortgage ASAP. Maybe when you reach an acceptable mortgage amount you an perform this technique.
But, again what is an acceptable amount?

Isn't life great and full of wonders...........




Any homeowner here using the Smith Manoeuvre technique? I am a fan of leverage investing. I do not own a home at the moment but when I do, I probably will set up Smith Manoeuvre on it. I totally bought his idea of retiring without the house paid off but owing a lot more investments instead.
In long term, a prudent leverage strategy almost always trump a non-leveraging one.

[grant]

Chrishall, your only post on this board is on a 3-month-dead thread... your post is nearly incoherent, you're ranting like a conspiracy theory communist. Do you really expect anyone to take you seriously? Why did you waste your time typing out that nonsense?

It looks like you have some kind of axe to grind on the subject so you troll search engines looking for forums in which to unload that chip on your shoulder.

[IceMan77]

It may be dead, but I'm glad he posted. i almost forgot about this thread. There's some good techniques mentioned in this thread. Mark's example is especially good. I'm going to see if I can put this thing to good use.

[spesci]

Hi can anyone comment on whether they have successfuly or un-successfuly implemented the Smith Manoeuvre?

Thanks

[pitz]

Hi can anyone comment on whether they have successfuly or un-successfuly implemented the Smith Manoeuvre?


I've made pretty good money over the past couple years using the basic techniques, albeit I have used a margin account, and *not* real-estate secured borrowing to do so.

The advantage of the Canadian market is that its somewhat counter-cyclical to rising interest rates, because of its heavy commodity and commodity-derived content. But on the flip side, when the economy slows down, unlike the US markets, the Canadian markets do not see outsized gains like the US ones traditionally have. The Nortel incident of the early 00's aside, the Canadian markets have been among the least volatile and best performing anywhere -- perfect for the Smith Manouevre.

Basically put, you can only be reasonably successful at the Smith Manoueuvre if you do the following:

1) Dollar-cost average your borrowing and your investing.
2) Minimize all hidden costs, spreads, commissions, management fees, account fees, cash loads, etc.
3) Don't invest in tax innefficient assets.
4) Don't invest in stuff that is highly correlated with real estate.
5) Don't get too greedy. Just because you can leverage your borrowing several times doesn't mean its wise.
6) Match currencies. Don't invest Canadian-dollar borrowed funds in US securities unless you also buy Canadian dollar futures to hedge.
7) Don't invest in companies that have extremely high levels of debt on their balance sheets. This means, generally speaking, avoid all income trusts.

I'd probably also be wary of borrowing too much against inflated real estate values to a large extent, especially if you are going to be somewhat stretched to pay the loan off at the end of the term.

[pitz]

Might I also add that the arguments for the Smith Manouevre, especially from a dividend investing style, are better today, than ever, due to recent changes in the federal budget concerning dividend taxation. In fact, for some income levels, receiving dividend income will actually save you money on taxes (negative incremental tax rate) and increase benefits entitlement (such as GST credits).

Now if Harper would live up to the election 'promise' of deferring the capital gains tax on re-invested monies....

[grant]

I've made pretty good money over the past couple years using the basic techniques, albeit I have used a margin account, and *not* real-estate secured borrowing to do so.
The smith maneuvre by definition involves "real-estate secured borrowing" (on your primary/vacation residence).

While you may be a savvy investor, what you described is off-topic.

[pitz]

While you may be a savvy investor, what you described is off-topic.

Please read what I wrote before making blind comments. All of the attributes of margined investing also apply to the Smith Manouevre. To suggest otherwise is just being ignorant of what the Smith Manouevre is, and that is, leveraged investing.

[grant]

Please read what I wrote before making blind comments. All of the attributes of margined investing also apply to the Smith Manouevre. To suggest otherwise is just being ignorant of what the Smith Manouevre is, and that is, leveraged investing.
Actually the smith manouevre is about making your otherwise-non-deductible mortgage interest deductible.

I think you do a disservice to people when you call it simply "leveraged investing" (which implies increased risk) when in fact, the textbook Smith Maneuvre results in NO increased borrowing.

Furthermore, the typical smith maneuvre results in the mortgage funds being invested in the owners own small business. This is not 'leveraged' investing. (very few people have a large enough non-rrsp equities portfolio to use that as the target of their entire mortgage.)

It is very rude of you to call me "ignorant" when I have in fact spoken to several national experts on this subjects in person as well as reading their literature.

If you think the smith maneuvre is nothing more than "leveraged investing" then I am sorry that your otherwise sharp financial acumen is being wasted on this subject, and I respectfully suggest it's you who ought to read more.

[mork]

And I asked around and most people will answer, it is never wise to borrow to invest. Just my 2 cents.


I've done a fair bit of reading on investing, and one of the things I realized early was;

'Buy stuff with money you have. Invest with money you don't have.'
(let's call that the mork manoeuvre).

All for the exact reasons described here.. the interest on money borrowed for an investment is tax deductable..

Most people do the opposite of my above statement.. and think they should never invest with borrowed money as their investments could go south and they'd have nothing to show for it but debt.

However, let's take an example (let's forget real-estate all together for the moment) of some dude who plans to do 2 things this year:
1) Buy a new car for $25,000
2) Start his investment portfolio with $25,000

He has $25,000 in cash laying around. Most people would recomend he finance the car and invest the $25k... but why? He should buy the car for cash (with money he has) and take a loan to invest with (money he doesn't have).

Assume, in this world, his interest rate is the same in either case. He still spent his $25k, and still ended up with both the car and the investments. Only by spending the money he has and investing some borrowings, he now has 'good debt' - that is, the interest is tax deductable.

so far, no risk at all as best as I can tell. And if he is risk adverse, he can simply pay down his loan just as he would've paid off the car over a few years. At the end, he's got his car (which is probably now worthless, but that is beside the point) and his investments (regardless of their losses/gains) and for that period of time the interest was tax deductible.

another realization is that we are all consumers. Replace car with whatever - could be a new bedroom set, whatever..

where's the risk? (Assuming he would have otherwise invested anyways - and most advisors would suggest you start building a portfolio as soon as possible.. this allows people to do it even sooner!).

Maybe there's something I'm missing, but the Smith Manoeuvre aside (so far as real estate goes) seems to be a specific application of the mork manoeuvre, doesn't it? Essentially buying your house with money you have and buying investments with money you don't have.

so, in the situation above, is it not wise to borrow to invest?


Yes, it is true it is never wise to borrow to invest.


Let's go even simpler and smaller.. Your friend gives you a hot tip, he's getting a few people interested, and tells you it is an opportunity you should not miss. You have $1k to blow.. he's looking for an investment of $1k. You also need a new couch, and the one you want to buy is $1k. You decide to go for it! Invest your $1k and finance the couch to keep your wife happy.

I can't imagine there being much of an argument for doing that. You'd be better off buying the couch with cash and borrowing $1k to invest in your friends scheme. The interest on your borrowings is then tax-deductible (and probably at a better rate than you'd get from a financing through a furniture store).


Interesting thread!

[pitz]

Most people do the opposite of my above statement.. and think they should never invest with borrowed money as their investments could go south and they'd have nothing to show for it but debt.


Exactly! Fraser Smith, being the entrepreneur that he is, threw his name on it, applied the basic concepts to real estate, and sells a book that makes him a lot of money.

Any way you slice it, whether you want to call it the mork manouevre, the Smith manouevre, or tax-deductible leveraged investing, its all exactly the same thing.

where's the risk?

The risk is that you make the investments into things that lose their value. For instance, imagine that you are a young engineer who was given a $100k/year job in San Jose or Seattle at the height of the tech boom hiring. for a startup. You use the $100k/year job offer to get a mortgage on a million dollar house, using the $50k you have saved up for the downpayment.

2001 rolls around, your house has gone up by $200k, so you pull the equity out, and buy a bunch of tech stocks.

2002 rolls around, the startup has gone bankrupt, real estate collapses, and those tech stocks that you borrowed money to invest in are worthless. You have negative net worth at this point, no job, and live in one of the most expensive places to live in America. Unless you pull off a miracle and find another good job, you would be insolvent.

Plus mork, our profession expells us if we go bankrupt, and expulsions and bankruptcies are a matter of public record. The risk is also to our reputations. Try getting liability, or E&O insurance as a bankrupt, or even as a discharged bankrupt. Its going to expose you to a lot more scrutiny, and higher premiums, I can assure you of that.

[dark169]

to pitz's post:

you should never invest too much in the industry/sector you work in. As your job is probably your largest source revenue generation, if your loose your job in a industry downturn its quite a kick in the pants to have your remaining investments tank as well :lol: I dont have alot of sympathy for peopel who went from being very rich on paper to very broke in real life beucase they held lots of shares.

[mork]

The risk is that you make the investments into things that lose their value.

I still think the risk is in the investment itself.. not in the fact that you borrowed money to invest with. With the $25k car example I gave above, if he was going to invest $25k anyways, doing so with borrowed money I don't think adds any risk.

Now, if he was off to buy a car and had no intentions of investing, I'm not suggesting he should absolutley borrow money to invest - that is adding risk.

I guess I'm saying that if tomorrow I was planning to buy $5k of some stock, I'd do it with borrowed money. The general thinking is the opposite - 'oh, I've come into a few thousand dollars. I should invest it.' - These same people later finance a purchase of some kind. It's all opposite. :)

[canadiantofu]

Exactly! Fraser Smith, being the entrepreneur that he is, threw his name on it, applied the basic concepts to real estate, and sells a book that makes him a lot of money.

Any way you slice it, whether you want to call it the mork manouevre, the Smith manouevre, or tax-deductible leveraged investing, its all exactly the same thing.



The risk is that you make the investments into things that lose their value. For instance, imagine that you are a young engineer who was given a $100k/year job in San Jose or Seattle at the height of the tech boom hiring. for a startup. You use the $100k/year job offer to get a mortgage on a million dollar house, using the $50k you have saved up for the downpayment.

2001 rolls around, your house has gone up by $200k, so you pull the equity out, and buy a bunch of tech stocks.

2002 rolls around, the startup has gone bankrupt, real estate collapses, and those tech stocks that you borrowed money to invest in are worthless. You have negative net worth at this point, no job, and live in one of the most expensive places to live in America. Unless you pull off a miracle and find another good job, you would be insolvent.

Plus mork, our profession expells us if we go bankrupt, and expulsions and bankruptcies are a matter of public record. The risk is also to our reputations. Try getting liability, or E&O insurance as a bankrupt, or even as a discharged bankrupt. Its going to expose you to a lot more scrutiny, and higher premiums, I can assure you of that.

I think you are missing an initial piece in your interpretation of the smith manoeuvre.

The original intent was that the investor had both a mortgage and investment in place to begin the manoeuvre. The investment must be able to cover the mortgage amount.

In terms of carrying risk.... The investor would have been carrying (investment/business) risk in the first place in order for him/her to have the investment$$ portion of the flip.... Therefore, the net affect of risk is Zero.
E.g. I sell 100k of home depot today to pay off my mortgage, and then buy
100k of home depot tomorrow via my loan.
There would be no addition leveraging of equity. Just additional avenues for tax savings.

[spesci]

Thanks for the discussion guys, I really enjoy reading your posts.

Here is my scenario:
Age: 27 (don't think that matters)
Location: Toronto

In the proccess of buying my first house and I will likely carry about a 225K mortgage. I do not have much experience with investing, but have a general understanding of the various concepts etc..

I just can't see myself investing 225K which is what would happen if I executed the Smith Manoeuvre to the fullest, I don't think I could stomach the risk.

I think I will seek the aid of a financial adivsor to assist me in planning to start investing (with borrowed money of course).

Does anyone have any advise for me on where to begin and the general do's and don'ts?

Thanks in advance :cheesygri

[pitz]

In the proccess of buying my first house and I will likely carry about a 225K mortgage. I do not have much experience with investing, but have a general understanding of the various concepts etc..


You probably need to supply more information, for instance, how much of a downpayment you are applying.

The Smith Manoeuvre really doesn't work for people who don't have equity. Ideally, to make sure you don't get wiped out if real estate declines, you would require a minimum of a 25% down payment. This also avoids the CMHC insurance and qualifies you for conventional financing.

If you have the 25% down, you go to your banker and you request one of the following:

1) A line of credit style mortgage (ie: Manulife One, or similar) or HELOC.

or alternatively,

2) An amortizing mortgage, that also includes an embedded line of credit, where a credit facility is extended against the principal repaid on the amortizing mortgage.

Generally speaking, the second option is the one that works out the best, as the portion that amortizes can either be at a fixed rate, or floating, your choice, at a very competitive rate (LIBOR + 100bp is a decent rate, whereas most HELOCs or Manulife One charge LIBOR + 175bp).

Once you get that setup -- then you start making payments and building up equity in the property, reducing your non-deductible mortgage balance. You then 're-borrow' these funds from the LOC associated with the mortgage, and invest them.

The investments you choose will pay dividends. These dividends should be siphoned out of your investment account, applied against your non-deductible mortgage debt, and then cycled back out into your investment account through 'reborrowing'. The dividends re-invested, of course. So a user of the "Smith Manoeuvre" will want to ensure that they are not enrolled in any automatic dividend re-investment plans.

Minimizing costs and commissions is of the utmost importance, especially since you will be investing every month. I suggest you get an account with Interactive Brokers, because the fees are so low as to facilitate the investment.

Obviously it goes without saying that you want an investment portfolio that pays, to some extent, dividends, to accelerate the process of swapping non-tax-deductible debt with tax deductible debt. But of course, a cardinal rule when it comes to investing is never chase yield!. Buy stocks and indicies based on their fundamentals, never based on their 'dividend' or 'income' yield.

If you are going to work with a 'financial advisor' or 'financial planner', I would strongly suggest that you work with one that is not a salesman. Stay away from traditional mutual funds as well. They significantly reduce the probability of profit, usually don't pay much in terms of dividends, are tax innefficient, and often come with large charges to buy and sell.

Also, be careful about investing in foreign currencies. You might want to hedge your exposure to the USD or any other foreign currencies using futures contracts or derivatives, especially since your mortgage is denominated in Canadian dollars. Certain types of investments already have this hedging built-in, at a very nominal cost.

[grant]

Does anyone have any advise for me on where to begin and the general do's and don'ts?
Yes: borrow a book, surf the web, go to seminars until you understand the specifics.

Find an accountant or financial planner who understands this technique and will guide you.

Don't start borrowing & investing just because someone will lend you money. This is a technique to be used with existing investments.

Unless you have a $225,000 portfolio outside your RRSP, you will have to use this technique by flowing through your personal business. If your part-time endeavor has $25,000/yr cash flow, you can make your mortgage fully deductible in 9 years.

[AlexH]

I think you are missing an initial piece in your interpretation of the smith manoeuvre.

The original intent was that the investor had both a mortgage and investment in place to begin the manoeuvre. The investment must be able to cover the mortgage amount.

I haven't read the book, so this may be answered in it, but how would one take advantage of this if they don't have the investment in place, and are just beginning to build equity? I guess just pay off your mortgage as fast as possible vs putting money away in investments?

EDIT: Oops, grant's reply came in before I submitted my reply. n/m. :D

[don242]

Just a question about this. If you borrow money from your home equity using this smith manouvre, you now end up paying your monthly mortgage payment as well as an additional payment on the money you borrowed? So you must be in the position to handle additional monthly payments in order to do this?


I am not planning on doing this and would obviously need to do a lot more research. Just had the question for interest sake.

[pitz]

Just a question about this. If you borrow money from your home equity using this smith manouvre, you now end up paying your monthly mortgage payment as well as an additional payment on the money you borrowed? So you must be in the position to handle additional monthly payments in order to do this?

When you qualify for a mortgage, you are already qualifying for the maximum possible accrual of interest, and that is, at the beginning of the mortgage.

Unless of course you manage to find a 'negative amortization' mortgage in Canada. But as far as I know, those mortgages (where principal actually increases over time) are confined pretty much to the USA.

Essentially with the Smith Manouevre, instead of accumulating equity in your home, you accumulate equity in a stock portfolio. Fraser Smith, on his website, in an interview puts it best -- when you use the Smith Maneouvre, you are intending to take out a mortgage or loan that you never repay. If you follow Smith's advice, you will always be in debt. Not a bad thing, however, because its deductible debt that will save you $$$ on taxes every year that you keep the loan open.



I am not planning on doing this and would obviously need to do a lot more research. Just had the question for interest sake.

Do I see a pun there ? ;)

[natefive]

I have used borrowed money to invest for almost 10 years now. Yes, there are risks involved, but if you invest wisely the payout can be great.

Think of it this way...

Option A (borrowing):

You borrow $50,000 at prime. For simplicity, we'll say your monthly interest payment will be $200. It will actually be ~ $170.

Option B (invest monthly):

Instead of borrowing the $50,000, you decide to invest that $200 per month you would've paid to interest.

Again, for simplicity, we'll say you invest in a mutual fund that has averaged about 10% over the last 15 years. Granted, future performance is not guaranteed, but let's say it's safe to estimate an 8% return over the next 15 years.

After 15 years you would have...

Option A: ~ $165,000 minus the $50,000 = ~ $115,000 net (before taxes)

Option B: ~ $69,000 net (before taxes)

Now, to make it more complex. Since the $200 interest payment for Option A is tax deductible, you will get part of that money back. Say you get $75 of it back. So, what if you also invest that extra $75 per month on top of the $50,000 lump sum. After 15 years, Option A now becomes even better....

Option A: ~ $191,000 minus the $50,000 = ~ $141,000 net (before taxes)

So, again, you have invested $200 a month for 15 years. This is a total of $36,000. Which would you rather have? $141k or $69k?

Where this arguement might break down is when you have higher interest rates. So let's look at how high the rates have to be before this theory falls apart.

Let's say prime increases to 7.25% and your monthly interest payment increases to $300. Remeber, all of that is still tax deductible and you'll get about $125 of that refunded. You will still reinvest that refund. So for Option B, you are going to invest $300 a month for 15 years. The results are...

Option A: ~ $209,000 minus the $50,000 = ~ $159,000 net (before taxes)

Option B: ~ $104,000 net (before taxes)

Even at prime = 7.25% Option A is still clearly the best option.

What if prime is 10%? Your monthly interest payments would be $420. Still tax deductible and say $175 of that is refunded. Invest as before for 15 years in the same mutual fund that will get you 8% a year.

Option A: ~ $226,000 minus the $50,000 = ~ $176,000 net (before taxes)

Option B: ~ $145,000 net (before taxes)

Granted -- income taxes and fluctuating interest rates makes these comparisons less black-and-white. But it should be clear that the strategy can pay off even when interest rates exceed the rate of return on the investment.

Other uses for the bigger tax refund you will get...

1) contribute it to an RRSP
2) pay down your mortgage
3) pay down the line-of-credit or investment loan
4) 2 weeks in Disney World
5) pay down any credit cards or car loans

Yes, I hate to admit it, but last year's income tax refund went towards our trip to Disney World. This year's refund went to the mortgage.
Can someone explain this to me? Why would the net increase if the interest rates increased?

[don242]

Can someone explain this to me? Why would the net increase if the interest rates increased?
I think in the example, the net increase in Option B is because it is assuming you are investing your interest payments on the loan. As prime increases, so does your loan payments and therefore the amount you would invest in Option B.

[dark169]

Can someone explain this to me? Why would the net increase if the interest rates increased?

the amount at the end of 15 years in case B is the amount of intrest your would be paying if you went plan A. He's assuming that if your choice are to pay the intrest on a loan OR invest that same montly payment into an investment. so with higher rates he's assuming you can afford to pay the now higher intrest, some what flawed as your monthly payment (or investment) should be the fixed varible not the investmetn loan amount

[Da Man]

I've been doing something similar to this for myself and my clients. I do a more advanced version of this method. For myself on funds invested I have done from 40%-60%+ returns in some years. On average my clients due to their lower risks have done around the 20% range on average. The ones with much lower risk are around 8-9%+ returns. I personally believe in heavy leveraging, though it is not for everyone. If you make decisions upon greed and do not know what you are doing, then you will lose alot. If you make smart decisions based on knowing what you are doing, than you can make alot as well. It's a double edged blade.

[grant]

Just a question about this. If you borrow money from your home equity using this smith manouvre, you now end up paying your monthly mortgage payment as well as an additional payment on the money you borrowed? So you must be in the position to handle additional monthly payments in order to do this?
People in this thread keep missing the point.

The smith maneuvre is all about your existing mortgage.

It's not about borrowing more money!!

[JacobStile]

Hello,

Have been lurking on RFD for a while now but decided today to register and submit my first reply.

I am intrigued by this Smith process but would like to determine if I am a good candidate for it. Here is my current situation:

1) Vancouver condo purchased for $323K
2) $120K (37%) downpayment
3) $203K outstanding mortgage
4) variable rate mortgage, renews in 6 years
5) weekly mortgage payments of about $290/week
6) approved for up to $240K of mortgage from the bank
7) $10K LOC also available
8) approx. $10K in RRSPs
9) approx. $10K in stocks

Thoughts?

[grant]

would like to determine if I am a good candidate for it.
At this point, not really.


3) $203K outstanding mortgage
6) approved for up to $240K of mortgage from the bank
9) approx. $10K in stocks

those are the only points that matter.

1) Sell the stocks
2) pay down your outstanding mortgage to $193k
3) start a new HELOC
4) re-purchase that $10k in stocks.

Voila, now $10,000 of your mortgage accrues deductible interest. However, to convert the other $193k, you will need to be operating a small business.

[dark169]

Hello,

Have been lurking on RFD for a while now but decided today to register and submit my first reply.

I am intrigued by this Smith process but would like to determine if I am a good candidate for it. Here is my current situation:

1) Vancouver condo purchased for $323K
2) $120K (37%) downpayment
3) $203K outstanding mortgage
4) variable rate mortgage, renews in 6 years
5) weekly mortgage payments of about $290/week
6) approved for up to $240K of mortgage from the bank
7) $10K LOC also available
8) approx. $10K in RRSPs
9) approx. $10K in stocks

Thoughts?

So you havent made a single mortage payment yet? as your outastanding mortage is your purchase price - your down payment. anway.

grant has it right, now if your setting aside a portion of your takehome for investment savings, redirect that to mortage principal payment and then withdraw it from your HELOC and invest. Same goes for any income from your investments. So end of the day your debt load hasn't changes at all, your investing like normal and yet your shifting debt from nontaxdeductable to tax deductable.

[hello99]

Can the investment be another home like a rental property?

[JacobStile]

Many thanks to Da Man, grant and dark169 for their advice. Very much appreciated.

Sounds like what I will do is:

1) get approval for the BMO interest-only HELOC at around 39K
2) cash out the stocks
3) push cash out into mortgage
4) borrow against HELOC amount paid down on mortgage
5) reinvest
6) deduct interest charges on LOC come tax-time
7) do the happy dance

I suppose going into the future, whenever I find myself with money that I would put against the mortgage, I should do that (pay the mortgage down) and then just pull more out on the LOC.

Mortgage owing decreases. LOC owing increases. Overall debt remains the same.

I guess that's the basic principle. Does not seem that hard.

Thanks again.

[grant]

1) get approval for the BMO interest-only HELOC at around 39K
4) borrow against HELOC amount paid down on mortgage
6) deduct interest charges on LOC come tax-time

yes... you borrow from your HELOC and use the proceeds to purchase an investment.

Read a book, talk to an experienced professional, and keep your paper trail simple... it's simple to many people but as this thread demonstrates, it seems like black magic to many.

[pitz]

1) get approval for the BMO interest-only HELOC at around 39K
2) cash out the stocks
3) push cash out into mortgage
4) borrow against HELOC amount paid down on mortgage
5) reinvest
6) deduct interest charges on LOC come tax-time
7) do the happy dance


8) Use the dividends from your stocks to help accelerate the mortgage pay down. This will accelerate the process. DO NOT use automatic dividend re-investment -- this will be detrimental to your success.

As the stock account builds up, you can gradually move away from borrowing against the house, and instead, borrow against the stock portfolio. Eventually you can be mortgage-free (and free of any restrictive covenants related to mortgages), and any collapse in your stock portfolio would have limited recourse to your principal residence.

Plus, historically speaking, mortgages are more expensive than equity-secured borrowing if you shop around. If the rate of foreclosures starts picking up, especially in the United States, lenders are going to start demanding much wider spreads on mortgage lending, versus stock lending.

[dark169]

Can the investment be another home like a rental property?

yes as long as there is an expectation of income. It doesnt work if your renting the house at a loss or subsidizing someons rent (kid at school / parents ect)

[circa76]

When you qualify for a mortgage, you are already qualifying for the maximum possible accrual of interest, and that is, at the beginning of the mortgage.

Unless of course you manage to find a 'negative amortization' mortgage in Canada. But as far as I know, those mortgages (where principal actually increases over time) are confined pretty much to the USA.

Essentially with the Smith Manouevre, instead of accumulating equity in your home, you accumulate equity in a stock portfolio. Fraser Smith, on his website, in an interview puts it best -- when you use the Smith Maneouvre, you are intending to take out a mortgage or loan that you never repay. If you follow Smith's advice, you will always be in debt. Not a bad thing, however, because its deductible debt that will save you $$$ on taxes every year that you keep the loan open.



I don't see the point of never paying back the loan. I mean, yes you save on taxes but those savings won't even make up what you actually pay out in interest.

So when you have the "mortgage" paid off, and you're sittting on a 100% LOC loan, then the next move to make it pay down the loan (by now you should have enough in your investments to pay off the loan and still have money leftover for emergencies). Use the savings in interest to invest. Eventually, you'll own the house and not have a lein against it. That should be the end state of the Smith Manouvre IMO.

[dark169]

I don't see the point of never paying back the loan. I mean, yes you save on taxes but those savings won't even make up what you actually pay out in interest.

So when you have the "mortgage" paid off, and you're sittting on a 100% LOC loan, then the next move to make it pay down the loan (by now you should have enough in your investments to pay off the loan and still have money leftover for emergencies). Use the savings in interest to invest. Eventually, you'll own the house and not have a lein against it. That should be the end state of the Smith Manouvre IMO.

my understanding is you can pay back the loan (or LOC) at the same rate as you would have paid back your mortage. So for example if your expected to be mortage free in 15 years. At the end of those 15 years your mortage has long been transfered to your LoC and your LoC would have been paid off. But rathe rthen pay back the LoC you've been investing those same $$'s the idea being that the LoC's rate minus the tax deduction is less then a reaonsable reate of return.

[pitz]

I don't see the point of never paying back the loan. I mean, yes you save on taxes but those savings won't even make up what you actually pay out in interest.


If you believe that, then you should stay well away from the Smith Manouevre altogether.

The underlying assumption about the Smith Manouevre (or any form of leveraged investing) is that you use borrowed money to fund investments, with the investments returning more than the borrowed money costs (all on an after-tax basis, of course).

If that condition does not exist, then your losses are amplified. It is not a scheme without risk.


So when you have the "mortgage" paid off, and you're sittting on a 100% LOC loan, then the next move to make it pay down the loan (by now you should have enough in your investments to pay off the loan and still have money leftover for emergencies). Use the savings in interest to invest. Eventually, you'll own the house and not have a lein against it. That should be the end state of the Smith Manouvre IMO.

1) Typically, if you invest in liquid instruments (stocks, many mutual funds, etc.) and you want a lien-free house, you can simply pledge the investments as collateral to secure new loans to replace the housing-secured loan.

2) Since a quality portfolio of equity investments typically grows faster than a house does, in value, by the time you have the 'mortgage' (being the non-deductible debt) paid off, the investments have appreciated substantially in value.

Often, people will end up having a $600,000 portfolio, and a $300,000 LOC, and a $500,000 house, if they started out with a $300,000 mortgage and a $400,000 house. Now, houses may not continue to go up in value, and stocks might not continue to go up in value as well, but the user of the Smith Manouevre actually is reducing overall portfolio risk by being exposed to a much greater diversity of assets.


Think of it this way -- if someone told you to invest 100% of your portfolio in a single, illiquid, small-cap stock, that had a 5% commission to buy or sell, and required 2% of its value to be paid every year as 'taxes', would you buy that investment? Sounds absurd, eh? But thats exactly what happens when you buy a house, and is a terrible thing, long-term, for one's portfolio.

[circa76]

1) Typically, if you invest in liquid instruments (stocks, many mutual funds, etc.) and you want a lien-free house, you can simply pledge the investments as collateral to secure new loans to replace the housing-secured loan.



Well for me I just don't like having a lein against my home for any longer period of time than necessary. After all, there's a certain sense of freedom knowing you own your property outright.

And you're right, you can use your portfolio as collateral, but unfortunately at only 50% of its value.

[pitz]

And you're right, you can use your portfolio as collateral, but unfortunately at only 50% of its value.

25% (for S&P500 stocks), or 30% (for certain Canadian stocks on the LSERM list) margining is also available.

Generally speaking, you are investing in some fairly volatile/risky stuff if its not on the 25% or the 30% list.

[JacobStile]

Hello pitz,

I just got off the phone with CRA and spoke to a lady there regarding eligibility requirements for deducting interest expense. Her summary was:

-had to be a Canadian investment
-had to provide either a) dividends or b) interest return
-interest expenses are not deductable if the investment return results in a capital gain (ie. buy some common shares, sell them, earn $X profit, $X profit is a taxable capital gain and therefore interest expense is not deductable).

So I guess the trick now would be to find some killer Candian stocks or mutual funds that provide dividends.

Does this sound about right? I really was hoping to include US securities in my portfolio under this method.

Thoughts?

[pitz]

-had to be a Canadian investment
-had to provide either a) dividends or b) interest return
-interest expenses are not deductable if the investment return results in a capital gain (ie. buy some common shares, sell them, earn $X profit, $X profit is a taxable capital gain and therefore interest expense is not deductable).


A lot of mistruths there.

1) Doesn't have to be a Canadian investment at all. Country doesn't matter, nor does the denomination of the currency you borrow.

2) The test is much more complicated than just looking for immediate dividends or interest. In essence, the test is that you must invest in a business entity with a reasonable expectation of profit, or debt obligations that have a reasonable prospect of repayment.

3) Not entirely true. The test is whether or not the investment is *capable* of paying dividends or interest. Not the actual fact of payment of dividends or interest.


For example, if you invest in a growth stock that does not pay dividends, this would be an eligible investment, since there is the possibility that, at some point in the future, dividends would be paid.

If you invest in a bar of gold, however, this would not be an eligible investment, since gold cannot produce income or dividends, but can only produce a capital gain or loss.

Don't expect the CRA to give you detailled legal advice concerning the interpretation of the Income Tax Act. They are not in the business of doing so, and any 'advice' given by the CRA is not binding upon them anyways.

I really was hoping to include US securities in my portfolio under this method.

Sure, go for it! You might want to ensure that you are borrowing US dollars if you are investing in US securities however. Unless you are confident enough that they will rise substantially in value if the US dollar slides.

Borrowing USD also saves forex costs.

[Hubster]

Subject: National post article


Pe r s o n a l F i n a n c e
Strategy looks like a revolution

Making your mortgage tax-deductible
J O NAT H A N C H E V R E AU
Financial Post



Four years after Fraser Smith self-published an eponymous book named the Smith Manoeuvre, the mortgage industry has seized on his technique for helping Canadians make home mortgages tax deductible.

About 200 mortgage brokers and financial planners met yesterday in Toronto to team up to exploit the strategy. Some - like Victoria's John Gallo and Guelph, Ont.'s Walter Dixon - are building their practices around the technique. This amounts to paying down your mortgage as quickly as possible, then repurchasing securities with a tax-deductible investment loan.

Smith, whose speaking fee has soared to $10,000, says his book has sold 26,000 copies, with 10,000 more being printed. After spreading the word in British Columbia in the 1990s, Smith decided to let the rest of the country in on the secret in 2002, when he retired and wrote the book. It was a brief retirement. Now 68, Smith is about to publish a follow-up called the Smith/Snyder Manoeuvre, aimed at helping Canadians build up personal pensions.

But the buzz in the mortgage business revolves around the first book, which now uses Is your mortgage tax deductible? as the main title, with the Smith Manoeuvre relegated to subtitle status.

Unlike the United States, Canadian mortgages are not normally tax deductible. However, by properly restructuring one's affairs, it's possible to use certain types of flexible mortgages - the Matrix mortgage from First Line Mortgages in particular - that gradually convert non-deductible mortgage debt into deductible investment loans.

In a four-hour presentation that began to the beat of George Harrison's Taxman, Smith said wealthy Canadians routinely use such techniques. The average strapped home-owner/taxpayer tends to defer making non-registered investments until the mortgage is paid off. But if they wait until a 25-year mortgage is fully amortized, they'll have no time left to build up a decent investment portfolio. Smith says the Canadian "nightmare" is to pay off a mortgage on retirement day at 65, then go back into debt the next day with a reverse mortgage to fund cash flow.

Smith has a dim view of reverse mortgages, which he says should be used only as a last resort. But the banks are gearing up to market them because they know it's the future.

Smith uses the image of a double elevator to describe his manoeuvre. You start out with a $200,000 mortgage that is not deductible. Every spare dollar is pumped into paying down the principal. With the Matrix mortgage or equivalent, each dollar knocked off principal is pumped back into a loan to buy investments, the interest on which is tax deductible.

Gradually, the mortgage falls to zero and the investment portfolio soars to $500,000 - assuming 10% returns over 22 years (a net $300,000 if you subtract the debt which remains in place).

Smith doesn't consider this "leverage" because the total debt remains the same - the real leverage was borrowing to buy the house in the first place.

Karl Straky, president of the Mortgage Training Group Inc., says the technique is "spreading like wildfire" because of referrals from happy customers. "People don't realize that a $300,000 house costs them $1-million after interest and taxes."

Obviously, the big banks aren't greatly motivated to tell consumers about it and the government's revenue arm would just as soon the little people didn't emulate the wealthy in their tax-effective wealth accumulation strategies.

Smith says the technique has never been challenged by any accountant, lawyer or the Canada Revenue Agency. Nor does he expect the CRA to change the rules if the movement gets too popular. That's because the technique requires reinvesting back into the economy.

Strangely, the net result on Canadian society may be more positive than in the United States, where mortgage interest can be deducted with no strings attached. But Americans tend to spend the savings on everyday consumption rather than invest it in securities. Because of Ottawa's stinginess, those disciplined enough to adopt this perfectly legal strategy are forced to invest regularly. In the long run that's arguably best for both the individual and the country.

Smith's Web site at www.smithman.net lists 375 financial planners across Canada already using the technique. He foresees a huge opportunity in the $600-billion Canadian mortgage market. Citing Statistics Canada, Smith says

10.5 million families are evenly split between renters, homeowners with mortgages and those who own their homes free and clear. That means seven million families are prospects.

On the investment side, the technique uses Stone and Co.'s Flagship Growth & Income Fund Canada. It's a blue chip balanced fund that aims to distribute 1% of the investment per month via a tax-deferred Return of Capital method.

Judging by the gleam in the eyes of most attendees, Smith's manoeuvre is the real deal. It may be nothing short of a revolution.

jchevreau@nationalpost.com

[pitz]

Smith doesn't consider this "leverage" because the total debt remains the same - the real leverage was borrowing to buy the house in the first place.


Still leverage nonetheless. Smith has never lived in a country which experienced deflation, but his so-called 'manouevre' would be laughed at in Japan which has experienced prolonged deflation in both equity markets and housing markets.

Obviously, the big banks aren't greatly motivated to tell consumers about it and the government's revenue arm would just as soon the little people didn't emulate the wealthy in their tax-effective wealth accumulation strategies.


Banks are in the business of selling product and they do not employ staff, at the branch level, who are capable of giving professional tax advice.

Further, anything that accelerates the availability of funds for discharge of a mortgage is going to be resisted by the banks.


Strangely, the net result on Canadian society may be more positive than in the United States, where mortgage interest can be deducted with no strings attached. But Americans tend to spend the savings on everyday consumption


Not quite true either, mortgage deductibility is reduced or eliminated with Alternative Minimum Tax for certain high-income earners.

The Canadian system is actually more generous because it allows a full deduction against income, and any capital gains on the principal residence are tax-exempt.


On the investment side, the technique uses Stone and Co.'s Flagship Growth & Income Fund Canada. It's a blue chip balanced fund that aims to distribute 1% of the investment per month via a tax-deferred Return of Capital method.


If the fund is distributing 1% per month, eventually they are going to have to distribute capital gains. And of course, being a mutual fund, its statistically likely to underperform the index in after-tax returns.

I'd also be concerned about the fund holding bonds. With a flat yield curve, there is nothing to be gained by simultaneously doing the Smith Manouevre, and holding bonds.

Hedged foreign content should also help to reduce overall risk. The Smith Maneouvre obviously works best if one can take advantage of the Canadian dividend tax credit as well.

[rtsen]

So I went out and bought the book; it was an easy read and I finished it in a couple days. He seems to repeat a lot of the stuff in each chapter haha. The basic principle is fairly easy to understand however it seems like the method is more tailored for equity investment and not real estate investments.

Here’s a scenario:

1) Principle house mortgage - $200k@4%
2) Rental property mortgage – $200k@5%, rent = expenses = $1000/month
3) $100k in cash

So Smith Manoeuvre tells us to apply the $100k towards our first mortgage and reborrow the equity to invest. Assuming you get approved for 75% of your equity, you should have a $75k HELOC @ 6%.

What do you do now?
1) Invest the $75k into the rental property. That reduces the principle of your rental property but the interest % of the HELOC is higher than the mortgage. Also if the property is a rental, isn’t the interest already tax deductible?
2) Invest in another rental property? Since Smith Manoeuvre assumes your debt is constant and $400k is your max allowable debt, you have only have $75k to find another property; which is very difficult to find.
3) Invest the $75k into stocks and hope that your Rate of return is greater than 6%

Is this the idea?

2nd question: in the book, Smith mentions Cash Flow Dam, how does this work?
Using the scenario above:
1) Principle house mortgage - $100k@4%
2) Rental property mortgage – $200k@5%, rent = expenses = $1000/month
3) $75k HELOC @ 6%

Renter pays you $1000; you use that $1000 to pay your house mortgage on top of your regular monthly payments. Then you use the HELOC to pay the mortgage of the rental property. Is this right? If this is correct, then you pay off your house mortgage more quickly but the interest is the lowest of the 3. So you are paying more taxes per month then you have to but your tax-deductible portion is greater so you get a bigger tax return.

Damn, seems like a lot of writing and questions; I appreciate any help/explanations that people can give me. Thanks in advance.

[pitz]

1) Invest the $75k into the rental property. That reduces the principle of your rental property but the interest % of the HELOC is higher than the mortgage. Also if the property is a rental, isn’t the interest already tax deductible?


Sure, but the Smith Maneouvre is all about obtaining a tax deduction on your original mortgage.

Obviously, you can re-leverage equity a number of times, up to the margin requirements established by your lenders.

For instance, with stocks, you could use the $75k to purchase $300k of US stocks (on 25% margin), or even up to $1.5 million if you use futures contracts.

Of course, if you use too much leverage, you will experience margin calls, on either your house (the banker simply won't renew the mortgage if the equity falls below requirements, as might happen if housing drops 20-30%), or through your broker. If you can't cover the deficiency in equity, then your property is foreclosed upon, or your stock/futures account liquidated until equity requirements are met.


2) Invest in another rental property? Since Smith Manoeuvre assumes your debt is constant and $400k is your max allowable debt, you have only have $75k to find another property; which is very difficult to find.


And insane as well, because you are investing heavily into an undiversified, single asset, that is highly correlated with the performance of your other assets (your houses). You are far better off reducing the risk by investing in a diversified stock portfolio.


3) Invest the $75k into stocks and hope that your Rate of return is greater than 6%


You don't even need a rate of return greater than 6%, because remember, you are deducting the interest charges, and stocks have, if the portfolio is properly managed, tax deferral characteristics of their own.

If you are in a 30% tax bracket, your stock investments only have to return 4.2% on an after-tax basis (not hard at all) to break even.


Is this the idea?


Risk management is imperative for success. Smith advises working with a financial planner, and of course, your investments made with the cash probably should not be made into real estate or real-estate sensitive sectors.


2nd question: in the book, Smith mentions Cash Flow Dam, how does this work?
Using the scenario above:
1) Principle house mortgage - $100k@4%
2) Rental property mortgage – $200k@5%, rent = expenses = $1000/month
3) $75k HELOC @ 6%

Renter pays you $1000; you use that $1000 to pay your house mortgage on top of your regular monthly payments. Then you use the HELOC to pay the mortgage of the rental property. Is this right? If this is correct, then you pay off your house mortgage more quickly but the interest is the lowest of the 3. So you are paying more taxes per month then you have to but your tax-deductible portion is greater so you get a bigger tax return.

Damn, seems like a lot of writing and questions; I appreciate any help/explanations that people can give me. Thanks in advance.

Sure, every last dollar of cash flow you have, under the Smith Manouevre, that you don't need immediately for living, should be funelled right into paying down the non-deductible mortgage balance, and then 're-advanced'.

Basically you would be looking to minimize the payments on the mortgage taken out against the rental property, and maximize the payments against the non-deductible mortgage.

Maximize tax-deductible debt, minimize non-deductible debt. Devote all cashflow possible to paying down non-deductible debt.

[timmee21]

Great read through the many informative posts, I also picked up the book and read it :)

Just wondering, if you own a small business, would this process be accelerated in any ways? or be even more beneficial?

[ullyeus]

>

[Dark Lord]

BTW, there's no magic in this method. You can pay down your mortgage faster because of two factors.

a) You make your mortgage tax deductible.
b) You are taking a higher leverage.

And point a) is Smith's true contribution in this scheme while b) is just nature taking its course.

[ullyeus]

I am the OP of this threat but never imagined the replies balloon to 7 pages in a hour:)


Actually you aren't...you just don't know how to use the search engine so I bumped a nearly identical thread someone else made.

[Dark Lord]

I'm a Certified Accountant and I have only read the PP file, not the book itself.

Smith says borrowing on your house equity to invest and this is nothing new.

Smith proposes to pay down your mortgage with your investment return and this is nothing new either.

What's new is Smith says to take out "extra" loan on your mortgage after you've paid it down to compound its effect in the long run, essentially, converting your mortgage to a tax deductible loan, this is the central point of the whole theory.

I don't think it is very practical to do this manoeuvre monthly. But quarterly or annually should not be a problem just because it is very hard to find an investment that will give you a relatively even monthly cash flow stream.

The theory is in itself sound but Smith makes it look like any lay man could pull it off with ease which I don't think so.

The beauty of it is you can pay off you mortgage sooner but the downside is you risk is now higher.

Some people think of risk as the chance of losing money, I think of risk as the opportunity to make money.

[Dark Lord]

Actually you aren't...you just don't know how to use the search engine so I bumped a nearly identical thread someone else made.

Roger that.

[grant]

The beauty of it is you can pay off you mortgage sooner but the downside is you risk is now higher.
How exactly is your risk "higher" if you owe the exact same amount of money and maintain the exact same investments as you would have without using the maneuvre?

[don242]

How exactly is your risk "higher" if you owe the exact same amount of money and maintain the exact same investments as you would have without using the maneuvre?

How can the risk not be greater? You went from owing money on your home to owing money on investments. Yes your investments could do great, but if the markets fall, you take the risk of the lenders asking for their loan back and because it is secured in your home equity, you have to pay back those loans on demand. So it is a risk, especially if you don't have enough money elsewhere to cover the loan.

[Dark Lord]

How exactly is your risk "higher" if you owe the exact same amount of money and maintain the exact same investments as you would have without using the maneuvre?

If you haven't paid off you mortgage, you are not supposed to have any investment. With the manoeuvre, you'll have your mortgage and investment at the same time, so your reward might be higher but so is your risk.

[grant]

If you haven't paid off you mortgage, you are not supposed to have any investment. With the manoeuvre, you'll have your mortgage and investment at the same time, so your reward might be higher but so is your risk.
You obviously misunderstand the maneuvre's purpose. it has nothing to do with increasing the investments a person would not otherwise make.

and what's this about "you are not supposed to have any investment"?? says who??

[Dark Lord]

You obviously misunderstand the maneuvre's purpose. it has nothing to do with increasing the investments a person would not otherwise make.

and what's this about "you are not supposed to have any investment"?? says who??

The premise of the manoeuvre is that normally people will divert all their funds to pay down their mortgage. Until that happens (mortgage paid off), they will hold no other investments which is what Smith calls the Plain Jane method.

Smith’s method is to borrow from your house equity to invest. So you’ll have extra investment when you still have a mortgage comparing to Plain Jane, and hence your risk is higher. You can pay off you mortgage faster with the manoeuvre because you are taking on more/higher risks.

What is truly innnovative about the manoeuvre is that you are increasing your investment while paying down your mortgage (the readvancing mortgage part) and hence converting non deductible mortgage interest into deductible one. The rest is just nature taking its course (higher risk higher return, lower risk lower return). The down side is the manoevre cannot be done without taking more risks. Some people wouldn’t mind that but some would. It will be much better if there’s a way to convert mortgage into deductible interest loan while maintaining the same level of risk.

[grant]

The down side is the manoevre cannot be done without taking more risks.
Utterly ridiculous statement.

1) Mr. Jones has a $200,000 non-deductible home mortgage at prime - 0.9% and a $500,000 stock portfolio.
2) Jones hears about the smith maneuvre and implements it by juggling his portfolio.
3) The dust settles, and now Jones has a $200,000 deductible mortgage at prime - 0.9% and the exact same $500,000 stock portfolio.

THAT is the gist of the smith maneuvre. How can you claim his risk has increased when both his mortgage & portfolio are the same as before??

You still haven't explained who "they" are that say people "shouldn't" have any investments while they still have a mortgage. If "they" are so smart why haven't i heard of "them"?

[don242]

1) Mr. Jones has a $200,000 non-deductible home mortgage at prime - 0.9% and a $500,000 stock portfolio.
2) Jones hears about the smith maneuvre and implements it by juggling his portfolio.
3) The dust settles, and now Jones has a $200,000 deductible mortgage at prime - 0.9% and the exact same $500,000 stock portfolio.

THAT is the gist of the smith maneuvre. How can you claim his risk has increased when both his mortgage & portfolio are the same as before??



The difference is that the $200,000 mortgage at the end is not a standard mortgage. It is a loan that can be called back by the bank at anytime they wish. If for instance, you have that $200,000 invested in a stock portfolio and the markets crash, not only are you out your losses, but the bank can ask you to repay that loan immediately (whereas a mortgage won't). In your example, Jones should be ok to cover that loan because of the size of the portfolio. For those who do not have that size of an investment portfolio, they could be on the hook for that money, and when you can't pay, you lose your house.

Other than that, the risk is not different between the two senarios.

[dark169]

Utterly ridiculous statement.

1) Mr. Jones has a $200,000 non-deductible home mortgage at prime - 0.9% and a $500,000 stock portfolio.
2) Jones hears about the smith maneuvre and implements it by juggling his portfolio.
3) The dust settles, and now Jones has a $200,000 deductible mortgage at prime - 0.9% and the exact same $500,000 stock portfolio.



your right, the other case, for those of us who dont have a large stock portfolio but would like to buld one is this:

Have a 200000 mortage at x%, would like to contribute $500 a month into an investment portfolio.
Rather then put that $500 in the investment portfolio, pay down the prinicpal on the mortage and take out a secured loan for $500 (via LoC or larger lump sums) and buy the same $500 shares. rinse and repeat.

You would now have the same amount of secured debt and now have some tax deductable intrest, no where does risk change, introduce itself or increase. If one is happy paying down their mortage with every last penny and not investing a cent until their mortage is paid off thats fine thats what almost everyone does, doesnt mean its wise or any safer.

[dark169]

The difference is that the $200,000 mortgage at the end is not a standard mortgage. It is a loan that can be called back by the bank at anytime they wish. If for instance, you have that $200,000 invested in a stock portfolio and the markets crash, not only are you out your losses, but the bank can ask you to repay that loan immediately (whereas a mortgage won't). In your example, Jones should be ok to cover that loan because of the size of the portfolio. For those who do not have that size of an investment portfolio, they could be on the hook for that money, and when you can't pay, you lose your house.

Other than that, the risk is not different between the two senarios.

If that is the case they could simply take out a mortage on their now free and clear home and the hole situation would return to what it was before it all started, no risk still. The loan is secured with the home, so the value of the securities have little bearing on the conversation, even if the shares went to ZERO, they would still be ahead as their debt level is the same and tax bill is less

The plan doesnt increase your debt, it shifts it.

[don242]

If that is the case they could simply take out a mortage on their now free and clear home and the hole situation would return to what it was before it all started, no risk still. The loan is secured with the home, so the value of the securities have little bearing on the conversation, even if the shares went to ZERO, they would still be ahead as their debt level is the same and tax bill is less

The plan doesnt increase your debt, it shifts it.

Never thought of that. Good point. I guess that works no matter what levels of investables and debts you have. I guess as long as you could remortgage your house, then it should be fine.

[Dark Lord]

Utterly ridiculous statement.

1) Mr. Jones has a $200,000 non-deductible home mortgage at prime - 0.9% and a $500,000 stock portfolio.
2) Jones hears about the smith maneuvre and implements it by juggling his portfolio.
3) The dust settles, and now Jones has a $200,000 deductible mortgage at prime - 0.9% and the exact same $500,000 stock portfolio.

THAT is the gist of the smith maneuvre. How can you claim his risk has increased when both his mortgage & portfolio are the same as before??

You still haven't explained who "they" are that say people "shouldn't" have any investments while they still have a mortgage. If "they" are so smart why haven't i heard of "them"?

Your example is not entirely correct, if Jones starts out with $200K mortgage and a $500K portfolio and he uses the Smith’s manoeuvre.

Over time, the $200K mortgage will be gone, replaced by a $200K investment debt and he should have a $700K stock portfolio by adding the $200K investment debt to the original $500K portfolio.

The house is still the same, but the portfolio is $200K higher than before, hence, his risk/exposure is higher with the manouevre.

The last part is the part you missed. The conversion process on a 25 year mortgage will take about 22 years, according to Smith.

If you started out with $200K mortgage and a $500K portfolio. After 22 years, if you only ended up with a $200 investment loan and still a $500K portfoilio, where had all your mortgage payements gone?

The other thing about your example is that if you have a $500K portfoilio, you can just use $200K of it to pay off the mortgage. Take out $200K Home Equity Line of Credit to buy back the same investment, your loan interest will be tax deductible already and you don’t need this manoeuvre at all.

That’s why the author starts with no portfolio and a $200K mortgage as the premises.

[qubikal]

Sorry to re-open an old thread.

I'm intrigued at the entire process, but am a little fuzzy with the tax laws..

What I want to know is that, this whole process assumes that your investments income/dividend/cap gains is greater than your investment expense for the interest expense to be deductible?

or can it be deducted against salary income?

[grant]

if your investment isn't showing a profit after deducting interest expense, then you made a mistake with that investment!

However it's still deductible against other income if you had a bona fide intention to earn income when your purchased the investment. So if your mortgage is 5% interest and your investment only returns 3%, yes the 2% extra is a loss that reduces taxable income.

[Joseph88]

Sorry to re-open an old thread.

I'm intrigued at the entire process, but am a little fuzzy with the tax laws..

What I want to know is that, this whole process assumes that your investments income/dividend/cap gains is greater than your investment expense for the interest expense to be deductible?

or can it be deducted against salary income?

An old but educational thread.

Whenever you use a loan to invest in something that will pay a dividend, you can deduct the interest paid for the year against your income. Yes, even if a stock that you invested in isn't a dividend producing stock, it can be argued that there is a "possibility" that the stock will pay a dividend.

[regrus]

The Smith Manoeuvre talks about making sure you get a readvanceable first Mortgage instead of a HELOC. Anyone know which banks offer these types of Mortgages?

[dealguy2]

Ok how about this situation. You take a loan out on your house equity and then "invest" the money in a bank account. You lose money of course because of the spread but there's zero risk. So do I get a tax deduction on the loan interest and then get to decrease my income by the amount of the loss? If so then I'm way ahead right?

[qubikal]

The Smith Manoeuvre talks about making sure you get a readvanceable first Mortgage instead of a HELOC. Anyone know which banks offer these types of Mortgages?

Most banks will gladly set up a HELOC for you. If you have enough equity in your home (~25%), then they should give you a rate at prime (or very near it)

Ok how about this situation. You take a loan out on your house equity and then "invest" the money in a bank account. You lose money of course because of the spread but there's zero risk. So do I get a tax deduction on the loan interest and then get to decrease my income by the amount of the loss? If so then I'm way ahead right?

I think if you show that you're just going to invest it in something risk free, then you're intent is not to earn income via the investments... CRA will see you borrowing at prime and investing to earn risk free rate of 3% which doesn't make sense just by itself.


However it's still deductible against other income if you had a bona fide intention to earn income when your purchased the investment. So if your mortgage is 5% interest and your investment only returns 3%, yes the 2% extra is a loss that reduces taxable income.

Great, that's what i wanted to know. Some of my investments are a little riskier, unlucky (for example, buying some income trust funds on Oct 30... :mad:

[grant]

Ok how about this situation. You take a loan out on your house equity and then "invest" the money in a bank account. You lose money of course because of the spread but there's zero risk. So do I get a tax deduction on the loan interest and then get to decrease my income by the amount of the loss? If so then I'm way ahead right?
There is no reasonable expectation of profit if you borrow at x% and invest at a fixed x-y%. The deduction is not legal in this case.

Your losses in income trusts will not crystalize til you sell them. So enjoy the distributions & dividends you get til then.

[don242]

Ok how about this situation. You take a loan out on your house equity and then "invest" the money in a bank account. You lose money of course because of the spread but there's zero risk. So do I get a tax deduction on the loan interest and then get to decrease my income by the amount of the loss? If so then I'm way ahead right?

Also losses aren't deductable from your income. If you have investment gains, then your losses can be subtracted from your gains and therefore lower your income. But losses can't simply be used to lower your income. If you have no investments gains in a year but take a $1000 loss, your deduction is zero. If your investments make $2000 and you have a loss of $1000 then that loss would bring your investment income down to a $1000.

[Joseph88]

The Smith Manoeuvre talks about making sure you get a readvanceable first Mortgage instead of a HELOC. Anyone know which banks offer these types of Mortgages?

Firstline offers the Matrix Mortgage.
Manulife offers the Manulife One Mortgage
RBC offers the Homeline mortgage (requires 25% down)
Scotia offers a similar product, but you need to get approved for an increased credit limit every month.
CIBC doesn't offer anything close.
Not sure about BMO or TD.

[rain111]

Firstline offers the Matrix Mortgage.
Manulife offers the Manulife One Mortgage
RBC offers the Homeline mortgage (requires 25% down)
Scotia offers a similar product, but you need to get approved for an increased credit limit every month.
CIBC doesn't offer anything close.
Not sure about BMO or TD.

Readiline for BMO

[fsmontenegro]

Hi!

I'm doing my due dilligence to possibly apply the Smith Manoeuvre to our situation. I read the book once (will read it again). I think our relevant details are:
House estimated at 350k
Outstanding 200k 5yr mortgage @ 5.29%
20,000k in non-registered investments (100% equity via mutual funds)
We typically fill up our RRSPs on a yearly basis, so we could potentially divert this to accelerating the SM if it made sense.

I understand the point that SM is meant to be debt conversion, not leveraging.

Quick questions:
1) given the details above, looks like we could sell the non-reg, borrow and reinvest, and then divert the RRSP payments into the mortgage and reborrow as per SM. Is this right?
2) right now I already service the mortgage (bi-monthly payments). If I borrow from the second LoC established for SM, won't I be ADDING to my monthly expenses? Does the SM expect that the income/dividend from the investments will offset the interest on the second LoC? Is it possible to reduce the monthly payments on the first mortgage as we increase the LoC?
3) Has anyone put together an Excel spreadsheet with the supporting calculations that they can share? I know I can buy the calculator on Smith's site, but I'll learn better if I go through a spreadsheet...
4) are there any fee-only planners in the GTA to help set up a SM? If so, what kind of fees are we looking at to set this up? I'm a DIY investor and do not need support on the investment side, only MAYBE in setting this up...

Thanks! It was great to find this thread: very informative...

Cheers,
Fernando

[grant]

Does the SM expect that the income/dividend from the investments will offset the interest on the second LoC?
No, the implication is that the non-deductible interest will decrease by exactly the same amount as deductible interest increases. If you truly understand that this is simply debt conversion, then this fact is obvious.

Is it possible to reduce the monthly payments on the first mortgage as we increase the LoC?
It's up to your lender.

... and then divert the RRSP payments into the mortgage and reborrow as per SM. Is this right?
Does Smith really recommend cutting back on RRSP payments? If so, i'm surprised, RRSPs are great because they compound faster than non-RRSP investments.

[fsmontenegro]

No, the implication is that the non-deductible interest will decrease by exactly the same amount as deductible interest increases. If you truly understand that this is simply debt conversion, then this fact is obvious.
I understand that the debt will be reduced on the non-deductible loan and increase on the deductible loan. Perhaps I should rephrase my question (sorry, English not first language..):
- Even if I prepay my mortgage, the monthly amount (P+I) is still the same. Of course, my principal is reduced, but that doesn't affect the monthly payments - it just makes the amortization period shorter...
- With that in mind, if I set up a second loan and start borrowing against it, won't I ALSO have to start paying interest on it?

It's up to your lender.
I've been approaching this with the notion that I don't have to make any changes or special requests from the first lender. Smith alludes to this when he describes how VanCity "swiped the [big bank]'s asset before they even know it was gone" (p.109)


Does Smith really recommend cutting back on RRSP payments? If so, i'm surprised, RRSPs are great because they compound faster than non-RRSP investments.
Check p.50 on his book (chapter 4, "wealth accumulation"). He does qualify by saying "many, but not all cases" and that the financial planner should make the determination to cash in (or hold contributions) to the RRSP. But he does mention that it may make sense to withdraw from the RRSP and prepay the mortgage. He then extends that if it makes sense to do this, it also makes sense to redirect contributions to mortgage prepayment...

[Joseph88]

I understand that the debt will be reduced on the non-deductible loan and increase on the deductible loan. Perhaps I should rephrase my question (sorry, English not first language..):
- Even if I prepay my mortgage, the monthly amount (P+I) is still the same. Of course, my principal is reduced, but that doesn't affect the monthly payments - it just makes the amortization period shorter...
- With that in mind, if I set up a second loan and start borrowing against it, won't I ALSO have to start paying interest on it?


If the extra interest payments are too much for you, SMITH recommends that you use the brute force method where you withdraw the required payment from your HELOC and re deposit it. It will count as a payment. Keep doing so until your non-ded mortgage is paid off at which time you'll have enough cashflow to pay your interest.

[fsmontenegro]

If the extra interest payments are too much for you, SMITH recommends that you use the brute force method where you withdraw the required payment from your HELOC and re deposit it. It will count as a payment. Keep doing so until your non-ded mortgage is paid off at which time you'll have enough cashflow to pay your interest.

Yes, this is the "add interest to loan balance" approach that is mentioned (I don't have the book handy right now).

OK, so if I understand it right, there IS a need for extra payments (namely, the interest on the second loan while one still pays the non-deductible first loan).

Before someone says it, yes, I think that if someone can't cover these extra payments they shouldn't be considering the SM, or that they should be comfortable with leveraging (vis-a-vis simple debt conversion) etc, etc, etc... (pretty much the same way that if you can't handle an increase in your lending rates you shouldn't have a mortgage).

I'm just trying to be thorough and fully understand the process...

[Joseph88]

Yes, this is the "add interest to loan balance" approach that is mentioned (I don't have the book handy right now).

OK, so if I understand it right, there IS a need for extra payments (namely, the interest on the second loan while one still pays the non-deductible first loan).

Before someone says it, yes, I think that if someone can't cover these extra payments they shouldn't be considering the SM, or that they should be comfortable with leveraging (vis-a-vis simple debt conversion) etc, etc, etc... (pretty much the same way that if you can't handle an increase in your lending rates you shouldn't have a mortgage).

I'm just trying to be thorough and fully understand the process...

Yep, you are understanding it right. If you implement the SM, you'll get a new HELOC which will require an INTEREST ONLY payment on top of your existing mortgage (unless you pay it off before getting the new heloc). The HELOC interest only payment is TAX DEDUCTIBLE (providing that you invest the heloc money) which is the whole premise behind the SM. Also note that as the HELOC gets bigger, so will your interest payment. Use the brute force method until your non ded mortgage is paid off.

[fsmontenegro]

Ok, so to sum up:


1) given the details above, looks like we could sell the non-reg, borrow and reinvest, and then divert the RRSP payments into the mortgage and reborrow as per SM. Is this right?

Looks like we could do this, but the issue of RRSP vs mortgage is not clear cut.

2) right now I already service the mortgage (bi-monthly payments). If I borrow from the second LoC established for SM, won't I be ADDING to my monthly expenses? Does the SM expect that the income/dividend from the investments will offset the interest on the second LoC? Is it possible to reduce the monthly payments on the first mortgage as we increase the LoC?

This was a big question I had. Basically, YES, I do need additional funds to service the interest on the second loan. There are two options:
- Absorb the cost and move on
- Do the "brute force method" of adding the interest to the principal on the second loan and pay it off when the first loan is paid for.

3) Has anyone put together an Excel spreadsheet with the supporting calculations that they can share? I know I can buy the calculator on Smith's site, but I'll learn better if I go through a spreadsheet...
I haven't found a SM spreadsheet but I found enough info to put something together on my own. Will be a good exercise...

4) are there any fee-only planners in the GTA to help set up a SM? If so, what kind of fees are we looking at to set this up? I'm a DIY investor and do not need support on the investment side, only MAYBE in setting this up...
This is still unanswered. Any insights?

Thanks for all the information so far!

Cheers

[Joseph88]

Quote:
4) are there any fee-only planners in the GTA to help set up a SM? If so, what kind of fees are we looking at to set this up? I'm a DIY investor and do not need support on the investment side, only MAYBE in setting this up...
This is still unanswered. Any insights?


Why would you need a planner if you are a DIY investor? To make it legit, just keep careful records to prove that you are using the HELOC money to invest and not on other spending.

[grant]

- Even if I prepay my mortgage, the monthly amount (P+I) is still the same.
The monthly amount may be the same. The interest portion will definitely not.

The amount of interest you accrue every period depends on how much principal you owe. If you reduce the principal, then you must accrue less interest.

[fsmontenegro]

The monthly amount may be the same. The interest portion will definitely not.

The amount of interest you accrue every period depends on how much principal you owe. If you reduce the principal, then you must accrue less interest.

Yes, you're right of course. What happens is that each mortgage payment is the same amount, but the principal portion rises.

What would be needed to do a SM without ANY increase in payments (other than doing the 'brute force' method of adding the interest payments to the HELOC itself) would be to arrange for the monthly payments on the non-deductible mortgage to be reduced automatically. Not sure the lender (Scotia, in my case) is set up to do that...

[pitz]

Also, make sure you file the appropriate paperwork, when possible (CRA Form T1213), to have your withholding taxes reduced from your employer.

This will improve cashflow, which, in turn, can be used to augment the mortgage payment, which will accelerate the Smith Manouevre process and/or reduce your overall interest expenses.

If you pay $10k/year in deductible interest, at an effective rate of 4% (after-tax), that means an extra $200 directly on your bottom line just by having your withholding adjusted appropriately. Or when invested appropriately, $500/year extra.

Also, when using the Smith Manouvre, you can accelerate the process by selecting dividend-paying investments, as the dividends can be withdrawn from the brokerage account, placed against the non-deductible debt, and then re-drawn. Income trusts technically would be a better option, but, IMHO, many/most are still significantly overvalued.

[Joseph88]

Also, make sure you file the appropriate paperwork, when possible (CRA Form T1213), to have your withholding taxes reduced from your employer.

This will improve cashflow, which, in turn, can be used to augment the mortgage payment, which will accelerate the Smith Manouevre process and/or reduce your overall interest expenses.

If you pay $10k/year in deductible interest, at an effective rate of 4% (after-tax), that means an extra $200 directly on your bottom line just by having your withholding adjusted appropriately. Or when invested appropriately, $500/year extra.

Also, when using the Smith Manouvre, you can accelerate the process by selecting dividend-paying investments, as the dividends can be withdrawn from the brokerage account, placed against the non-deductible debt, and then re-drawn. Income trusts technically would be a better option, but, IMHO, many/most are still significantly overvalued.

Great tips Pitz on optimizing the Smith Manoeuvre. Never thought about using the dividends to pay down the non-ded mortgage.

[cannon_fodder]

Also, when using the Smith Manouvre, you can accelerate the process by selecting dividend-paying investments, as the dividends can be withdrawn from the brokerage account, placed against the non-deductible debt, and then re-drawn. Income trusts technically would be a better option, but, IMHO, many/most are still significantly overvalued.

I don't grasp the logic so perhaps you can explain this to me. I have assumed that a "dividend paying investment" is a stock.

Let's say I have 1,000 shares of XYZ (@ $20 each )and it pays out $0.19 a share per quarter. Each quarter I receive $190 (which I have to declare as income). I then use this to pay down the mortgage.

I then take that $190 out and try to buy, what, more XYZ? Any fee associated with it would be, I'm guessing, at least $10. So, I end up with 9 more shares.

Borrowing that $190 back would net about a $10 interest charge per year of which $4.63 at best would be returned to you as a tax refund.

If this XYZ stock had a DRIP plan, it seems to me it would be better to just have it reinvested, get 9 shares and $10.

I would declare the $190 as income which, I hope this is right, would be taxed at about 25% in Ontario. This would be the same regardless of whether I DRIP'ed or didn't, correct?

If I've done this right, then I'd have 1009 shares and have to declare $190 as dividend income. However, in the first scenario, I paid $10 to service the debt over 12 months and got a refund of $4.63. In the second scenario, I have a credit of $10.

Did I miss something? Wouldn't the best scenario for the SM to be invested in an income producing product that pays the least amount of income as possible?

[cannon_fodder]

For those that have argued for/against the idea that the SM is using leverage, please consider this. I recently attended a seminar held jointly by a FP and a Mortgage Broker. They talked about the "Turbo" SM and that is for those homeowners that have created additional equity in their home (because of paying down the principal and/or the increased value of the home).

Thus, you:

Purchased a home for $400,000
Took out a mortgage for $300,000

and then, 5 years later:
Home is worth $500,000
Mortgage principal is $250,000

You then convert your mortgage into a readvanceable mortgage of 75% of the home's current value. Thus,

$500,000 home
$375,000 readvanceable mortgage split into:
$250,000 mortgage and $125,000 LOC for investing

This way you get a significant investment portfolio from day 1. Putting it through the SM calculator shows a dramatic decrease in the time to pay down the mortgage and large tax refunds from the first year.

What is the general consensus on this 'wrinkle'?

[tarnator]

I suppose that I am now in the position to consider the 'accelerated' SM. We bought 3 years ago and our appt. has gone from $275K to about $550. Crazy.

We have no other debt. And my hubbie will be doubling his salary (hopefully!) in the second half of this year.

It seems reasonable that we use the line of credit to buy some RRSPs for hubbie (who has none) and anything left over becomes extra investment. The bonus is the LOC interest is a tax write-off. correct?

I will have to run this past some of my friends who know more about money than I....

[cannon_fodder]

You wouldn't be able to deduct interest on the investments that go into the RRSP. That would be a case of having your cake and eating it too.

If I'm not mistaken, if you borrow money to purchase investments to earn income and then you sell them or put them in an RRSP, you no longer can write off the interest. From the taxman's point of view, once you place those investments in the RRSP you have to consider them sold and declare any gains on them.

[inntents]

is it safe to assume that the SM should ONLY be undertaken once all other debt, especially revolving-credit debt, is completely wiped out? Step #1 of any financial planning is to get rid of credit card debt, no?

The SM sounds very intriguing, and as many others have posted, runs counter to how too many of us think about how we should handle our money. Great posts, all, and very informative, too. Thanks.

[pitz]

I don't grasp the logic so perhaps you can explain this to me. I have assumed that a "dividend paying investment" is a stock.


Sure. Or it could be preferred shares, or even GICs. It really doesn't matter, just so long as there are cash flows associated with the investment.

Obviously you wouldn't use a GIC because the typical after-tax return of a GIC is less than a typical mortgage. But there have been occaisons in the past where performing this form of arbitrage with preferred shares and/or GICs has been profitable and generated returns in excess of one's cost of capital.


Let's say I have 1,000 shares of XYZ (@ $20 each )and it pays out $0.19 a share per quarter. Each quarter I receive $190 (which I have to declare as income). I then use this to pay down the mortgage.
I then take that $190 out and try to buy, what, more XYZ? Any fee associated with it would be, I'm guessing, at least $10. So, I end up with 9 more shares.


My broker charges me $1/trade. I do agree that you need to consider fees under such a scenario, and ideally, minimize them.


I would declare the $190 as income which, I hope this is right, would be taxed at about 25% in Ontario. This would be the same regardless of whether I DRIP'ed or didn't, correct?


Yes, but the $190 hopefully would be eligible for a dividend tax credit or be in some other form of tax-advantaged form, and not taxxed at one's marginal rate.


If I've done this right, then I'd have 1009 shares and have to declare $190 as dividend income. However, in the first scenario, I paid $10 to service the debt over 12 months and got a refund of $4.63. In the second scenario, I have a credit of $10.

Did I miss something? Wouldn't the best scenario for the SM to be invested in an income producing product that pays the least amount of income as possible?

How is such a product possible? "an income producing product that pays the least amount of income possible" sounds like a contradiction to me.

Actually such a product does exist -- its called the BMO Dividend fund. The 'dividends' are extracted by its managers in the form of management expense, making its MER very expensive. If you have to pay an investment manager a management fee, you want to be paying it out of pre-tax income, and not tax-advantaged income such as Canadian dividends.

Any 'income' received from investments will accelerate the SM process so that the non-deductible balance is reduced as quickly as possible. The intent of the SM process is to, as quickly as possible, swap the entirety of your non-deductible consumer debt (ie: housing, credit cards, etc.) into deductible investment debt. Typically a house is used as the underlying asset, but other assets (an investment portfolio, for instance) can be similarly used.

[pitz]

For those that have argued for/against the idea that the SM is using leverage, please consider this. This way you get a significant investment portfolio from day 1. Putting it through the SM calculator shows a dramatic decrease in the time to pay down the mortgage and large tax refunds from the first year.

What is the general consensus on this 'wrinkle'?

The issues are:

1) Will your investment portfolio provide a return above and beyond the after-tax cost of capital?

2) Will your house retain its value and continue to appreciate and provide returns over and above the after-tax cost of capital.

3) Will you always be able to find willing lenders to obtain the desired amounts of credit.

If worldwide stock markets have a slow or negative year, and housing prices decline, then your overall level of equity (net worth) will decline.

You might want to look at Japan in the 1990s and recently for an example of how leveraged investment (in stocks, or in real estate) went bad. The housing market, and stock market simultaneously lost a substantial amount of value. Wages didn't grow. Plug those numbers into your favourite calculator and realize how well the Smith Manouevre works.

The SM works best during periods of high interest rates and high rates of inflation, because the real cost of capital is generally low, while inflation helps the performance of stocks and real estate. High nominal interest rates also increase the effectiveness of the tax deduction associated with the Smith Manouevre (while low interest rates inflate asset prices). So its not all bad, but modelling overall expected performance should be approached with caution.

As for point #3, while mortgage money has been very cheap, that always hasn't been the case. Once banks start taking losses on bad housing loans, credit will tighten, and more speculative forms of credit will entail higher interest rates and tighter restrictions and covenants. If you do not understand (and have not lived through a few iterations of) the credit cycle, do not attempt the Smith Manouevre.

[CoolEddie]

Is anyone here actually doing the Smith Manouevre? I'm a little bit puzzled.

Correct me if I'm wrong. If your mortgate payment is $1000 a month, wouldn't it stay at a $1000 a month despite the principle decreasing? Plus, every month you are taking out an investment loan on the principle you pay off on your house, say $200. And let's say interest rate is 5%. So now your monthly payments will be $1000 + 0.83. Then the next month it will be $1000 + 1.67, then 1000 + 2.50, etc. So is this suppose to happen?

[TrevorK]

Is anyone here actually doing the Smith Manouevre? I'm a little bit puzzled.

I am - I use a secured line of credit instead of a mortgage.


Correct me if I'm wrong. If your mortgate payment is $1000 a month, wouldn't it stay at a $1000 a month despite the principle decreasing? Plus, every month you are taking out an investment loan on the principle you pay off on your house, say $200. And let's say interest rate is 5%. So now your monthly payments will be $1000 + 0.83. Then the next month it will be $1000 + 1.67, then 1000 + 2.50, etc. So is this suppose to happen?

I think all your confusion lies in the fact that you are paying down a traditional style mortgage, so seeing the numbers / payoffs is much harder to do.

I don't see how people can use a traditional mortgage for the Smith Manoeuvre. They will either need to refinance into a:
- secured line of credit
- matrix mortgage (Mortgage portion, as it's payed down a secured line of credit against your home equity increases)
- HELOC (in conjunction with an existing mortgage)

Using a traditional mortgage you will pay it down, and you will then need a way to borrow back some of your equity (Which isn't a feature of a traditional mortgage). This is where the three options I listed above come into play.



I think you are grasping the basics, if you get a HELOC for the equity in your home, your existing mortgage payment is still intact. In addition, you will now have another interest payment on the money that you have borrowed through your HELOC. Which makes your monthly payment X + Y (Mortgage payment + HELOC interest payment).

The only products I have seen that allow the LOC portion to go up as you pay the mortgage portion down are the matrix style mortgages. Each bank has their own name for it, but basically it gives you a mortgage and LOC. As you pay down the mortgage, the principle becomes available on your LOC.


Does that make more sense?

[cannon_fodder]

I think the assumption is that as you get closer and closer to paying down the mortgage, your carrying costs of the entire LOC (part mortgage, part investment LOC) will continue to rise (assuming that you pay the interest portion of the investment LOC with after tax dollars via your monthly cash flow).

Your mortgage payments, if on a fixed interest rate, don't change. But, your interest charges for the investment LOC continue to rise.

Let's take an example:
$500,000 home
$375,000 "Matrix" mortgage or the like which could be composed of (in one person's particular case) representing 75% of the value of the home
$250,000 mortgage principal
$125,000 investment LOC

Assume you max out the investment LOC from day 1. Then the next payment period you would have both the mortgage payment (P+I) and the investment LOC (I only).

As you use the SM, you are paying down the mortgage principal and reborrowing the same amount (again, trying to cover interest charges with monthly cash flow) increasing your investment payments. In fact, at the end, wouldn't you have basically a mortgage payment + interest payment on the entire $375,000? This would make it very hard for most people to handle the cost of the SM without either:

selling some of the investment portfolio to fund the payments, thus reducing the interest charges writeoff;
borrow the mortgage principal payment, but pay for the interest charges out of the payment which means there would be very little to invest.

I haven't run the numbers... just trying to figure it out in my head.

I believe that is where CoolEddie is coming from... it certainly is what has me concerned.

[pitz]

I think the assumption is that as you get closer and closer to paying down the mortgage, your carrying costs of the entire LOC (part mortgage, part investment LOC) will continue to rise (assuming that you pay the interest portion of the investment LOC with after tax dollars via your monthly cash flow).


No, the carrying costs of the entire LOC remain level throughout the entire scheme. However, as you progress with the Smith Manouevre, 2 things happen:

1) The income stream associated with the investments generally grows, accelerating the paydown of the non-deductible portions.

2) The proportion of deductible interest increases, thus increasing the amount of interest deduction you can claim on taxes. This, in turn, accelerates cashflows available for paying down even more of the mortgage.

As you can sort of imagine, the process exponentially increases the rate of paydown of overall debt, by reducing the overall cost of capital. For instance, 6% mortgage, 40% tax bracket -- the effective after-tax cost of capital is a mere 3.6%.

Plug 3.6% into your favourite on-line mortgage interest calculator and plug 6% into your favourite calculator. You'll see that cutting the interest expense on a mortgage down dramatically reduces the repayment period.

Plus you build an investment portfolio simultaneously, which diversifies and reduces overall portfolio asset risk. Properly executed, the Smith Manouevre dramatically reduces the level of risk for the homeowner/investor.


Your mortgage payments, if on a fixed interest rate, don't change. But, your interest charges for the investment LOC continue to rise.


Sure, but as you increase the investments, the income from those investments should also increase as well. Plus the interest deductibility associated with the investment LOC provides a positive contribution to cashflow. Cashflow planning is important when executing/planning the SM, but if the proper types of investments are selected, cashflow generally doesn't become a huge concern.

Assume you max out the investment LOC from day 1. Then the next payment period you would have both the mortgage payment (P+I) and the investment LOC (I only).

Maxxing out the LOC from day 1 is taking on a lot of unnecessary risk. And yes, the cashflow associated with the scenario you provide is slightly higher initially, however, once you get your witholding adjusted, and start receiving a stream of dividends from the investments made from the LOC, most cashflow issues should dissappear.

Not paying a professional advisor a small fortune (ie: 2% MERs) is absolutely critical to the success of the SM. Pay a professional a couple thousand $$ up-front to help you plan your Manouevre if you must, but don't fall into the trap of giving away the entirety of your income stream from your investments.



As you use the SM, you are paying down the mortgage principal and reborrowing the same amount (again, trying to cover interest charges with monthly cash flow) increasing your investment payments. In fact, at the end, wouldn't you have basically a mortgage payment + interest payment on the entire $375,000? This would make it very hard for most people to handle the cost of the SM without either:
selling some of the investment portfolio to fund the payments, thus reducing the interest charges writeoff;
borrow the mortgage principal payment, but pay for the interest charges out of the payment which means there would be very little to invest.


The investments should buy income. If you are buying investments with no dividends and with nosebleed valuations and almost no earnings (ie: GOOG, SBUX, or whatever the latest fad stock is), then the Smith Manouevre isn't likely to work out for you.

As always, if you don't understand the math, don't even attempt this.

[pitz]

is it safe to assume that the SM should ONLY be undertaken once all other debt, especially revolving-credit debt, is completely wiped out? Step #1 of any financial planning is to get rid of credit card debt, no?


Yes, it goes without saying that other debt should be consolidated into the non-deductible mortgage debt whenever possible.

If you need to restructure your financing, you may be able to do the SM, and roll the CC/car loan debt all into one new loan.

The SM is not for the financially irresponsible though. If you were coming to see me for professional advice on the matter, I would inquire as to why you racked up other debts in the first place.

[inntents]

Yes, it goes without saying that other debt should be consolidated into the non-deductible mortgage debt whenever possible.

If you need to restructure your financing, you may be able to do the SM, and roll the CC/car loan debt all into one new loan.

The SM is not for the financially irresponsible though. If you were coming to see me for professional advice on the matter, I would inquire as to why you racked up other debts in the first place.

Points taken - thank you!

[regrus]

Some of you are reporting that you are using a HELOC for the Smith Manoeuvre. My main problem with a HELOC is that banks report HELOC's to credit reporting agencies as revolving debt wherein a readvanceable mortgage is not reported at all.

In my case I don't owe anything except for a $150,000.00 HELOC against a $400,000.00 home. It pisses me off when I check my credit report and it always says "my outstanding balance is too high in proportion to my available credit." This hurts my Score.

The way I look at it is I have a $150,000.00 credit against $400,000.00 property which is under 40% debt ratio. The credit agency looks at as I am using $150,000.00 of $150,000.00 available credit. Not good in their eyes.

[cannon_fodder]

No, the carrying costs of the entire LOC remain level throughout the entire scheme.

I challenge you to offer proof of that, because if you are successful then I will have greatly increased my understanding.
And I don't mean offsetting the costs with increased income from investments, or siphoning off a portion of principal redraws to pay the interest charges, but the actual total liability each payment period must increase.

My argument is based on these premises:

1. The mortgage payment continues unchanged until the mortgage is fully paid off. (Of course, the principal payment increases as the interest payment decreases, but each period payment is the same.)
2. The SM increases the deductible interest charges because the LOC liability also increases. In fact, near the end, you have to pay interest on the entire LOC AND a full mortgage payment.

While you MAY see an equivalent (or greater) offset due to tax refunds and investment income, that does not change the fact that the cost to service the SM increases.

However, the tax refunds are supposed to be used to pay down the mortgage faster, not service the deductible interest on the LOC, correct?

Perhaps you are suggesting that the investments should be chosen more for their income producing capability (like an income trust) rather than their solid, dependability (e.g. blue chip stocks with 5 year + history of increasing dividends). If so, then that is where we are coming at it from two different angles and your thinking might have merit that I have not been able to discern.

I'll try and develop a spreadsheet that attempts to mimic the SM and see what they tell me.

[pitz]

And I don't mean offsetting the costs with increased income from investments, or siphoning off a portion of principal redraws to pay the interest charges, but the actual total liability each payment period must increase.


If you borrow additional funds, sure, the liability increases.

With a conventional mortgage arrangement, your liabilities are the greatest at the beginning of the mortgage, and then they subsequently decline as you pay down the principal of the mortgage through an amortized blend of principal and interest payment.

With the Smith Manouevre, your liabilities remain level until you have completely swapped the entirety of your non-deductible debt for deductible debt.


1. The mortgage payment continues unchanged until the mortgage is fully paid off. (Of course, the principal increases as the interest decreases, but each period payment is the same.)

2. The SM increases the deductible interest charges because the LOC liability also increases. In fact, near the end, you have to pay interest on the entire LOC AND a full mortgage payment.


Sure, but the mortgage payment, at/near the end, is nearly 100% principal, and 0% interest. The payment on the LOC, at/near the end, is always 100% interest.

Don't confuse the payment of interest with the payment of principal. Principal contributes to capital/equity accumulation. Interest is the expense associated with renting investment capital.


While you MAY see an equivalent (or greater) offset due to tax refunds and investment income, that does not change the fact that the cost to service the SM increases.


Sure, the SM does produce a greater interest bill. But at the end of the manouevre, you have twice as many assets.


However, the tax refunds are supposed to be used to pay down the mortgage faster, not service the deductible interest on the LOC, correct?


Yes.


Perhaps you are suggesting that the investments should be chosen more for their income producing capability (like an income trust) rather than their solid, dependability (e.g. blue chip stocks with 5 year + history of increasing dividends). If so, then that is where we are coming at it from two different angles and your thinking might have merit that I have not been able to discern.


If you can find quality income trusts, then they are ideal for the purpose. Unfortunately, there are very few examples of quality income trusts in Canada, and certainly not enough to build anything resembling a properly diversified portfolio. Canadian Oilsands is the only trust i'd consider as part of a 'blue-chip' portfolio, and I think you can agree that it would be very highly risky to go 100% into COS.UN.


I'll try and develop a spreadsheet that attempts to mimic the SM and see what they tell me.

Sure, try and understand the math.

[pitz]

Some of you are reporting that you are using a HELOC for the Smith Manoeuvre. My main problem with a HELOC is that banks report HELOC's to credit reporting agencies as revolving debt wherein a readvanceable mortgage is not reported at all.


So replace some of the tax-deductible mortgage debt with tax-deductible margin debt. In other words, borrow from your broker, not from your mortgage lender.

Problem solved.

[cannon_fodder]

To pitz:

I think my understanding of the math is far better than you've given me credit for. Some of the statements you made could be misinterpreted, or were simply incorrect.

I, too, made some statements that did not accurately reflect what I was trying to say. For example, I said "1. The mortgage payment continues unchanged until the mortgage is fully paid off. (Of course, the principal increases as the interest decreases, but each period payment is the same.)" What I meant to say was that "... the principal payment increases as the interest payment decreases..."

I believe I have constructed an Excel spreadsheet which reflects the SM. It does not have a glossy front end, but it is probably a little bit more flexible in that I could put in any prepayments at any time (e.g. for winfalls, other components of my tax refund, etc.)

If you perform the Plain Jane SM at the end you should have a total payment that is equal to your mortgage payment + the interest portion of your first mortgage payment. This is because you have converted the mortgage to be a tax-deductible LOC. Since you are having to pay down the mortgage (both P+I) but you only have to pay the I on the LOC, then this makes sense.And my Excel spreadsheet confirmed that.

What I was driving at is that this is a real, and significant, increase in cash outlay. What I infer from your statements is that the income generated from your investments will be planned to substantially contribute, and perhaps completely offset, the increased cost to service the declining mortgage and the increasing cost to service the growing LOC liability.

That is an interesting perspective, but my initial reaction is that I'm now declaring additional, taxable income. Would you argue that all income you receive from the investments:

- should be used to pay down the mortgage even faster and then redraw the amount to invest,or
- should be split into two parts: only enough to cover the additional carrying costs; and use the rest to paydown the mortgage, redraw & invest, or
- something completely different?

I'll plug in some numbers to see how this affects everything if I receive income which:

- is returned at a level less than the interest costs of the LOC
- is returned at a level more than the interest costs of the LOC

I'm going to read the SM book again, but I don't think he adequately addresses the increase in cost to service the mortgage and LOC. Sure, he drills into you that the total liability does not change. BUT, he does not provide any information, yet alone numbers IIRC, that show that or how much your periodic payments increase.

[cannon_fodder]

Just saw that www.smithman.net has announced the formation of "Smith Manouevre Financial Corporation". They also talk about the "Freeboard Equity" program where you implement a readvanceable mortgage by tapping into the increased equity in your home since you took out your mortgage.

http://www.smfc.com/services/for_home_owners/

The approach suggested is one that others have implied - invest in income producing mutual funds with monthly cash distributions and pay down the mortgage first, redraw and invest.

[pitz]

What I was driving at is that this is a real, and significant, increase in cash outlay. What I infer from your statements is that the income generated from your investments will be planned to substantially contribute, and perhaps completely offset, the increased cost to service the declining mortgage and the increasing cost to service the growing LOC liability.


Is it really a 'cost' if its being used to accumulate equity? While analyzing for cash flows is important in the context of the Smith Manouevre, I think you should be taking the approach of analyzing for overall net worth. Think of the Smith Manouevre as giving you a discount on your mortgage interest rate at your highest marginal rate. If you were previously paying 6% on your mortgage in a 40% tax bracket, once you have the entirety of the debt swapped over, you will be paying an effective rate of 3.6%.

The technicalities of the Smith Manouevre (and the Income Tax Act) dictate that you must have the investment portfolio in order to receive the deduction, however, so you can't merely just accelerate your mortgage payoff as though you could if you truly were paying 3.6% on a cash basis.



That is an interesting perspective, but my initial reaction is that I'm now declaring additional, taxable income. Would you argue that all income you receive from the investments:

- should be used to pay down the mortgage even faster and then redraw the amount to invest,or
- should be split into two parts: only enough to cover the additional carrying costs; and use the rest to paydown the mortgage, redraw & invest, or
- something completely different?


I would argue that if you have non-deductible debt of any kind, it should be first repaid. Whether you choose to re-draw to invest is ultimately your decision. If you feel the stock markets are over-valued, then maybe just paying off the mortgage is the better idea.

I don't encourage market timing, but when Nortel was 45% of the TSX index, probably wasn't a very good time to consider investing in it. Generally speaking, you always want to invest in 'stuff' that produces after-tax GAAP earnings greater than your cost of capital.

Yes, over time, there is an increasing effect on your overall taxable income. However, hopefully you had the foresight to invest in instruments that provide income in the form of either capital gains or tax-advantaged Canadian dividends. This is a very valid point and should be included in your modelling.


I'll plug in some numbers to see how this affects everything if I receive income which:

- is returned at a level less than the interest costs of the LOC
- is returned at a level more than the interest costs of the LOC

I'm going to read the SM book again, but I don't think he adequately addresses the increase in cost to service the mortgage and LOC. Sure, he drills into you that the total liability does not change. BUT, he does not provide any information, yet alone numbers IIRC, that show that or how much your periodic payments increase.

The cashflows associated ultimately depend on the type of financing used.

Its possible to get a LOC, for the purposes of the Smith Manouevre, that does not have any 'payments' associated with it. Or you can use a margin account which doesn't require any 'payments' for a portion of the borrowing. There are lots of ways of managing the cashflows.

[cgtor]

i'm not exactly sure how the timing works with respect to the investment loans under SM method

i was just approved for a mortgage of approximately 200,000 and i came across the book

after having read the book, i am curious to learn how often the loans should be taken

for example, suppose i put a lump sum payment of $1000 this month, and $1000 next month, does it not seem odd to be approaching the bank every month to ask for a loan of $1000 for investing? is it better to do it this way, or better to do it semi-annually, say every 6 months?

[grant]

So replace some of the tax-deductible mortgage debt with tax-deductible margin debt. In other words, borrow from your broker, not from your mortgage lender.

Problem solved.
My margin account is prime + 1.5 or 2%. A HELOC would be Prime + 0%. So it's not an ideal solution.

[fsmontenegro]

To pitz:
I'm going to read the SM book again, but I don't think he adequately addresses the increase in cost to service the mortgage and LOC. Sure, he drills into you that the total liability does not change. BUT, he does not provide any information, yet alone numbers IIRC, that show that or how much your periodic payments increase.

Yes, that is my impression as well. The two approaches that have been recommended (both in the book and in the website) are:
- Pay the interest on the LoC from the amount that is borrowed. Example:
mortgage payment = $800 ($400 P + $400 I)
borrow from LoC = $ 400
assuming LoC interest due = $10
amount to invest = $400-$10 = $390

- Do the "guerrila" method (or something like that) and arrange for capitalizing the interest owned. In the example above, take $400, invest $400 and add the $10 to the LoC balance. Apparently not too many places will allow you to do this (any references to lenders that actually allow this? please let me know...)

Hope this helps.

Cheers,
Fernando

[cannon_fodder]

Well, I finally have a really good approximation of the SM calculator at least in that I can plug in his numerical examples and get the same answers within plus or minus a couple of bucks. There are certain assumptions that he made that I wasn't aware of but it seems to work.

I can see that, unlike the FP who talked to me about this method, the SM calculator DOES pay for the additional, and increasing, interest costs for the LOC through capitalizing interest and from siphoning off money that you withdraw. It does NOT require that you use any of the income that the investments generate to pay for it.

As an example, if we take the one quoted in his book:

$200,000 mortgage amortized over 25 years, 5 year term at 7% interest compounding semi-annually
Investment LOC at 5% interest supporting capitalization of interest(one of the many items that bother me in his book - if I have just put together this readvanceable mortgage why would my mortgage be at 2% higher than my investment LOC? No explanation as to why this strange difference.)
Investment growth at 10%
Tax rate 40%
Monthly payment at $1,400.83
Reinvest tax refunds
Assume mortgage begins January 1, 2007 for this example

On February 28, 2029, you make a mortgage payment of $1,400.83 as usual, you only have $563.30 to invest because about $15.23 goes to the mortgage interest and $822.30 goes to the investment LOC for interest.

I believe this is what pitz has been trying to get through to me that there is no additional strain put on your finances through this application of the SM. The FP who had sat down with me suggested a different, what he considered 'much better' approach, whereby the investment LOC interest was paid with external cash (e.g your salary). This, of course, would allow the full amount of any payment to the principal of the mortgage to be actively invested. I think I could say that both pitz and I were right, but we were coming at it from quite different angles. Sorry, pitz, for my stubborness!

Here are some key points I discovered in creating my spreadsheet:

The SM calculator assumes the tax refund will come in 6 months after the end of the year (e.g. start your mortgage on January 1, 2007 and your first refund will be used to pay down your mortgage June 30, 2008.)
The end calculations of tax refunds and investment portfolio amount are indeed at the end of the amortization period. I had mistakenly thought that this was what you would have as soon as the mortgage was discharged. I think this is a bit misleading, or at least, it should be made very clear. I would bet that I'm not the only person who didn't realise that you had to let this SM go on for the full 25 years to reach those numbers.

To be fair, it is probably the best way to compare apples to apples
- don't do the SM and this is where you are
- no mortgage and no investments, no tax refunds OR
- do the SM and this is where you are
- no mortgage, $510k in investments and a nice $4k in tax refunds each year and all it will cost you is $10k in interest charges which is less than the almost $17k you used to make in mortgage payments.

In the example he uses in the book, the mortgage is paid off 2.75 years earlier. At that point, the portfolio is about $361,079 and the tax refunds total about $32,400. But, for the next 2.75 years you keep paying the $1,400.83 into this SM (subtracting the $833.33 for the investment LOC carrying costs leaving $567.50 for investing) and keep applying the tax refunds and you will wind up with the figures he quotes.

Now I'm going to work on adding the "Freeboard Equity" wrinkle to my spreadsheet.

[pitz]

My margin account is prime + 1.5 or 2%. A HELOC would be Prime + 0%. So it's not an ideal solution.

My margin account is roughly Prime - 0.6%, or currently, approximately 5.3% (in Canadian dollars).

It certainly pays to shop around (http://www.interactivebrokers.ca) ;) .

[FrugalTrader]

i'm not exactly sure how the timing works with respect to the investment loans under SM method

i was just approved for a mortgage of approximately 200,000 and i came across the book

after having read the book, i am curious to learn how often the loans should be taken

for example, suppose i put a lump sum payment of $1000 this month, and $1000 next month, does it not seem odd to be approaching the bank every month to ask for a loan of $1000 for investing? is it better to do it this way, or better to do it semi-annually, say every 6 months?

That's why if you want to do the SM, you need to obtain a re-advancable mortgage. These mortgages will AUTOMATICALLY increase your HELOC credit limit as you pay down your non-ded principle. Some examples of these mortgages are:
First Line: The Matrix Mortgage
RBC: The Homeline Mortgage
Manulife: Manulife ONE

FrugalTrader
http://www.MillionDollarJourney.com

[noodles]

Would love to see that spread sheet, or one similar? I would like to pug in my numbers and see what it comes out with.

[FrugalTrader]

Would love to see that spread sheet, or one similar? I would like to pug in my numbers and see what it comes out with.

I second that. :)

[fsmontenegro]

Hi!

As I do my research for implementing the SM (see my earlier posts), I came across the M1 product from Manulife. For those interested in it, there's a couple of threads on this forum (just search for it) as well as a LONG and nice discussion on a separate blog (http://mork.ca/archives/51-Manulife-One-First-Impressions.html).

Has anyone here implemented SM with M1? Any experiences they'd like to share?

Thanks!

[FrugalTrader]

Hi!

As I do my research for implementing the SM (see my earlier posts), I came across the M1 product from Manulife. For those interested in it, there's a couple of threads on this forum (just search for it) as well as a LONG and nice discussion on a separate blog (http://mork.ca/archives/51-Manulife-One-First-Impressions.html).

Has anyone here implemented SM with M1? Any experiences they'd like to share?

Thanks!

The Manulife one product is definitely a candidate for the SM, the only thing I don't like about it is that they charge a monthly fee of $14.

[fsmontenegro]

The Manulife one product is definitely a candidate for the SM, the only thing I don't like about it is that they charge a monthly fee of $14.

Hi. Yes, the fee is annoying, but understandable. My opinion is that the benefit is worth it. Two things come to mind:
- my current bank requires me to leave $x balance at all times to waive fees (just under $10). This is money not really doing anything.
- I don't mind paying something for the benefit of automatic "mortgage prepayments" without having to double-up, prepay, etc... myself.

Between these two factors, I find the $14/month quite reasonable.

Cheers!

[cannon_fodder]

I have no problem with sharing what I've come up with. If you can make it better, please offer up some expertise.

I'm a perfectionist - so, IMO, my baby is still too ugly to show off. I'd love to develop some sort of front end for it and it is unwieldy right now if you want to go back and forth between monthly mortgage payments vs. biweekly, etc.

I'll keep playing around, but if anyone wants to send me some hypothetical numbers to plug in, I can do that. It might help me validate and improve it.

It is making me wonder why I need a mortgage broker who will charge me a fee to service the readvanceable mortgage (as explained to me). They will take care of the communication to the FP so that s/he is aware of what to expect in terms of PAC. If I have my own spreadsheet I can determine that.

[fsmontenegro]

Going back to my SM implementation, a few questions on tax deductability.

The SM is based on the notion that the interest paid on a loan made for investment purposes is tax deductible. Can anyone comment if there are any tax breaks/deductions for the following investment expenses:
- Legal fees and appraisal fees to set up a HELOC used for investment purposes.
- Brokerage comissions.
- (this is a stretch, but hey, if it works...) the management fees charged by a mutual fund.

Also, is it possible to have a higher income spouse claim the interest expense on one return and have the lower income spouse declare the dividends obtained? If so, any recommendations on how to best document it?

Thanks!

[pitz]

=
The SM is based on the notion that the interest paid on a loan made for investment purposes is tax deductible. Can anyone comment if there are any tax breaks/deductions for the following investment expenses:
- Legal fees and appraisal fees to set up a HELOC used for investment purposes.


I've always deducted expenses associated with setting up bank loan facilities under carrying charges, and have never been challenged.


- Brokerage comissions.


Brokerage commissions must be capitalized into the purchase price of the assets you purchase. For instance, if you buy 1000 shares of $10 each, and pay $29.95 commission, your total cost base is equal to $10,029.95.


- (this is a stretch, but hey, if it works...) the management fees charged by a mutual fund.


Management fees of funds are usually deducted, by the fund itself, against the investment income produced by the fund. If you are charged and pay an explicit cash management fee by your investment advisor, under certain circumstances, it may be deductible.


Also, is it possible to have a higher income spouse claim the interest expense on one return and have the lower income spouse declare the dividends obtained? If so, any recommendations on how to best document it?


Sort of. You need to apportion the expenses associated with the income received, and further, you need to do so along the lines of the original capital contributed I understand.

For example, if your spouse makes half of the interest payments, and provided half of the downpayment, its logical that she claims one half of the dividend income, and one half of the interest expense.

[cannon_fodder]

My Readvanceable Mortgage Excel Workbook is up for viewing (http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls). If anyone feels like contributing to make it better, please do.

I've noticed that my calculations don't match exactly with the ones published in the book (when it comes to Steps III and IV, as well as Cash Flow Dam, our investment portfolio amounts aren't identical). They are quite close however.

My longstanding thought is that I have made an error in my formulas or in the spreadsheets. But, after reviewing his book, I have noticed there are errors (e.g. page 100 last paragraph he writes an interest expense of $833.73 for a $200,000 loan at 5% interest, and then correctly reports it in the last sentence on the page). I can't figure out where my logic is wrong, especially since it works for the other situations but perhaps a fresh set of eyes can resolve it.

Whether he is right and I am wrong, or vice versa, or we are both wrong, at least the numbers come out quite close.

My Workbook allows you to specify the following additional parameters which I could not see from the book's screen shots of his calculator (perhaps they are included in a separate screen or a newer version):

- Cash Flow Dam check box and expense amount
- Amortization
- Number of payments per year (although I only have spreadsheets for 12, 24 and 26 - trying to make one spreadsheet cover all scenarios was driving me crazy)
- Starting LOC (for the "Freeboard Equity", "Turbo Smith Maneouvre" or whatever you want to call it. This is when you want to tap into equity built up and draw upon that to a 75% readvanceable mortgage)
- Tax Refund date (I get mine in early March, some people get theirs after April 30th.)

You'll also quickly see what the investment portfolio amount is once the mortgage is retired. The faster you retire it, the smaller the amount is. Taking the full 25 year period (as in his examples) gives more time for the portfolio to grow. I found it helpful as when I was reading the book I mistook the portfolio amount quoted to be when the mortgage was free and clear, not after the full 25 years.

The one thing I haven't allowed for is for you to specify a beginning date for the mortgage. I have placed January 1, 2007 as the starting point so if you look at the spreadsheets themselves you have to go from there. That could affect slightly the calculations because if you start your readvanceable mortgage late in the year, that first year will have a small tax refund but it will be applied before a full 12 months are up.

I hope it is helpful for others.

[Rosico]

great stuff - thanks!

[FrugalTrader]

My Readvanceable Mortgage Excel Workbook is up for viewing (http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls). If anyone feels like contributing to make it better, please do.

I've noticed that my calculations don't match exactly with the ones published in the book (when it comes to Steps III and IV, as well as Cash Flow Dam, our investment portfolio amounts aren't identical). They are quite close however.

My longstanding thought is that I have made an error in my formulas or in the spreadsheets. But, after reviewing his book, I have noticed there are errors (e.g. page 100 last paragraph he writes an interest expense of $833.73 for a $200,000 loan at 5% interest, and then correctly reports it in the last sentence on the page). I can't figure out where my logic is wrong, especially since it works for the other situations but perhaps a fresh set of eyes can resolve it.

Whether he is right and I am wrong, or vice versa, or we are both wrong, at least the numbers come out quite close.

My Workbook allows you to specify the following additional parameters which I could not see from the book's screen shots of his calculator (perhaps they are included in a separate screen or a newer version):

- Cash Flow Dam check box and expense amount
- Amortization
- Number of payments per year (although I only have spreadsheets for 12, 24 and 26 - trying to make one spreadsheet cover all scenarios was driving me crazy)
- Starting LOC (for the "Freeboard Equity", "Turbo Smith Maneouvre" or whatever you want to call it. This is when you want to tap into equity built up and draw upon that to a 75% readvanceable mortgage)
- Tax Refund date (I get mine in early March, some people get theirs after April 30th.)

You'll also quickly see what the investment portfolio amount is once the mortgage is retired. The faster you retire it, the smaller the amount is. Taking the full 25 year period (as in his examples) gives more time for the portfolio to grow. I found it helpful as when I was reading the book I mistook the portfolio amount quoted to be when the mortgage was free and clear, not after the full 25 years.

The one thing I haven't allowed for is for you to specify a beginning date for the mortgage. I have placed January 1, 2007 as the starting point so if you look at the spreadsheets themselves you have to go from there. That could affect slightly the calculations because if you start your readvanceable mortgage late in the year, that first year will have a small tax refund but it will be applied before a full 12 months are up.

I hope it is helpful for others.


Thanks for sharing!

[CoolEddie]

Great spreadsheet!! I gota learn how to make them that good.

[noodles]

I haven't read the entire thread as it's so long, but I do have some questions:


Has anyone here on this forum actually implememted the Smith Manoeuvre? If so, please give some details. Where? How?
I keep reading about the re-advanceable mortgage. Who offers these? Can I use a traditional mortgage?
This seems too good to be true. Is it?


I am not a financial expert. We have a financial advisor who invests a small amount for us in RRSP's, some mutual funds and an RESP for our daughter. He has done very well and the average return this year is about 15%. He works for Berkshire. Should I talk to him? Will he know what I'm trying to do? Can he set it up?

We are buying a new place in the new year, closing date is April 26, 2007 but could be pushed back, our mortgage is going to be somewhere between 300-350K, with also about 200K-250K of our own money. I would love to get this going from the start and I just really need some advice on where to go and who to talk to. I cannot do this on my own.

I would want this to all happen automatically every month or 2 weeks, I don't want to be having to shuffle funds myself somehow all the time. i'm surprised noone offers something like this and takes care of all the details for you.

[pitz]

I am not a financial expert. We have a financial advisor who invests a small amount for us in RRSP's, some mutual funds and an RESP for our daughter. He has done very well and the average return this year is about 15%. He works for Berkshire. Should I talk to him? Will he know what I'm trying to do? Can he set it up?



15% isn't that impressive for this year. But yes, he should be able to set it up.

The issue, however, is that the only way you can really make good money by using leverage insofar as investment is concerned is to aggressively manage costs and taxes.

A traditionally compensated 'mutual fund' advisor:

1) Won't put you into tax-efficient ETFs, but will rather place you into less tax efficient actively managed funds.

2) Won't put you into fee-efficient ETFs because the advisor does not receive compensation (beyond the initial commission).

3) Probably won't help you out with certain tax aspects or optimization aspects.


We are buying a new place in the new year, closing date is April 26, 2007 but could be pushed back, our mortgage is going to be somewhere between 300-350K, with also about 200K-250K of our own money. I would love to get this going from the start and I just really need some advice on where to go and who to talk to. I cannot do this on my own.


Simple, get a re-advanceable mortgage ("Matrix Mortgage" is one name) from your favourite mortgage broker. Open an account with Interactive Brokers. Every month, make your mortgage payment, and then transfer the amount of your mortgage payment from the line of credit associated with the mortgage to your brokerage account.

Invest the proceeds in a currency-hedged basket of ETFs. Do not invest in bonds or bond funds (as doing so is counter-productive).

When you receive dividends in the brokerage account, withdraw them from the account, and use the proceeds to pay down the mortgage. Withdraw the equivilant from the LOC and re-deposit to the brokerage account to purchase additional securities.

As I see it, the only professional advice you should really need would concern the overall composition of your portfolio, and how you can make the portfolio as tax efficient as possible.


I would want this to all happen automatically every month or 2 weeks, I don't want to be having to shuffle funds myself somehow all the time. i'm surprised noone offers something like this and takes care of all the details for you.

Its not that hard once you have the planning aspect of things down. Recycling the dividends from your investments should accelerate the process of transforming the mortgage from a non-deductible one to a deductible one.

Keep good records. Make sure there is a clear correlation between amounts removed from the Matrix Mortgage LOC, and the amounts deposited to the brokerage account. Make sure you currency hedge your investments (using hedged ETFs/funds, or through futures/options/forex borrowing).

99% of what you need to know can be found in these forums.

[ProStor]

Thanks for sharing, have been reading this thread for a while, very educational.

My Readvanceable Mortgage Excel Workbook is up for viewing (http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls). If anyone feels like contributing to make it better, please do.

I've noticed that my calculations don't match exactly with the ones published in the book (when it comes to Steps III and IV, as well as Cash Flow Dam, our investment portfolio amounts aren't identical). They are quite close however.

My longstanding thought is that I have made an error in my formulas or in the spreadsheets. But, after reviewing his book, I have noticed there are errors (e.g. page 100 last paragraph he writes an interest expense of $833.73 for a $200,000 loan at 5% interest, and then correctly reports it in the last sentence on the page). I can't figure out where my logic is wrong, especially since it works for the other situations but perhaps a fresh set of eyes can resolve it.

Whether he is right and I am wrong, or vice versa, or we are both wrong, at least the numbers come out quite close.

My Workbook allows you to specify the following additional parameters which I could not see from the book's screen shots of his calculator (perhaps they are included in a separate screen or a newer version):

- Cash Flow Dam check box and expense amount
- Amortization
- Number of payments per year (although I only have spreadsheets for 12, 24 and 26 - trying to make one spreadsheet cover all scenarios was driving me crazy)
- Starting LOC (for the "Freeboard Equity", "Turbo Smith Maneouvre" or whatever you want to call it. This is when you want to tap into equity built up and draw upon that to a 75% readvanceable mortgage)
- Tax Refund date (I get mine in early March, some people get theirs after April 30th.)

You'll also quickly see what the investment portfolio amount is once the mortgage is retired. The faster you retire it, the smaller the amount is. Taking the full 25 year period (as in his examples) gives more time for the portfolio to grow. I found it helpful as when I was reading the book I mistook the portfolio amount quoted to be when the mortgage was free and clear, not after the full 25 years.

The one thing I haven't allowed for is for you to specify a beginning date for the mortgage. I have placed January 1, 2007 as the starting point so if you look at the spreadsheets themselves you have to go from there. That could affect slightly the calculations because if you start your readvanceable mortgage late in the year, that first year will have a small tax refund but it will be applied before a full 12 months are up.

I hope it is helpful for others.

[noodles]

Pitz, Thanks for the help. Few more questions for you, please bear with me, I'm not a dumb person just not an expert in finance as it's not my field.

Are you doing the Smith Manoeuvre yourself?

15% isn't that impressive for this year. But yes, he should be able to set it up.

The issue, however, is that the only way you can really make good money by using leverage insofar as investment is concerned is to aggressively manage costs and taxes.

A traditionally compensated 'mutual fund' advisor:

1) Won't put you into tax-efficient ETFs, but will rather place you into less tax efficient actively managed funds.

2) Won't put you into fee-efficient ETFs because the advisor does not receive compensation (beyond the initial commission).

3) Probably won't help you out with certain tax aspects or optimization aspects.


Can you explain why the funds are less tax efficient? I am assuming they are taxed more than the ETF's you are talking about. Can you (or anyone) explain the difference between the 2 and why they are taxed differently?


Simple, get a re-advanceable mortgage ("Matrix Mortgage" is one name) from your favourite mortgage broker.


I assume not everyone offers this? Currently we're with www.wscu.com in the Vancouver area but I didn't see anything like it on their site. I obviously don't need to stay with them for the new mortgage, and I have no problem moving. Does PC Financial offer anything that could be used?


Open an account with Interactive Brokers. Every month, make your mortgage payment, and then transfer the amount of your mortgage payment from the line of credit associated with the mortgage to your brokerage account.


www.interactivebrokers.ca Is this the site?


Invest the proceeds in a currency-hedged basket of ETFs. Do not invest in bonds or bond funds (as doing so is counter-productive).


Why is it counter-productive? I understand bonds are usually lower interest rate, so I would probably stay away from them anyways, is this why?


When you receive dividends in the brokerage account, withdraw them from the account, and use the proceeds to pay down the mortgage. Withdraw the equivilant from the LOC and re-deposit to the brokerage account to purchase additional securities.


Understood.


As I see it, the only professional advice you should really need would concern the overall composition of your portfolio, and how you can make the portfolio as tax efficient as possible.




Its not that hard once you have the planning aspect of things down. Recycling the dividends from your investments should accelerate the process of transforming the mortgage from a non-deductible one to a deductible one.


I'm starting to understand, the longer you go the more the debt moves to the LOC and thus more tax deductions.


Keep good records. Make sure there is a clear correlation between amounts removed from the Matrix Mortgage LOC, and the amounts deposited to the brokerage account. Make sure you currency hedge your investments (using hedged ETFs/funds, or through futures/options/forex borrowing).

99% of what you need to know can be found in these forums.


I'm a newb, what does "currency hedge" mean?


Thanks again. Sorry if the questions seem simple, but I'm not going to know if I never ask.

[pitz]

Pitz, Thanks for the help. Few more questions for you, please bear with me, I'm not a dumb person just not an expert in finance as it's not my field.

Are you doing the Smith Manoeuvre yourself?


No. I do not own real estate. But I do invest using borrowed funds, and have advised individuals concerning the SM or similar techniques.


Can you explain why the funds are less tax efficient? I am assuming they are taxed more than the ETF's you are talking about. Can you (or anyone) explain the difference between the 2 and why they are taxed differently?


To make a long story short, there are 3 main types of 'income' possible from an investment in Canada:

1) Interest -- taxed at your highest marginal rate.
2) Canadian Dividends -- Taxed at a very low rate, in fact, almost tax-free until your income hits $60,000/year or more.
3) Capital gains -- taxed at one half the highest marginal rate, but deferrable.

Generally speaking, you want the majority of the return from your investment to comprise 2) and 3).

Dividends occur when they are declared by the company you are investing in, and paid out. Capital gains occur when an investment is sold.

Tax efficiency is the concept of optimizing an overall portfolio so that realization of capital gains (buying and selling of investments) is minimized. Generally the most well-known strategy for doing so is known as indexxing.

Indexxing is where you essentially buy a large representative sample of the stock market, rather than trying to beat the overall market. Because its basically a buy-and-hold strategy with minimal fees, it tends to outperform.

Indexxing is also highly tax efficient because rarely are stocks bought and sold.


I assume not everyone offers this? Currently we're with www.wscu.com in the Vancouver area but I didn't see anything like it on their site. I obviously don't need to stay with them for the new mortgage, and I have no problem moving. Does PC Financial offer anything that could be used?


PCF is just a front-end for CIBC anyways, as I understand. CIBC also owns FirstLine Mortgages, which offers the "Matrix Mortgage". Most other banks and mortgage lenders offer similar mortgages as well -- you just need to shop around. Make sure you get one with the lowest interest rates possible, and seperate billing for a re-advanceable line of credit, as well as a primary mortgage.

The seperate accounting keeps things neat and tidy, and also ensures that money is not co-mingled between deductible and non-deductible uses, when used properly.


www.interactivebrokers.ca Is this the site?


Yes. I like IB because of their very low commissions. But I do not recommend them if you are a beginner investor because the interface can be harder to use. But $2 Canadian stock purchases are pretty hard to beat.

If you want something thats a bit more idiot-proof but still low-cost, try Canadian Shareowner. Ideally you want something thats economical enough to buy investments on a monthly basis without costing you a fortune in commissions.


Why is it counter-productive? I understand bonds are usually lower interest rate, so I would probably stay away from them anyways, is this why?


Yes, there is no point to borrowing money at a higher interest rate than you will earn on your investments. Most mortgages are well over 5% these days, while most bonds, government and corporate, in Canada, only bear interest rates slightly above 4%. Borrowing at 5%, to invest at 4%, is a way of destroying capital.

If your asset allocation calls for bond component, then you need to just pay down the (non-deductible) mortgage instead.


As I see it, the only professional advice you should really need would concern the overall composition of your portfolio, and how you can make the portfolio as tax efficient as possible.

I'm starting to understand, the longer you go the more the debt moves to the LOC and thus more tax deductions.


Yes. At first, you will not receive much of a tax deduction overall. But as the investment LOC portion increases, so will the tax deduction, and the cashflow from your (dividend-paying) investments, which, in turn, compounds upon itself. Give it a few years, and eventually the dividends will be paying the entirety of your mortgage payment (freeing up cashflow for other things).
I'm a newb, what does "currency hedge" mean?


Thanks again. Sorry if the questions seem simple, but I'm not going to know if I never ask.

Currency hedging is where you hedge out risk associated with currency fluctuations by matching the currency of your assets with the currency of your liabilities. For instance, if you borrowed Canadian dollars to buy US dollar stocks over the past few years, you would have lost a lot of money because of the drop in the US dollar (relative to the Canadian dollar).

However, if you borrowed US dollars to invest in US stocks, you would have done quite well, with significantly less volatility overall. Or vice versa, if you borrowed US dollars in the 1990s to invest in Canadian stocks, you would have lost your shirt. The stock market is a risky enough place to begin with -- no need to add additional risk in the form of currency exposure, especially when investing on credit.

[cannon_fodder]

Please see http://taxtips.ca/ontax.htm

The 2006 changes in the dividend tax credit seem to imply that unless you exceed $110k that dividend income is most tax efficient.

Using the chart, I calculate that, in Ontario, if you earned $110,885 in dividend income you would pay $8,999.20 in taxes. If you earned the same amount in capital gains you would pay $8,999.21 in taxes. Would someone be able to verify that because I tried to find a site that would show the tipping point between capital gains and dividends and didn't find one.

I think, though, for low income seniors relying on capital gains or dividends, the gross up of dividends could cause claw back on certain benefits quicker than capital gains.

[FrugalTrader]

Keep good records. Make sure there is a clear correlation between amounts removed from the Matrix Mortgage LOC, and the amounts deposited to the brokerage account. Make sure you currency hedge your investments (using hedged ETFs/funds, or through futures/options/forex borrowing).


Pitz,

For tax purposes in proving that you used the LOC money for investment, do you only have to show that you transfered the money to your brokerage? Or do you also have to show the money being used to purchase an investment?

For those of you interested, here are the Smith Manoeuver summaries that I wrote:

Part 1:
http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-1.htm

Part 2:
http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-2.htm

[fsmontenegro]

Hi!

I don't mean to violate any forum rules on specific stocks/investments. If I'm out of line, please let me know and I'll drop the subject.

For those who have performed the SM or something similar, what has been your approach to building a non-reg portfolio? For now I'm assuming a dividend-focused portfolio...

a) Buy individual stocks that together make up a dividend-focused portfolio on a monthly basis via brokerage (I'll likely use IB for the low, low commissions). Achieve balance by buying different stocks throughout the year to make up a balanced portfolio.
b) Buy a dividend-focused mutual fund on a monthly basis
c) Buy a dividend-focused ETF on a monthly basis
d) Other (please elaborate)

Thanks!

[pitz]

For tax purposes in proving that you used the LOC money for investment, do you only have to show that you transfered the money to your brokerage? Or do you also have to show the money being used to purchase an investment?


Its not rational to borrow money on a LOC, and just deposit it to a brokerage account without purchasing an investment. The broker might pay you a pittance of interest on your cash balances, but it will be nowhere near your mortgage rate (and you will still have to pay taxes on the interest paid to you by your broker).

So why would you do that? Technically it should be deductible, if the broker pays you interest on cash balances, but it doesn't sound like a logical thing to do.

[fsmontenegro]

Its not rational to borrow money on a LOC, and just deposit it to a brokerage account without purchasing an investment. The broker might pay you a pittance of interest on your cash balances, but it will be nowhere near your mortgage rate (and you will still have to pay taxes on the interest paid to you by your broker).

So why would you do that? Technically it should be deductible, if the broker pays you interest on cash balances, but it doesn't sound like a logical thing to do.

I remember reading somewhere (maybe even in this thread) that the CRA could even rule that this scenario - investing in something that does not have the possibility of generating income afetr considering the loan costs - would not qualify for deductibility of interest.

Hope this helps.

[BHA1]

I have my LOC with my bank and have a brokerage account. I sent an EFT deposit from bank to brokerage in order to invest.

My bank statement shows "EFT of $xxx" but says it went to a clearing house (not the actual name of the brokerage). Funds were transferred out of the LOC on approximately Feb 1 06

My brokerage statement shows "EFT transfer in of $xxx" but doesn't say where it came from. Funds received on approximately Feb 4 06. Purchased some index funds the same day and have had them ever since.

Would CRA assume these two transactions were the same thing? I didn't write a cheque from the LOC, so I have no paper backup.

Do I need to get something from the bank showing where the funds went to, along with something from the brokerage showing where the funds came from?


Related question:
Purchased a rental property using the above mentioned LOC. The LOC was a combined "mortgage/LOC" product like Firstline's Matrix Mortgage. Amount of rental property was 1/5 of total mortgage amount (4/5 was for my home and 1/5 was for the rental property).

Refinanced mortgage 2yrs later with another bank. Now have both of the above pieces (home + rental property) as one mortgage.

Question: Can I write off 1/5 of the interest paid, since it relates to the rental property? Or should I be pursuing (ASAP!) a refinance of the rental property with its own mortage to be safer? Don't want to find out 5yrs down the road that CRA won't allow the interest!

[pitz]

Related question:
Purchased a rental property using the above mentioned LOC. The LOC was a combined "mortgage/LOC" product like Firstline's Matrix Mortgage. Amount of rental property was 1/5 of total mortgage amount (4/5 was for my home and 1/5 was for the rental property).

Refinanced mortgage 2yrs later with another bank. Now have both of the above pieces (home + rental property) as one mortgage.

Question: Can I write off 1/5 of the interest paid, since it relates to the rental property? Or should I be pursuing (ASAP!) a refinance of the rental property with its own mortage to be safer? Don't want to find out 5yrs down the road that CRA won't allow the interest!

Ick, your co-mingling of accounts definitely is something the CRA could challenge you on, and make your life miserable.

On the other hand, you might also have difficulty coming up with a refinance transaction satisfactory to the CRA without triggering capital gains tax.

You probably should seek professional advice. Not only that, but your overall debt allocation structure is sub-optimal. Interest on the primary residence mortgage is never deductible, while 100% of the interest on the rental property would be deductible.

[raj672]

This was a very good read. I am still not understanding as to how the payments will stay the same even though you will be paying the mortgage payment and the interest only payment on your loan???

It was mentioned that you can just withdraw from the same loc and deposit it as a payment(I don't think any bank will allow this as you will never pay them off !!!!!!)

What am i missing here???

Do you think an average person can do this on it's own and not deal with the smith man's team of (brokers/accountants/advisor's etc)

[pitz]

This was a very good read. I am still not understanding as to how the payments will stay the same even though you will be paying the mortgage payment and the interest only payment on your loan???


The combined effect of the tax savings associated with the interest deduction, as well as the dividends from a quality portfolio of ETFs or stocks, should take care of most of the increase in payments.

Undoubtedely, unless very carefully planned, there will be some short-term cash hickups. Which ultimately brings us to the solution you suggest below:


It was mentioned that you can just withdraw from the same loc and deposit it as a payment(I don't think any bank will allow this as you will never pay them off !!!!!!)

What am i missing here???


Its secured credit, the bank doesn't care whether its paid off or not, as they can always realize on their security if you default. But they need a monthly payment (irregardless of source), merely to prove to banking regulators that your loan isn't risky/delinquient.

Banks don't like having their loans classified as delinquient. It increases their borrowing costs and reduces the amount of leverage they are allowed to employ per government banking regulations.



Do you think an average person can do this on it's own and not deal with the smith man's team of (brokers/accountants/advisor's etc)

Each individual usually brings their own set of unique circumstances to the table, concerning investments, the size of mortgage, income, consistency of income, the industry in which income is derived, and their ability to access credit.

If you do not have expertise in the area, I feel its probably worthwhile to pay a couple thousand $$ for proper professional advice that is free of conflict of interest.

Avoiding Conflict of interest means that you don't receive your advice from a mortgage broker, nor a stock or life insurance salesman, nor from the government.

[raj672]

I think since it's failry new, we won't hear any horror stories anytime soon. It will interesting to attend one of their seminars to see how it is presented to a general public.

I would love to see a proper professional who can assess my situation and provide/recommend a proper course of action in attempting this.

so using a financial planner would not make sense b/c of conflict of interest then really who can u use to come up with a etf/stock plan and monitor on a regular basis :confused:

[ullyeus]

Some of you are reporting that you are using a HELOC for the Smith Manoeuvre. My main problem with a HELOC is that banks report HELOC's to credit reporting agencies as revolving debt wherein a readvanceable mortgage is not reported at all.

In my case I don't owe anything except for a $150,000.00 HELOC against a $400,000.00 home. It pisses me off when I check my credit report and it always says "my outstanding balance is too high in proportion to my available credit." This hurts my Score.

The way I look at it is I have a $150,000.00 credit against $400,000.00 property which is under 40% debt ratio. The credit agency looks at as I am using $150,000.00 of $150,000.00 available credit. Not good in their eyes.


simple question...but who cares what it shows when you have that much assets and already have a mortgage? Isn't the whole point in good credit so you can get a mortgage, and after that...who cares?

ps: Realize I am being somewhat "basic" here.

[pitz]

simple question...but who cares what it shows when you have that much assets and already have a mortgage? Isn't the whole point in good credit so you can get a mortgage, and after that...who cares?

Mortgages have to be renewed periodically, every 5 years or so is the typical term.

Borrowing from a margin account can be used to get around this problem instead of solely relying upon the HELOC. Interactive Brokers lends at a lower interest rate than most HELOCs.

[cannon_fodder]

Thanks to fsmontenegro's great suggestions, I have updated my Workbook to help with 'what if' scenarios for the Smith Manoeuvre that take into account common strategies used to pay down the mortgage faster.

Raj672, once you put in the various parameters on the Input sheet, you can then go to the respective tab (based on payments per year - 12=> Monthly, 24=> Twice Monthly and 26=> BiWeekly) and follow each payment to see how the money flows. It is based on the premise that no external money (through your regular cash flow or even through income from your investments) is used to help with the interest payments.

You can find it here:

http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls

[grant]

For tax purposes in proving that you used the LOC money for investment, do you only have to show that you transfered the money to your brokerage? Or do you also have to show the money being used to purchase an investment?
Yes, keep both. If you are not currentely receiving trade confirmations from your broker, get that started.

So why would you do that? Technically it should be deductible, if the broker pays you interest on cash balances, but it doesn't sound like a logical thing to do.
If the interest the broker pays is less than the interest the mortgage accrues, then there is no reasonable expectation of profit... thus non-deductible.

[pitz]

If the interest the broker pays is less than the interest the mortgage accrues, then there is no reasonable expectation of profit... thus non-deductible.

Are you 100% sure that the required test under the Income Tax Act is a reasonable expectation of profit (from the borrowing/investing itself)?

As far as I am aware, the reasonable expectation of profit only applies to the investment itself. For instance, the 'investment' must not be a total sham business that only subsists for the purpose of losing money (but enriching its directors/employees).

So, correct me if I am wrong, but theres no requirement in the ITA that the actual process of borrowing and investment have a 'reasonable expectation of profit', but only that the investments themselves are such that they have 'reasonable expectations of profit'.

Therefore, the interest on money borrowed to place on deposit with a broker/bank should be deductible. However, as I stated earlier, doing so is irrational.

[cannon_fodder]

This might provide some helpful information re: allowable deductions which appears to supports pitz' position.

http://www.camagazine.com/1/4/0/7/4/index1.shtml

[grant]

Are you 100% sure that the required test under the Income Tax Act is a reasonable expectation of profit (from the borrowing/investing itself)?
My research has been in regards to real estate investing. The issue has been dealt with a few times in the courts, for example, in the link that cannon_fodder presented:

Brian Stewart purchased four condominium units as rental properties. All units were highly leveraged, with Stewart paying only $1,000 in cash per unit. The developer's projections contemplated negative cash flows and tax deductions for a 10-year period, with the prospect of a gain at the end. The actual experience was even worse than projected. In the years in question, Stewart's interest expenses exceeded his rental income. The losses claimed consisted primarily of interest expenses. The CCRA disallowed these losses on the basis that Stewart had no reasonable expectation of profit, and therefore no source of income. Both the Tax Court and the Federal Court of Appeal agreed with the decision.

Why was the deduction disallowed? Because Stewart KNEW that he would be generating a loss. It is exactly the same as we discuss.

As far as I am aware, the reasonable expectation of profit only applies to the investment itself. For instance, the 'investment' must not be a total sham business that only subsists for the purpose of losing money (but enriching its directors/employees).

So, correct me if I am wrong, but theres no requirement in the ITA that the actual process of borrowing and investment have a 'reasonable expectation of profit', but only that the investments themselves are such that they have 'reasonable expectations of profit'.

Either you are borrowing to pursue a business venture, or you are not. You can't have it both ways. If you claim an interest expense as a reduction of your business's income, then it by definition is affecting its profitability.

However, Cannon_Fodder's link suggests there is precedent to ignore the REOP requirements when planning taxes, which if true would render this discussion moot!

[Joseph88]

My research has been in regards to real estate investing. The issue has been dealt with a few times in the courts, for example, in the link that cannon_fodder presented:

Brian Stewart purchased four condominium units as rental properties. All units were highly leveraged, with Stewart paying only $1,000 in cash per unit. The developer's projections contemplated negative cash flows and tax deductions for a 10-year period, with the prospect of a gain at the end. The actual experience was even worse than projected. In the years in question, Stewart's interest expenses exceeded his rental income. The losses claimed consisted primarily of interest expenses. The CCRA disallowed these losses on the basis that Stewart had no reasonable expectation of profit, and therefore no source of income. Both the Tax Court and the Federal Court of Appeal agreed with the decision.

Why was the deduction disallowed? Because Stewart KNEW that he would be generating a loss. It is exactly the same as we discuss.


Either you are borrowing to pursue a business venture, or you are not. You can't have it both ways. If you claim an interest expense as a reduction of your business's income, then it by definition is affecting its profitability.

However, Cannon_Fodder's link suggests there is precedent to ignore the REOP requirements when planning taxes, which if true would render this discussion moot!

What if you take the HELOC and invest in dividend paying stocks? You will EXPECT that the dividends will eventually grow to a point where they exceed the interest costs.

What do you guys think?

[pitz]

What if you take the HELOC and invest in dividend paying stocks? You will EXPECT that the dividends will eventually grow to a point where they exceed the interest costs.

What do you guys think?

Absolutely. And if history is any indication, its pretty insane to use borrowed money to invest in publicly traded securities that do not pay dividends.

The issue being outlined above is that if you intend to use the interest deduction in order to create a mockery or sham of the system, or if you intend to use interest as a means to create deductible 'expense' out of capital investment (through excessive rates of interest, for instance) outside of the capital cost allowance mechamism, the CRA will challenge such positions. Competent tax advice is a must.

But will the CRA go after someone who borrows at 6%, to hold money in short-term bonds as part of a balanced portfolio allocation for the Smith Manouevre, (even though such an arrangement is hardly profitable). Probably not. But doing so isn't exactly very intelligent either.

[circa76]

My research has been in regards to real estate investing. The issue has been dealt with a few times in the courts, for example, in the link that cannon_fodder presented:

Brian Stewart purchased four condominium units as rental properties. All units were highly leveraged, with Stewart paying only $1,000 in cash per unit. The developer's projections contemplated negative cash flows and tax deductions for a 10-year period, with the prospect of a gain at the end. The actual experience was even worse than projected. In the years in question, Stewart's interest expenses exceeded his rental income. The losses claimed consisted primarily of interest expenses. The CCRA disallowed these losses on the basis that Stewart had no reasonable expectation of profit, and therefore no source of income. Both the Tax Court and the Federal Court of Appeal agreed with the decision.

Why was the deduction disallowed? Because Stewart KNEW that he would be generating a loss. It is exactly the same as we discuss.


Either you are borrowing to pursue a business venture, or you are not. You can't have it both ways. If you claim an interest expense as a reduction of your business's income, then it by definition is affecting its profitability.

However, Cannon_Fodder's link suggests there is precedent to ignore the REOP requirements when planning taxes, which if true would render this discussion moot!

But the Supreme Court disagreed and sent the trial back for re-assessment.

Ref: 2002 SCC 46, 212 D.L.R. (4th) 577, 2002 D.T.C. 6969


Brian J. Stewart, Appellant v. Her Majesty The Queen, Respondent

VII. Conclusion

69 For these reasons, we conclude that the appellant's rental activities constituted a source of income. As a result, we would allow the appeal with costs throughout, set aside the judgment of the Federal Court of Appeal and refer the assessments for the taxation years in issue back to the Minister for reassessment on the basis that the taxpayer had a source of income from which he was entitled to deduct losses from the rental properties in question.


with I think the key point being in p.37 (emphasis mine)


37 It has been pointed out that, as a matter of logic, the fact that an activity carried on with a reasonable expectation of profit is a sufficient requirement for a source of income (the proposition from Dorfman) does not entail that a reasonable expectation of profit is a necessary requirement for a source of income (the proposition from Moldowan): see Brian S. Nichols, "Chants and Ritual Incantations: Rethinking the Reasonable Expectation of Profit Test," 1996 Conference Report, Report of Proceedings of the Forty-Eighth Tax Conference, Vol. 1 (Toronto: Canadian Tax Foundation, 1997), 28:1, at pp. 28:4-28:5; Sheldon Silver, "Great Expectations: Are they Reasonable?", Corporate Management Tax Conference 1995, Real Estate Transactions: Tax Planning for the Second Half of the 1990s (Toronto: Canadian Tax Foundation, 1996), 6:1, at pp. 6:6-6:7. In other words, it is argued that by taking the comments from Dorfman out of their particular context and applying them generally, Moldowan mistakenly equated "source of income" with " reasonable expectation of profit ."

[FrugalTrader]

Absolutely. And if history is any indication, its pretty insane to use borrowed money to invest in publicly traded securities that do not pay dividends.

The issue being outlined above is that if you intend to use the interest deduction in order to create a mockery or sham of the system, or if you intend to use interest as a means to create deductible 'expense' out of capital investment (through excessive rates of interest, for instance) outside of the capital cost allowance mechamism, the CRA will challenge such positions. Competent tax advice is a must.

But will the CRA go after someone who borrows at 6%, to hold money in short-term bonds as part of a balanced portfolio allocation for the Smith Manouevre, (even though such an arrangement is hardly profitable). Probably not. But doing so isn't exactly very intelligent either.

When you borrow on margin, is the interest tax deductible there? If so, what if the stock trader uses the margin to do short term trading? Is that still considered an "investment" loan?

[pitz]

When you borrow on margin, is the interest tax deductible there? If so, what if the stock trader uses the margin to do short term trading? Is that still considered an "investment" loan?

If the money borrowed on margin is used to invest in taxable securities that have a prospect of paying dividends in the future, then "yes", you can deduct the interest.

Canadian tax law does not differentiate between short-term trades and long-term trades, unlike US tax law. However, if the CRA deems you are running a 'business' of securities trading, they can force you to apply income treatment to the entirety of your investments.

I think its fairly reasonable to say that if you have a full time job, but also borrow a few thousand to flip a few (eligible) stocks here and there, that you could deduct the interest. If you are a daytrader, and don't have an 'other' job, then its possible the CRA could demand 'income' treatment of your gains.

[CoolEddie]

So what kind of investments are best for the Smith Manouevre? Stocks seem out of the questions since the commissions will kill any profit and it's hard to buy stocks for the exact amount your principle is. So index funds are out too (although this is recommended by Smith) for the same reasons. High interest savings accounts are out because there is no expected return since your LOC is going to have a higher interest rate than your account. So isn't the only viable option left mutual funds?

[pitz]

So what kind of investments are best for the Smith Manouevre? Stocks seem out of the questions since the commissions will kill any profit and it's hard to buy stocks for the exact amount your


I can buy stocks for $1 per trade (200 shares maximum). Commissions are hardly a big deal, but obviously you want to keep your overall commission/fee drag to a minimum, while maintaining a diversified portfolio.

This inevitably leads to index funds/ETFs as a tax-efficient means of implementing the SM.


principle is. So index funds are out too (although this is recommended by Smith) for the same reasons. High interest savings accounts are out because


Why would index funds be out? You can buy TD eFunds without explicit commissions and very low MERs. Or you can use the brokerage I use and buy ETFs for $1 per purchase.


there is no expected return since your LOC is going to have a higher interest rate than your account. So isn't the only viable option left mutual funds?

Sure, you can use mutual funds as well. Obviously you need to be careful to select ones that are relatively tax efficient, do not charge high fees/MERs, and ideally pay a tax-advantaged stream of dividends which you can recycle into paying down your non-tax-deductible debt.

If you do not understand the whole investment aspect of the SM, please seek professional advice, preferrably by a fee-only investment counsel. You may be charged $1000-$3000 for an investment plan that is compatible with the SM, but the money is well worth it.

[fsmontenegro]

So what kind of investments are best for the Smith Manouevre? Stocks seem out of the questions since the commissions will kill any profit and it's hard to buy stocks for the exact amount your principle is. So index funds are out too (although this is recommended by Smith) for the same reasons. High interest savings accounts are out because there is no expected return since your LOC is going to have a higher interest rate than your account. So isn't the only viable option left mutual funds?

Hi!

I won't quote specific investments here as it is not allowed by the forum rules. What I will say is:
- Comissions on stock purchases vary from $2/trade (Canadian) at InteractiveBrokers through $4.95/trade at Questrade, $9.99 at E-trade all the way to $19.99 at E-trade (if you don't have a large number of transactions each quarter) to the regular $29/trade at many brokerages.
- ETFs (Exchange Traded Funds) trade as stocks, so same comissions apply.
- Many mutual funds (INCLUDING index funds) can be purchased in relatively small lots after the first initial purchase. As an example, a fund may require an initial $2000 purchase and then accept increments of $50 or $100.
- High interest saving accounts are not recommended because their return is likely less than the LoC rate. If you use something like this, the CRA may actually challenge you on it...

Many of the recommendations I've seen (and the one I'm following) is to have a dividend-focused portfolio in your non-reg account. Canadian dividends get preferred tax treatment. I know different rules apply about US dividends than foreign (non-US, non-Canada) dividends. If someone can clarify, that would be great.

In summary, I think using a cheaper brokerage (IB or Questrade) and focusing on dividend generating stocks (in a balanced manner!) is a nice way to implement the SM. That's exactly what I'm in the process of setting up.

Naturally, nothing in this post constitutes financial advice. If in doubt, you MUST consult a licensed professional...

Cheers

[FrugalTrader]

Hi!

I know different rules apply about US dividends than foreign (non-US, non-Canada) dividends. If someone can clarify, that would be great.
Cheers

US dividends are taxed like interest, 100% taxable.

[raj672]

To:cannon_fodder

Thank you for doing all this work and sharing it with us. This will be most helpful as you have provided us with a snap shot of what the overall result would be ..

My mortgage doesn't renew until 2009. Do you guys think it would be ok to break up the mortgage or will it be better to wait until renewal to avoid fees and I will have more equity in my house by that time.

I don't have a sizeable portfolio of any kind (currently RSP of 5k). Debt would be of a car loan 20k-(no interest for 5 yrs) and student loan of 10k

[taxguru]

This might provide some helpful information re: allowable deductions which appears to supports pitz' position.

http://www.camagazine.com/1/4/0/7/4/index1.shtml

The Stewart case and the commentary in this article has been superceded by a proposed new "Reasonable Expectation of Profit" rule, announced on October 31, 2003. This was the Dept of Finance's response to the ruling by the Supreme Court of Canada in the Stewart case.

If this rule is enacted as drafted it will indeed mean that there must be a "Reasonable expectation of profit" or REOP in order to deduct a net loss in respect of a business or investment activity.

The REOP requirement is cumulative. This means that to deduct a loss in a particular year you must expect to earn a cumulative profit from the business or investment over its life.

According to the CRA:

"the relevant test is the expectation of cumulative profit over the whole of the profitablity time period, and a taxpayer would be able to claim a loss provided their expectations for a cumulative profit over the entire relevant time period were reasonable."

Also, capital gains and losses are not factored in to the calculation of income or loss for the purpose of this test. You must show a REOP excluding capital gains. This basically means you have to earn a profit from dividends, interests and rents after deducting carrying costs, such as interest.

This proposed REOP rule could have some very harsh negative consequences for leveraged equity investors, and the Dept of Finance is considering commentary from tax professionals (and I hope considering some relieving provisions) before this new rule becomes law.

[pitz]

This proposed REOP rule could have some very harsh negative consequences for leveraged equity investors, and the Dept of Finance is considering commentary from tax professionals (and I hope considering some relieving provisions) before this new rule becomes law.

Doesn't sound too scary to me, overall. Just means that you have to invest in 'stuff' that produces explicit growing dividends. Not being able to deduct interest incurred to invest in Nortel shares isn't the end of the world -- and maybe companies that destroy value (ie: Nortel, Air Canada) and don't pay dividends won't have such easy access to capital in the future.

Actually, forcing people to show a REOP actually might save many investors from themselves and their greed and their leverage. Imagine that, the tax department actually looking out for people!

[cannon_fodder]

To:cannon_fodder

Thank you for doing all this work and sharing it with us. This will be most helpful as you have provided us with a snap shot of what the overall result would be ..

My mortgage doesn't renew until 2009. Do you guys think it would be ok to break up the mortgage or will it be better to wait until renewal to avoid fees and I will have more equity in my house by that time.

I don't have a sizeable portfolio of any kind (currently RSP of 5k). Debt would be of a car loan 20k-(no interest for 5 yrs) and student loan of 10k

You are welcome. As for your question, I have used the workbook to help my with various 'what if' scenarios. It seems to come back, time and time again, the sooner you start the better - even with paying a penalty. Now, in my case, the interest rate on my current mortgage and a new one are almost identical. In your case perhaps your new mortgage rate would be substantially higher, or lower, which could have a significant impact on your decision.

[grant]

If this rule is enacted as drafted it will indeed mean that there must be a "Reasonable expectation of profit" or REOP in order to deduct a net loss in respect of a business or investment activity.

The REOP requirement is cumulative. This means that to deduct a loss in a particular year you must expect to earn a cumulative profit from the business or investment over its life.
Thanks taxguru. It sounds like the court case cannon_fodder mentioned was basically a mirage for people hoping to set up clever deductions for unsupported expenses.

As for the "best" way to implement the smith maneuvre, the "best" way (imho) is by continuing whatever investments or business ventures you are doing already. E.g. if you run a home based business, then use that to convert your debt.

[raj672]

wondering if any of the poster's have actually done this or intend to do it in near future.

I'm attending one of their workshop to see how they are presenting this, what investments they are using etc, will keep you posted. ;)

[fsmontenegro]

wondering if any of the poster's have actually done this or intend to do it in near future.

I'm attending one of their workshop to see how they are presenting this, what investments they are using etc, will keep you posted. ;)

Hi,

After sifting through a LOT of information, I made the decision to go ahead and implement this. I opened a line of credit with Scotiabank and I am in the process of setting up an account with Interactive Brokers. Once this is done, I will:
- sell the non-reg investments I currently have (not a lot, under $20K)
- apply to the mortgage as prepayment (I have enough room)
- borrow the same amount from the LoC
- invest in a diversified portfolio of Canadian equities with a tilt towards dividend generation.

Based on my own comfort level with the issues (investing, taxation, etc...), I saw no value in engaging a financial planner or mortgage broker, though of course others may feel differently.

Some of my sources for information were:
- Smith's book and website (I did not purchase the calculator)
- "Smith manoeuvre" threads at RFD (this one) as well as various Canadian blogs (Million Dollar Journey comes to mind, but there were others)
- additional info from Financial Webring Forum, a blog entry on the Manulife One product, as well as info from CRA (specifically IT533 on taxation of interest).

Hope this helps.

[FrugalTrader]

Hi,

After sifting through a LOT of information, I made the decision to go ahead and implement this. I opened a line of credit with Scotiabank and I am in the process of setting up an account with Interactive Brokers. Once this is done, I will:
- sell the non-reg investments I currently have (not a lot, under $20K)
- apply to the mortgage as prepayment (I have enough room)
- borrow the same amount from the LoC
- invest in a diversified portfolio of Canadian equities with a tilt towards dividend generation.

Based on my own comfort level with the issues (investing, taxation, etc...), I saw no value in engaging a financial planner or mortgage broker, though of course others may feel differently.

Some of my sources for information were:
- Smith's book and website (I did not purchase the calculator)
- "Smith manoeuvre" threads at RFD (this one) as well as various Canadian blogs (Million Dollar Journey comes to mind, but there were others)
- additional info from Financial Webring Forum, a blog entry on the Manulife One product, as well as info from CRA (specifically IT533 on taxation of interest).

Hope this helps.

Which re-advancable mortgage did you get with Scotia bank? The last time I spoke with a rep, they explained that if I want a new credit limit on the HELOC, I would have to fill out paperwork every time.

[circa76]

- additional info from Financial Webring Forum, a blog entry on the Manulife One product, as well as info from CRA (specifically IT533 on taxation of interest).

Hope this helps.

In case anyone is curious, this is the Interpretation Bulletin IT-533.

What he's doing here is "Restructuring Borrowings":


Restructuring borrowings

15. A taxpayer may restructure borrowings and the ownership of assets to meet the direct use test.

Example 1

Ms. A owns 1,000 shares of B. Corp., a corporation listed on the TSX. Ms. A also owns a personal use condominium that was financed with borrowed money. At this point, the direct use of the borrowed money was to acquire the condominium. Ms. A may choose to sell the 1,000 shares of B. Corp., use the proceeds from the sale of the 1,000 shares of B. Corp. for any purpose, including paying down the borrowed money used to acquire the condominium, and subsequently obtain additional borrowed money to acquire another 1,000 shares of B. Corp. At this point, the additional borrowed money is directly used to acquire 1,000 shares of B. Corp.


This is, at a high level, what the Smith Manouvre is about.

[fsmontenegro]

Which re-advancable mortgage did you get with Scotia bank? The last time I spoke with a rep, they explained that if I want a new credit limit on the HELOC, I would have to fill out paperwork every time.

I set up an "Total Equity Plan" (for 75% of the appraised value of my home) and a Scotialine line of credit under that plan.

You're right in that the increase is not automatic. However, it is not a difficult process - I can go to the branch, call my manager or even do it online.

In my particular situation it is not a problem, for two reasons:
- the monthly increase on my equity (and therefore the potential increase in my LoC) is barely $1K/month.
- I'm not going to use the full LoC for the manoeuvre. Out of the existing limit, I'm setting aside 50K or so to leave as an "emergency fund".

With this in mind, I'm absolutely OK with manually increasing my LoC limit (because of increase home equity) once or twice a year.

As always, YMMV.

Hope this helps.

[don242]

Which re-advancable mortgage did you get with Scotia bank? The last time I spoke with a rep, they explained that if I want a new credit limit on the HELOC, I would have to fill out paperwork every time.

I just finished talking to Scotiabank and they said the same thing as well, but it was simply to come in and sign a paper each time you want the limit increased. You are already approved for the full 75% value of your home, just increasing your limit requires your signature. I thought it was a little dumb as well but unless you are paying large chunks off your mortgage each month, the increases to your limit are minimal so to go in twice a year isn't that big a deal.

[don242]

1) Interest -- taxed at your highest marginal rate.
2) Canadian Dividends -- Taxed at a very low rate, in fact, almost tax-free until your income hits $60,000/year or more.
3) Capital gains -- taxed at one half the highest marginal rate, but deferrable.



I know this response was from awhile back (still trying to understand a few loose ends).

What I want to know is in regard to #2 above, how are dividends almost tax free? Depending on your bracket isn't the actual amount of dividends is grossed up by 1.45. Then the tax is applied on that amount at the marginal tax rate. Then the dividend tax credit is calculated at 19% of the grossed up amount. The dividend tax credit amount is then deducted from the income tax.

Here is an example of a person in a 30% tax bracket with $1000 dividends.
$1000 X 1.45 = $1450. 30% tax on $1450 = $435. Dividend tax credit on $1450 is $1450 X 19% = $275.50. Tax owing on the $1000 dividends is $435 - $275.50 = $159.50. So in this case the dividends are ultimately taxed at a rate of 15.95%.

[FrugalTrader]

I think Pitz means that dividend income is almost tax free when dividends are your PRIMARY income.

[ghostryder]

Here is an example of a person in a 30% tax bracket with $1000 dividends.
$1000 X 1.45 = $1450. 30% tax on $1450 = $435. Dividend tax credit on $1450 is $1450 X 19% = $275.50. Tax owing on the $1000 dividends is $435 - $275.50 = $159.50. So in this case the dividends are ultimately taxed at a rate of 15.95%.

You have only included the Federal DTC. You left out calculating the provincial DTC.

For example, for me (in my province), in addition to your above calculations I would get

grossed up div amount x 11%

$1450 x 11% = 159.50 Prov DTC

$435 - ($275.50 + $159.5) = 0


My real numbers would be slightly different since I have a combined FED/Prov MTR of 26.5%. I actually end up with a negative taxation rate on dividends which means that for every dollar in dividends I recieve the DTC offsets $0.05 of tax withheld from my income. So I get a (tiny) refund for every dollar in dividends that I get.

[don242]

Here is an example of a person in a 30% tax bracket with $1000 dividends.
$1000 X 1.45 = $1450. 30% tax on $1450 = $435. Dividend tax credit on $1450 is $1450 X 19% = $275.50. Tax owing on the $1000 dividends is $435 - $275.50 = $159.50. So in this case the dividends are ultimately taxed at a rate of 15.95%.

You have only included the Federal DTC. You left out calculating the provincial DTC.

For example, for me (in my province), in addition to your above calculations I would get

grossed up div amount x 11%

$1450 x 11% = 159.50 Prov DTC

$435 - ($275.50 + $159.5) = 0


My real numbers would be slightly different since I have a combined FED/Prov MTR of 26.5%. I actually end up with a negative taxation rate on dividends which means that for every dollar in dividends I recieve the DTC offsets $0.05 of tax withheld from my income. So I get a (tiny) refund for every dollar in dividends that I get.

Actually the 30% tax bracket approximation assumes both federal and provincial (22% fed + 9.15% Ont) and the tax credits were a combined credit. But you may be right, I need to double check using an actual tax return. Thanks.

[edrempel]

Hi, All,

I just noticed this blog thread and there is a fascinating discussion going on. We are the main advisors doing the SM in the GTA and have implemented it several hundred times. A few comments:

- There have been a lot of comments about REOP, but CRA has in practice accepted investments in stocks and mutual funds even if they don't pay any distributions, despite what he Act says. If there is an expectation that they will eventually be profitable in addition to the interest cost and an expectation that they could pay distributions, that is enough. Any stock or mutual fund could pay dividends - there is no requirement that they have to. Companies buy parts of each other all the time and should all the purchase interest be disallowed because the other company doesn't pay dividends? CRA considered this a few years ago, but seems to have abondoned it. They would have to deny interest deductions on millions of transactions to try this - most purchases of companies by each other, most leverage and most In fact, any stock or mutual fund that is 100% tax-efficient (has never paid a distribution) is still accepted by CRA.

- Dividends are tax-preferred - the tax is almost as low as capital gains for all but the lowest incomes. Dividends are tax-free if you have essentially NO other income and total income under $23,000, but hardly any of us fit this. Of course Deferred capital gains are taxed at the lowest possible rates - zero. Focussing on getting income just costs you tax. I've tested various scenarios and receiving income and paying it down on the mortgage and then reinvesting is still less effective than having a 100% tax-efficient investment.

- Scotia STEP mortgage is actually the most awkward of all the major banks readvanceable mortgages, since it doesn't readvance automatically and you can't invest directly from the credit line. CIBC has no readvanceable. The other 3 major banks all have good products that automatically readvance, each with advantages and disadvantages. We haven't found any mortgage broker product we like, except Merix, but it still has many technical service and cost issues. The best products are the other banks and the best choice depends on your individual circumstances.

- To raj, figuring out whether to pay the penalty now and implement SM now or wait till the due date is a complicated calculation that we do on a spreadsheet. The factors are the penalty cost, your current interest rate vs. the new rate, the benefit of the SM that you would lose if you wait, how much other debt you could refinance at the same time at lower rates, and tax consequences. In your case, you wouldn't roll in your car loan or RRSP, but probably the student loan. In practice, we find it almost always is worth paying a penalty if your mortgage is due in more than 2 years, and often not worth it if it is due in less than 1 year, so it is most likely worth it for you to pay the penalty.

- The risk of the SM is essentially only the investments - not really anything else including interest rates. Interest rates rising would only be an issue if they went to double digits, which is extremely unlikely. Demographics clearly point to long term continuing declining interest rates. Studies actually show that a breakeven on leverage over the long term is an investment return of 2/3 of the interest rate. So, if you borrow at prime (6% now) and invest in a reasonably tax-efficient investment and make 4% long term, you will find that after tax you broke even. This is because of the different tax treatments and because the gains compound while the credit line interest is flat. For reference, check out the leverage guru Talbot Stevens at www.talbotstevens.com. Since the risk is only the investments, make sure you have a sound, long term strategy and be tax-efficient.

- To circa, "restructuring borrowings" is only one of the added enhancements to the SM, not a high level of the SM. The SM in simple terms is reborrowing the principal from every mortgage payment to invest (eg. bi-weekly) and then compounding the tax refunds. Leverage combined with dollar cost averaging is very effective. In addition to the SM, there are various enhancements that can give you a much higher benefit, such as including restructuring existing non-RRSP investments as you mentioned, the "debt miracle" of rolling in other higher-rate debt and adding the payments to your new mortgage, and various strategies such as the "Rempel Maximum" to leverage more highly and have the extra leverage cost paid out of your mortgage. But don't forget the basics of the regular SM investment.

Ed

[pitz]

- Dividends are tax-preferred - the tax is almost as low as capital gains for all but the lowest incomes. Dividends are tax-free if you have essentially NO other income and total income under $23,000, but hardly any of us fit this. Of course Deferred capital gains are taxed at the lowest possible rates - zero.


The deferral becomes due at some point. Even if you use a 40-year hold period, 10%/year, and a 40% incremental rate, the annualized tax rate will still be around 8%. If you can receive Canadian dividends at a tax rate similar to the long-term annualized rate, and swap additional debt to tax-deductible status, I would argue that such a scenario is almost always superior.



Focussing on getting income just costs you tax. I've tested various scenarios and receiving income and paying it down on the mortgage and then reinvesting is still less effective than having a 100% tax-efficient investment.


Yes, a couple things:

1) Its a fairly well accepted fact out there that, on average, dividend portfolios outperform non-dividend portfolios. In fact, the stock market itself is just one giant discounting machine -- the stock market computes the net present value of all expected future dividends from a company. Without dividends, a stock, in the long run, is worthless.

Since the Smith Manouevre is also about investing for the long run, don't you really want to invest in stocks with good track records of regular dividend payment and regular dividend growth?

2) A 100% tax efficient investment isn't very feasible either in the context of a portfolio because portfolios require rebalancing. The payment of dividends helps to facilitate this rebalancing as cash is available from the portfolio to be directed into under-weighted assets. If you go with a 100% tax efficient stock (ie: no dividends), then you end up liquidating securities (and incurring cap gains tax prematurely) in order to perform rebalancing.


- The risk of the SM is essentially only the investments - not really anything else including interest rates. Interest rates rising would only be an issue if


But stocks, like bonds, are inversely correlated to interest rates. If rates rise, and you borrowed short, the liability remains, while it costs much more to service the liability. Further the value of the investment decreases due to this negative correlation.

I think you also need to look at currency risk. Most advisors recommend a diversified portfolio, including international equities, but very rarely do SM promoters actually provide proper hedging solutions. Hedging out currency is an important part, if you want to minimize the long term volatility in the portfolio.

[edrempel]

Hi Pitz,

Very good points. I have a few comments though.

On your tax on dividends scenario, your question isn't quite fair, since here in Ontario, dividends are only taxed around 8% with an income under $36,000 (income under $8,000/year for foreign dividends), while the 40% tax bracket starts at income about $72,000. You calculated average tax rates for 40 years, but with a 100% tax-efficient investment, you also get the compound growth on the tax payment for 40 years.

I ran the numbers anyway. With a 10% return with 8% tax paid on the dividends every year, $100 would grow to $3,095 in 40 years (for a low-income dividend stock investor). With a 100% tax-efficient investment and a 40% tax bracket (20% since it is capital gains) and the tax paid on sale after 40 years, the $100 grows to $3,312. If you assume the same low tax rate investor, so the tax bracket is 22%, the $100 grows to $3,673. In all scenarios, the dividend return is lower because of the tax paid every year.

Regarding your other 4 points:
1) Your point about dividend stocks out-performing is very interesting. It's funny there isn't specifically a study on this. In fact, even Jeremy Siegel (Stocks for the Long Run) shows in his 1998 edition that growth stocks out-perform over long periods. But then in his 2001 edition, he shows that value and dividend stocks out-perform over long periods. The greatest investors even disagree on this with some swearing by dividends and some claiming it is earnings that matter and the portion paid out is not really relevant. Small cap stocks have out-performed large caps long term, and they tend to pay much lower dividends.

Your quote on companies valued by their discounted long term dividends is meant hypothetically to include the final dividend on eventually winding up the company. Otherwise, it is not true. The best example is Berkshire Hathaway. It has never paid a dividend, but has widely out-performed all dividend-paying stocks. And you can't argue it is a worthless stock!

In general, you are right though, that the risk/return on dividend-paying stocks is generally very good and suitable for the SM. My issue here is Canada now is that we are arguably in a "dividend bubble". After the tech bubble, we seem to have gone to another extreme with mini-bubbles happening simultaneously in resource, precious metals, income trusts and dividend stocks over the last 4 years. Almost every individual investor I talk to has 100% of his money in 1 of these 4. Yield and defensive stocks have been king and have all 4 probably just had their best runs in history. Dividends are the latest income fad, since the income trust rules changed. The resource and income trust bubbles have now burst. Precious metals and dividend stocks are due for a period of under-performance. My question to you is - the next time dividend stocks under-perform the markets 5 years in a row (and it will happen again), will you stick with dividend stocks, Pitz? If so, then your strategy is sound.

2) We tend to use mutual funds, many of which come in tax-efficient corporate structures. Therefore, it is possible to invest in dividend stocks, but still never pay any tax until you eventually sell. With the SM, rebalancing is done bi-weekly by adjusting the automatic investment. Just add more of it to the under-performing holding and rebalancing will happen without ever having to sell anything.

In practice, 100% tax-effiency is difficult only because we search for the world's best fund managers with long term records of beating the indexes by wide margins - and not all are available in the corporate structures. Being 100% tax-efficient is very nice, but tax is only one of the considerations in choosing the best investments.

3) Your point about stocks being inversely correlated to interest rates, that may be true short term (if you exlude the fact that the markets are always anticipating), but isn't true long term. Long term, rates only rise if we have prolonged higher inflation. Companies can usualy adjust for inflation, so the stock market is a good inflation hedge long term (unlike bonds).

The same is true of currencies. They can add volatility and affect returns short term, but have little effect long term. In fact, a declining currency tends to make countries more competitive, which then stimulates the stock market, so it is largely self-adjusting in the long term. Your point about hedging to reduce risk is reasonable, though. Global fund managers that hedge currencies tend to have slightly lower long term returns, but noticeably lower volatility.



Ed

[Apcol2002]

The first thing that came into mind is "risk". I am not too sure what the Smith Manoeuvre is but it is risky to use your home equity as investment, especially on an investment that earns 7-8%. You would also have to keep in mind that interest income from investments are also taxed, some higher than others. (Capital gains vs. Interest Income).

For the average Canadian who do not have a background in Finance, this may not work. Even if you sit with a financial planner, they may not have the skills or time to fully plan the perfect investment strategy.

Is there any calculations that can show that the SMith Manoeuvre works? I would be very interested in taking a look at it.

I do design the Smith Maneouvre to the specifics of my clients and if you are interested, will be happy to do it for you too. By the way, risk is a secondary factor here. The main benefit is assured by the different compounding of interest rates in mortgages versus loans.
If you send me a private email we can discuss the details in an exchange and I shall calculate your case for you.

Sandor

[Apcol2002]

Hi!

I don't mean to violate any forum rules on specific stocks/investments. If I'm out of line, please let me know and I'll drop the subject.

For those who have performed the SM or something similar, what has been your approach to building a non-reg portfolio? For now I'm assuming a dividend-focused portfolio...

a) Buy individual stocks that together make up a dividend-focused portfolio on a monthly basis via brokerage (I'll likely use IB for the low, low commissions). Achieve balance by buying different stocks throughout the year to make up a balanced portfolio.
b) Buy a dividend-focused mutual fund on a monthly basis
c) Buy a dividend-focused ETF on a monthly basis
d) Other (please elaborate)

Thanks!

You can buy dividend funds and some minority equity as well, but look into segregated funds, because the capital in those are guarantied.
I invest exclusively in segfunds because of the guarantied capital.

Sandor

[don242]

I have been working on a spreadsheet that compares various scenarios of investing in your RRSP, paying down your mortgage, etc. I think cannonfodder already did something like this but unfortunately I don't have excel on my computer right now (must get it sometime) so I did mine in QuattroPro.

Anyway I ran a number of scenarios where the basic premise is using a fixed amount of money monthly to either pay down your mortgage (included required payment) or invest in your RRSP. Tax refunds could be applied to either RRSP or mortgage paydown. Once mortgage was pid, all payments would move to the RRSP.

When comparing without the SM, obviously investing in the RRSP with all money came out the best at the end of 25 years (because RRSP is the higher rate).

However, as soon as I include the SM that uses dividends taxed at 8.24% (assumed the marginal tax rate of 31.15%, Ontario) and the tax writeoff refund going to either RRSP or mortgage, the scenarios evened out, RRSP contributions vs paying down mortage (and leveraging). The only real difference (though not much) was that the scneario where paying off the mortgage was the priority after 25 years resulted in the same net amount as the RRSP scenario except that less of your money was in the RRSP and therefore already taxed. I believe this was partially what pitz has been saying all along (though I never had the means in place to actually run the numbers).

The SM itself provided only a small percentage (~15%) of the wealth in the end but served to even out the scenarios and provide wealth that is already taxed at retirement.

I realize that changing paramaters in each scenario changes the outcome and I didn't give all the details of each scenario but this was the general conclusions I found. I would be happy to share more specific details in interested. I am now planning to modify the spreadsheet to account for more real life savings methods. I also still have one flaw as the spreadsheet doesn't realize the contribution limits each year for your RRSP which may also lessen the value of the RRSP scenario since some growth will need to occur outside of the taxfree area.

[edrempel]

Hi, Don,

You've done some work on this. You should find that with the "Plain Jane" SM, the RRSP will initially get you ahead, since you get a refund on your entire new contribution, while the SM gives you a refund on only the interest. However, after you retire, this reverses, since the RRSP will be fully taxed on withdrawal, while the SM is only capital gains on a systematic withdrawal. This assumes you are buying similar investments in the RRSP and SM.

With some of the SM enhancements where you leverage extra amounts beyond just the credit line and have all the interest paid from your SM, the SM can do better than the RRSP.

Your scenario is interesting, but in practice, other considerations are more important. Hardly anyone invests all the mortgage payments, once it is paid off, which makes the mortgage scenario much worse in practice. The SM normally takes none of your cash flow, so you can still do all the RRSP you would otherwise. The best strategy usually is to plan so that by the time your retire, you have your mortgage fully converted to tax deductible plus your RRSP max'd.

I'm curious about what scenario you used where the SM provided only 15% of the wealth. I've done hundreds of practical scenarios and most of the time, the RRSP and SM end up at similar values at retirement.



Ed

[don242]

Hi, Don,

You've done some work on this. You should find that with the "Plain Jane" SM, the RRSP will initially get you ahead, since you get a refund on your entire new contribution, while the SM gives you a refund on only the interest. However, after you retire, this reverses, since the RRSP will be fully taxed on withdrawal, while the SM is only capital gains on a systematic withdrawal. This assumes you are buying similar investments in the RRSP and SM.

With some of the SM enhancements where you leverage extra amounts beyond just the credit line and have all the interest paid from your SM, the SM can do better than the RRSP.

Your scenario is interesting, but in practice, other considerations are more important. Hardly anyone invests all the mortgage payments, once it is paid off, which makes the mortgage scenario much worse in practice. The SM normally takes none of your cash flow, so you can still do all the RRSP you would otherwise. The best strategy usually is to plan so that by the time your retire, you have your mortgage fully converted to tax deductible plus your RRSP max'd.

I'm curious about what scenario you used where the SM provided only 15% of the wealth. I've done hundreds of practical scenarios and most of the time, the RRSP and SM end up at similar values at retirement.

Ed

Your points are all valid and I am beginning to understand everything more now that my spreadsheet is nearly completed. I am planning to show my advisor my spreadsheet this weekend in case I am missing something that will change things drastically but I am quite confident it gives a good representation now for comparing various scenarios.

As you mentioned, the scenarios I ran would require complete discipline (ie. investing your mortage payments after your mortgage is paid off) but the only true comparison can be a disciplined comparison. If you didn't invest your mortgage payments, then it would be expected, that paying off your mortgage as the priorrity would hurt.

I too came to the same conclusion in my scenarios, that both RRSP method and SM method are quite comparable after 25 years.

My statement about the wealth generated by the SM being only 15% included a continous monthly investment (say $800) into either mortgage or RRSP. And since the SM is capped at the value of your home (no other leveraged investments were considered since I am not at that point of understanding yet), the overall value of wealth is only about 15% since your RRSP grows considerably more because the investment value is so much higher (no cap as in the SM). Hopefully that made sense.

Basically my spreadsheet compares paying off mortgage as priority or paying toward RRSP as a priority or any combination between. The SM can then be applied to either scenario generated with tax refunds from SM and RRSP contributions being reinvested in your chosen priority. I have just recently added functions that allow me to change monthly contributions every 5 years, or change interest rates every 5 years to give a more variable (true life) future. I also just finished adding the RRSP maximum contributions to the spreadsheet which affect it. My original comparison didn't include the max contributions. I need to clean it up again to get a better comparison.

[cannon_fodder]

I have been working on a spreadsheet that compares various scenarios of investing in your RRSP, paying down your mortgage, etc. I think cannonfodder already did something like this but unfortunately I don't have excel on my computer right now (must get it sometime) so I did mine in QuattroPro.


Actually, all I did was craft a calculator that, I believe, mimics the Smithman Calculator with the various scenarios. You might say that is a first step in the evaluation process and yours is following after.

I'm sure people would appreciate if you would post/host your spreadsheet for others to utilize in their decision making.

I hadn't realised how myopic my perspective was... if you have the inclination and the time, would you mind going to:
http://www.microsoft.com/downloads/details.aspx?FamilyID=c8378bf4-996c-4569-b547-75edbd03aaf0&displaylang=EN
and see if the free Microsoft Excel Viewer 2003 allows you to use my calculator? Unfortunately, my PC has Excel and so it obviously works for me. Or, if someone can suggest a way I can export the Excel workbook with all its functionality so that anyone without Excel can view it that would be appreciated. (I know that individual spreadsheets can be exported in HTML but not the workbook - perhaps I could export the individual spreadsheets and link them?)

P.S. The calculator can be found here: http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls)

[don242]

Actually, all I did was craft a calculator that, I believe, mimics the Smithman Calculator with the various scenarios. You might say that is a first step in the evaluation process and yours is following after.

I'm sure people would appreciate if you would post/host your spreadsheet for others to utilize in their decision making.

I hadn't realised how myopic my perspective was... if you have the inclination and the time, would you mind going to:
http://www.microsoft.com/downloads/details.aspx?FamilyID=c8378bf4-996c-4569-b547-75edbd03aaf0&displaylang=EN
and see if the free Microsoft Excel Viewer 2003 allows you to use my calculator? Unfortunately, my PC has Excel and so it obviously works for me. Or, if someone can suggest a way I can export the Excel workbook with all its functionality so that anyone without Excel can view it that would be appreciated. (I know that individual spreadsheets can be exported in HTML but not the workbook - perhaps I could export the individual spreadsheets and link them?)

P.S. The calculator can be found here: http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls)


I will give that link a try tomorrow and see if I can get your spreadsheet to work. I did have excel somewhere at one time but it must have been on my old computer and I can't find the disc anywhere right now.

I will definately share what I have as well but give me the weekend since I want to go over some of it with my advisor to be sure I have most of my logic correct. Plus it is Quattro Pro so not sure how well it will convert but I will see what I can do.

By the way, do you or anyone know offhand the taxes on capital gains. Is it just 50% is taxable at your marginal tax rate or is there more to consider? I am meaning to check just thought I would ask if anyone knows offhand.

[don242]

Actually, all I did was craft a calculator that, I believe, mimics the Smithman Calculator with the various scenarios. You might say that is a first step in the evaluation process and yours is following after.

I'm sure people would appreciate if you would post/host your spreadsheet for others to utilize in their decision making.

I hadn't realised how myopic my perspective was... if you have the inclination and the time, would you mind going to:
http://www.microsoft.com/downloads/details.aspx?FamilyID=c8378bf4-996c-4569-b547-75edbd03aaf0&displaylang=EN
and see if the free Microsoft Excel Viewer 2003 allows you to use my calculator? Unfortunately, my PC has Excel and so it obviously works for me. Or, if someone can suggest a way I can export the Excel workbook with all its functionality so that anyone without Excel can view it that would be appreciated. (I know that individual spreadsheets can be exported in HTML but not the workbook - perhaps I could export the individual spreadsheets and link them?)

P.S. The calculator can be found here: http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls)


You got me curious so I tried the excel viewer now. Unfortunately it doesn't allow you to alter any of the numbers, only allows me to view what is currently there. The spreadsheet does look good though (a lot neater than mine is at this point) and yours has some functions that mine does not. I tended to design mine with our situation in mind so right now the marginal tax rate is not variable and I just assume monthly mortgage payments.

But as you said, it has been interesting and has certainly broadend the possibilities for potential wealth building scenarios.

Once I clean up my spreadsheet I will see if I can export it to something useful for those with excel. It isn't a perfect representation but should be close. There may be small (non significant) errors in due to logistics with payments made at the end or beginning of a month but that error (if there) is only in play for one month so the impact is minimal. The more I do, the more variables I want to include which makes it a little confusing.

[cannon_fodder]

By the way, do you or anyone know offhand the taxes on capital gains. Is it just 50% is taxable at your marginal tax rate or is there more to consider? I am meaning to check just thought I would ask if anyone knows offhand.

I don't know if it is the best site, but I have found it quite full of useful information - www.taxtips.ca

[FrugalTrader]

By the way, do you or anyone know offhand the taxes on capital gains. Is it just 50% is taxable at your marginal tax rate or is there more to consider? I am meaning to check just thought I would ask if anyone knows offhand.

You are right, you just take your profits from your stock sale - commissions/fees multiply by 50% and add that onto your taxable income for that year. Example:
Profit: $1000 from stock sale after commissions
Taxable: $1000 x 0.50 = $500 taxable
Tax Payable: $500 * marginal tax rate.

[edrempel]

Hi, Don,

The one variable you left out of your spreadsheet is that your home goes up in value over time. If you plan the SM to always stay at 75% of your home value, then there is a rising ceiling. A reasonable home increase assumption is 2% over inflation, which is the average for the last 30 years.

The tax on capital gains is that 50% is taxable, but the other variable is the tax-efficiency of the investment (or turnover). For example, if you hold stock for 30 years and never sell, the capital gains tax only applies at the end. Only the dividends are taxable. If your strategy involves changing investments now and then or rebalancing, then some capital gains will result.

With mutual funds, they publish their tax-efficiency, which relates to the amount of turnover inside the fund. Many that are in corporate structures manage to to be 100% tax-efficient, because they have various sectors and regions within the overall corporation, so they can always claim some losses somewhere to offset gains. They also allow switching funds without it being considered a taxable event.

Therefore, your spreadsheet should include an assumption of tax-efficiency, which will depend on your investment strategy.

You will find the RRSP is ahead until you retire and start withdrawing money, but after that the SM will catch up rapidly.

With the RRSP, what do you assume for the tax refund, Don? Is it added to the RRSP, or do you pay it down on the mortgage and invest it with the SM?

If you want to try something fun, try a version where the SM beats the RRSP, even before retirement. We have an enhancement to the SM we call the "Rempel Maximum" which is the theoretical maximum investment loan you can finance within the SM without using any of your cashflow. For example, if you pay $500/month of principal on your mortgage, instead of investing that $500 as in the "Plain Jane" SM, you can use that $500/month to make the interest-only payments on an investment loan of $85,000-$100,000 (depending on the investment loan rate). The loan can be increased every year or 2. The loan payments are always made from the SM until your mortgage is fully paid off and can often be made directly from your credit line in your readvanceable mortgage (depending on which bank it is at). This will also pay off your mortgage much more quickly, because you get much larger tax refunds early in the SM. The entire $500/month is fully tax deductible from the beginning.

You should try this enhancement in your spreadsheet. You will find it usually beats the RRSP before retirement and then widely beats it after retirement.






Ed

[pitz]

value, then there is a rising ceiling. A reasonable home increase assumption is 2% over inflation, which is the average for the last 30 years.


I'd dispute your very optimistic figures of home price appreciation. First of all, the statistics are skewed upwards because modern houses contain more 'toys', and are fitted with higher quality and more expensive finishes, HVAC systems, and other systems than ever before.

Secondly, appreciation has occurred against the backdrop of a decline in long-term interest rates that started around 1980 (when interest rates were 15% or higher), and bottomed out recently. Even if rates remain flat, housing isn't likely to see substantial capital gains.

And thirdly, cashflows, even imputed cashflows, do not even support valuations today for most residential real estate in the major centres in Canada. A house is only technically worth the net present value of the net imputed cashflows. This is a recipe for a decline, or at least a flattening of growth in housing values.


With mutual funds, they publish their tax-efficiency, which relates to the amount of turnover inside the fund. Many that are in corporate structures manage to to be 100% tax-efficient, because they have various sectors and


The 'corporate' structures are not immune to tax. They allow an individual investor to rebalance holdings according to their individual asset allocation model, but ultimately, do not provide a true shield of tax that they purport to.

Add in the additional fees associated with the structure (legal, audit, management), and the tax innefficiency they represent with respect to dividends, and I'm not convinced most investors are better off.


regions within the overall corporation, so they can always claim some losses somewhere to offset gains. They also allow switching funds without it being considered a taxable event.


An individual holding their own portfolio can do loss harvesting just as efficiently. And an individual can rebalance their own holdings by directing new contributions towards underweighted asset classes.


If you want to try something fun, try a version where the SM beats the RRSP, even before retirement. We have an enhancement to the SM we call the "Rempel Maximum" which is the theoretical maximum investment loan you can finance within the SM without using any of your cashflow. For example, if

Thats introducing additional leverage, and thus, additional volatility.

I'm pretty convinced, at least in my mathematical studies of RRSPs and mortgages, that one shouldn't contribute to a RRSP at all if they have a mortgage. Take all your free cashflow, throw it on the mortgage, and then have it re-advanced through the SM to invest in tax efficient non-registered equities.

Why? Because the investors' marginal cost of capital is reduced with the non-reg scenario, and RRSPs do not a meaningful long-term tax advantage compared to the non-reg scenario in a sufficient enough amount to outweigh the lower cost of capital associated with investment borrowing.

[FrugalTrader]

Hi, Don,


If you want to try something fun, try a version where the SM beats the RRSP, even before retirement. We have an enhancement to the SM we call the "Rempel Maximum" which is the theoretical maximum investment loan you can finance within the SM without using any of your cashflow. For example, if you pay $500/month of principal on your mortgage, instead of investing that $500 as in the "Plain Jane" SM, you can use that $500/month to make the interest-only payments on an investment loan of $85,000-$100,000 (depending on the investment loan rate). The loan can be increased every year or 2. The loan payments are always made from the SM until your mortgage is fully paid off and can often be made directly from your credit line in your readvanceable mortgage (depending on which bank it is at). This will also pay off your mortgage much more quickly, because you get much larger tax refunds early in the SM. The entire $500/month is fully tax deductible from the beginning.

Ed

Ed,

Could you explain this scenario further? I'm not quite sure that I understand what you are describing. Are you talking about getting an ADDITIONAL investment loan on top of your existing HELOC?

[minghia]

Does anybody know of a financial planner/bank that will assist me with the SM specific to my financial situation in the Montreal area?

Would like to get advice from a reputable financial planner who is experienced with the SM. I have asked my local TD Bank financial planner and he has never heard of the concept.

[cannon_fodder]

http://www.smfc.com/contact_us/

This is the Smith Manoeuvre Financial Corporation's "Contact Us" link. I'm sure if you fill this out you will be provided several names of FP's, Mortgage Brokers or both.

You could always go here as well (don't be fooled by the URL - it has both FP's and MB's):

http://www.smithman.net/locateplanner.html

[edrempel]

Does anybody know of a financial planner/bank that will assist me with the SM specific to my financial situation in the Montreal area?

Would like to get advice from a reputable financial planner who is experienced with the SM. I have asked my local TD Bank financial planner and he has never heard of the concept.


Hi, Ming,

I would suggest finding an independent financial planner at:

http://www.smithman.net/locateplanner.html

The SMFC is a new company being set up and we don't know what their quality will be yet. Look for a planner, not a broker, since a broker can only get you the mortgage, not advise you on the best way to implement the SM. The best SM mortgages are from some of the major banks and are not offered through mortgage brokers.




Ed

[edrempel]

Ed,

Could you explain this scenario further? I'm not quite sure that I understand what you are describing. Are you talking about getting an ADDITIONAL investment loan on top of your existing HELOC?

Hi, Frugal,

Sure. The "Rempel Maximum" is the maximum benefit you can get from the Smith Manoeuvre without using any of your cash flow. Essentially, it is the maximum additional leverage, which could be from the credit line portion of the readvanceable mortgage on your home or from an additional leverage loan.

For example, if your mortgage payment pays $500/month of principal ($6,000/year), you divide the $6,000 by the interest rate (say 6%), which gives you $100,000. You increase the credit line limit on your readvanceable mortgage to 75% of your home value, which is often done for free at the major banks. Then you borrow and invest up to the credit line limit. If there is less than $100,000 available, then you finance the rest from an investment loan.

With this strategy, the entire $100,000 is financed from your mortgage and uses none of your cash flow. Usually with the SM, the interest on the $6,000/year is tax deductible, but now the entire $6,000 is tax deductible. If you buy a 100% tax-efficient investment and never sell or take any distributions from your investment, then you can pay zero tax on the growth until you retire.

Yes, Frugal is right that this is extra leverage, but the SM works because it is a leverage strategy. If you invest effectively and believe in leverage, the Rempel Maximum maximizes all the benefits of the Smith Manoeuvre.





Ed

[Webhead]

This is a little late and I haven't read through the entire post but there was an article in the Toronto Star about Fraser Smith.
Sorry if this is a repost:
http://www.thestar.com/article/174167

[qubikal]

Might be an entirely new topic, but the question relates to the Smith Maneuver:

Situation: One is a higher tax bracket income earner; whereas the spouse is a lower tax bracket income earner.

In a simple financial planning world, you would have the higher income earner make all the usual family expenses, bill payments etc, and then have the lower income earner's income go towards investments as investment income is taxed at a much lower rate.

The question: How is this scenario affected if we are using the Smith Maneuver? Do you want to have the investments under the higher income earner because the tax refund on the deductible interest expense is higher? and therefore allowing you more cash flow to pay back into the mortgage?

or

Do you still want the investments under the lower income earner's name, because you assume that your investment rate of return is always better than the rate of borrowing?

Hope this didn't confuse anyone....:twisted:
Thanks

[edrempel]

The question: How is this scenario affected if we are using the Smith Maneuver? Do you want to have the investments under the higher income earner because the tax refund on the deductible interest expense is higher? and therefore allowing you more cash flow to pay back into the mortgage?


What a great question, since the interest deduction and the investment income are taxed to the same person(s). The short answer is that you usually want the SM taxed to the higher-income spouse, if in a significantly higher tax bracket. This is because, with tax-efficient investments, you should be getting tax refunds almost every year. Even after your investments have grown significantly and you are retired & starting to take income from them, you can still arrange to be very tax efficient by using a systematic withdrawal plan, so any small amount of capital gains will probably still usually be lower than the interest deduction. Taxing it all to the higher income spouse may well mean larger tax refunds all your life, since you can keep the interest deduction right through retirement.

This means that strategies that plan for income splitting after retiring, such as spousal RRSP's are more important. The new pension-splitting rules will help with this.




Ed

[cferneyh]

As someone who is using the Smith Manoeuvre, under what scenarios does it make sense for me to cash out my RRSPs, use the proceeds to pay down my mortgage, and then "re-borrow" and invest the same amount?

I've been using the Smith Manoeuvre for a few months now (with Manulife One), and I've got about $100K in RRSPs (all stocks and ETFs). Since I stopped contributing to my RRSPs once I started using the Smith Manoeuvre, I'm just wondering if it makes sense for me to cash out, cut a cheque to the government for $39K (I'm in Alberta where the highest marginal rate is 39%) and apply the $61K to my mortgage (and then do the Smith Manoeuvre - or even the Rempel Maximum with that $61K)?

Or should I just leave 'em be?

(Also, big thanks to cannon_fodder for the Excel worksheet - great stuff!)

[pitz]

Since I stopped contributing to my RRSPs once I started using the Smith Manoeuvre, I'm just wondering if it makes sense for me to cash out, cut a cheque to the government for $39K (I'm in Alberta where the highest marginal rate is 39%) and apply the $61K to my mortgage (and then do the Smith Manoeuvre - or even the Rempel Maximum with that $61K)?

Or should I just leave 'em be?


I doubt it would make sense to cash out existing RRSPs and pay the taxes early. But as you suggest, its best not to contribute any new money.

[FrugalTrader]

As someone who is using the Smith Manoeuvre, under what scenarios does it make sense for me to cash out my RRSPs, use the proceeds to pay down my mortgage, and then "re-borrow" and invest the same amount?

I've been using the Smith Manoeuvre for a few months now (with Manulife One), and I've got about $100K in RRSPs (all stocks and ETFs). Since I stopped contributing to my RRSPs once I started using the Smith Manoeuvre, I'm just wondering if it makes sense for me to cash out, cut a cheque to the government for $39K (I'm in Alberta where the highest marginal rate is 39%) and apply the $61K to my mortgage (and then do the Smith Manoeuvre - or even the Rempel Maximum with that $61K)?

Or should I just leave 'em be?

(Also, big thanks to cannon_fodder for the Excel worksheet - great stuff!)

If it were me, I would leave the RRSP alone and let it compound tax free. Perhaps you can withdraw from your RRSP during low income years.

[HoTiCE_]

Minghia,
Don't forget to inform yourself thoroughly with a financial advisor as fiscal laws are somewhat distinct (pun intended) in Quebec that limits (not completely) the advantages of the Smith Maneuver in La Belle Province.

Just thought I'd warn you before you plunge into anything...

[edrempel]

As someone who is using the Smith Manoeuvre, under what scenarios does it make sense for me to cash out my RRSPs, use the proceeds to pay down my mortgage, and then "re-borrow" and invest the same amount?

CF,

Cashing in your RRSP will mean a large tax bill right away and significantly lower investements than you have now. Keep your RRSP's for their tax-free compounding.

There might be an argument for cashing in RRSP's if you do a large leverage loan, such as the Rempel Max strategy, in order to give you more investments. However, in all likelihood, you could do it anyway and keep the RRSP's.

You should be able to do both fully during your work life, since the SM required none of your cash flow. You will likely fully convert your mortgage and max your RRSP's during your work life. While I am very confident in the benefits of the SM, RRSP's are also beneficial because you will likely be in a lower tax bracket when you retire, because of the tax-free compounding, and because you can use the refunds to your benefit over the years.

Do both the RRSP & the SM. They even work well together, since you can readvance the RRSP tax refunds in the SM.



Ed

[cferneyh]

CF,

Cashing in your RRSP will mean a large tax bill right away and significantly lower investements than you have now. Keep your RRSP's for their tax-free compounding.

There might be an argument for cashing in RRSP's if you do a large leverage loan, such as the Rempel Max strategy, in order to give you more investments. However, in all likelihood, you could do it anyway and keep the RRSP's.

You should be able to do both fully during your work life, since the SM required none of your cash flow. You will likely fully convert your mortgage and max your RRSP's during your work life. While I am very confident in the benefits of the SM, RRSP's are also beneficial because you will likely be in a lower tax bracket when you retire, because of the tax-free compounding, and because you can use the refunds to your benefit over the years.

Do both the RRSP & the SM. They even work well together, since you can readvance the RRSP tax refunds in the SM.



Ed

Thanks for the advice Ed. I've actually decided to cash out the portion of RSPs that are in my wife's name since she'll have a lower income this year (on mat leave) and her portion was only 15% of the $100K. Additionally, at her job she has a pension.

Would you mind sending me more information about the Rempel Maximum? I can be emailed at chris.ferneyhoughATgmail.com.

Thanks!

CF

[edrempel]

Thanks for the advice Ed. I've actually decided to cash out the portion of RSPs that are in my wife's name since she'll have a lower income this year (on mat leave) and her portion was only 15% of the $100K. Additionally, at her job she has a pension.

Would you mind sending me more information about the Rempel Maximum? I can be emailed at chris.ferneyhoughATgmail.com.

Thanks!

CF

CF,

Here is some info on the Rempel Maximum.

The Rempel Maximum is an enhancement to the SM that is the maximum possible benefit of the SM, without using any of your cash flow. The benefit is usually triple the Plane Jane SM (but depends on the situation).

It involves the maximum leverage that can be financed from the SM. For example, if you are paying down $500/month principal on your mortgage, instead of investing the $500, you multiple by 12 and divide it by the loan interest rate (say 6%) to get the maximum loan you can finance from the $500/month (in this case $100,000).

In short, instead of investing $500/month, you would borrow $100,000, but the payments are all made from within the SM, by readvancing the principal portion of the mortgage payment. So, you have a $100,000 investment on which you never have to make any payments from your cash flow.

The $100,000 will grow much faster than the $500/month would grow. And while the $500/month will increase as you pay increasing amounts down on your mortgage, you can use this to increase the loan every year or 2, still without ever using any of your cash to make any payments.

The investment loan could be from using your secured credit line within your readvanceable mortgage (if you have enough equity), or it could be a separate investment loan (or some combination of the 2).

The projected benefit of this is surpisingly high. For the SM, it is typically about double the starting mortgage over 25 years. The projected benefit of the Rempel Maximum is typically about triple that number, or about 6 times the starting mortgage.






Ed

[Da Man]

Sorry, I haven't gone through this entire thread, just the last few posts.

Using a more simple plan, you could take the $100k loan, put it into a return of capital fund that averages 10% a year, and has a distribution of 8%/year. So assuming your same $500/month principal and it being readvanced to your account. It becomes tax deductible if you just invest it. For simple purpose, put it into a corporate class fund. You get all the benefits now of a monthly pac into an rrsp structure, but none of the rrsp problems when removing the money. It'll be taxed as capital gain when money is withdrawn.

So now you've got $500/month tax deductible and growing tax deferred and taxed as capital gains. Also you have $666.67/month being paid out as return of capital(tax free for 12.5 years) and put it back into the principle of your mortgage. Readvance it all together so you will get 1167.67 a month thats tax deductible. $500/month for the $100k loan, + $666.67 going into a monthly pac. So you get about $14,000 in tax deductions a year. Ontop of it, you could get an rrsp loan if you feel.

This is a very basic version, this could get very complicated and make a hell of alot more money if done to its full potential. But you would use other components to help speed things up growth wise and could eventually reduce your taxes to 0.

Assuming an actual growth of 2% after distribution to the $100k, it will be roughly $164k in 25 years. Payback the loan so you pocket $64k. Ontop of that assuming around 32% marginal tax bracket, and $14k deduction, you would get an additional $4,484 of refunds that you can dump into the principal, draw back out, and repeat. Technically increasing your deduction each year. You could easily bank over $1M based on an assumed return of 10% avg. Easily. Best part is, at the end it will be capital gains.

[aphextwin2050]

Interesting post..anyone else have comments? I've been pre-approved for a 100K line of credit, and would the below work with a HELOC?
Sorry, I haven't gone through this entire thread, just the last few posts.

Using a more simple plan, you could take the $100k loan, put it into a return of capital fund that averages 10% a year, and has a distribution of 8%/year. So assuming your same $500/month principal and it being readvanced to your account. It becomes tax deductible if you just invest it. For simple purpose, put it into a corporate class fund. You get all the benefits now of a monthly pac into an rrsp structure, but none of the rrsp problems when removing the money. It'll be taxed as capital gain when money is withdrawn.

So now you've got $500/month tax deductible and growing tax deferred and taxed as capital gains. Also you have $666.67/month being paid out as return of capital(tax free for 12.5 years) and put it back into the principle of your mortgage. Readvance it all together so you will get 1167.67 a month thats tax deductible. $500/month for the $100k loan, + $666.67 going into a monthly pac. So you get about $14,000 in tax deductions a year. Ontop of it, you could get an rrsp loan if you feel.

This is a very basic version, this could get very complicated and make a hell of alot more money if done to its full potential. But you would use other components to help speed things up growth wise and could eventually reduce your taxes to 0.

Assuming an actual growth of 2% after distribution to the $100k, it will be roughly $164k in 25 years. Payback the loan so you pocket $64k. Ontop of that assuming around 32% marginal tax bracket, and $14k deduction, you would get an additional $4,484 of refunds that you can dump into the principal, draw back out, and repeat. Technically increasing your deduction each year. You could easily bank over $1M based on an assumed return of 10% avg. Easily. Best part is, at the end it will be capital gains.

[marnone]

Thanks for the great info.. I am going to buy a home in the next 4years and this will help me hoe to pay off the loan faster. Thanks again.

[Da Man]

Interesting post..anyone else have comments? I've been pre-approved for a 100K line of credit, and would the below work with a HELOC?

Yes it would. I have also done this with other clients and i am an advisor. Majority of my clients choose this method as it is very simple and alot more reasonably to them. With my more aggressive clients, I had done about 40%+ average, some 80% returns last year, but they are very aggressive. So big gains, but you can also see big losses. If you can't handle that, stick to the original thing I mentioned. Small reasonable gains that will be ALOT in 25 years. With very little worries if any.

[Sanchez]

Using a more simple plan, you could take the $100k loan, put it into a return of capital fund that averages 10% a year, and has a distribution of 8%/year. So assuming your same $500/month principal and it being readvanced to your account. It becomes tax deductible if you just invest it. For simple purpose, put it into a corporate class fund. You get all the benefits now of a monthly pac into an rrsp structure, but none of the rrsp problems when removing the money. It'll be taxed as capital gain when money is withdrawn.

So now you've got $500/month tax deductible and growing tax deferred and taxed as capital gains. Also you have $666.67/month being paid out as return of capital(tax free for 12.5 years) and put it back into the principle of your mortgage.

The problem (http://www.financialwebring.org/forum/viewtopic.php?t=104522&sid=f045cfaeb2bbd157ce4065c50130c984) is that RoC proportionally reduces the amount of interest you can deduct from your investment loan.

Thanks for the great info.. I am going to buy a home in the next 4years and this will help me hoe to pay off the loan faster. Thanks again.

Does ye hoe know you talk about her like that?

[edrempel]

So now you've got $500/month tax deductible and growing tax deferred and taxed as capital gains. Also you have $666.67/month being paid out as return of capital(tax free for 12.5 years) and put it back into the principle of your mortgage. Readvance it all together so you will get 1167.67 a month thats tax deductible. $500/month for the $100k loan, + $666.67 going into a monthly pac. So you get about $14,000 in tax deductions a year.

Sanchez,

You're right. Since there is a ROC distribution being paid down on the mortgage, the investment loan becomes non-deductible. If $8,000 is paid out of the fund and paid down on the mortgage, then only $92,000 of the $100,000 investment loan is deductible. After 12 years, the investment loan is entirely non-deductible.

In the example, the interest deduction is being double-counted, by claiming the interest deduction on both the original investment loan, even though $8,000 is paid out, and also on the readvanceable credit line as you readvance the same $8,000/year.

IF this would work, someone would create a 100%/day ROC distribution fund. Then I could make convert a $500,000 mortgage fully in 5 days with a $100,000 investment. (It would be nice...)

In fact, in the example, the correct return would be higher with zero distributions. Since the distribution is paid down on the mortgage and reborrowed from the credit line, which is at a higher rate, receiving the distribution actually reduces the return of the strategy.

There is no tax advantage from investing in a ROC fund.





Ed

[Da Man]

The problem (http://www.financialwebring.org/forum/viewtopic.php?t=104522&sid=f045cfaeb2bbd157ce4065c50130c984) is that RoC proportionally reduces the amount of interest you can deduct from your investment loan.


No sorry, it does not.

Sanchez,

You're right. Since there is a ROC distribution being paid down on the mortgage, the investment loan becomes non-deductible. If $8,000 is paid out of the fund and paid down on the mortgage, then only $92,000 of the $100,000 investment loan is deductible. After 12 years, the investment loan is entirely non-deductible.

In the example, the interest deduction is being double-counted, by claiming the interest deduction on both the original investment loan, even though $8,000 is paid out, and also on the readvanceable credit line as you readvance the same $8,000/year.

IF this would work, someone would create a 100%/day ROC distribution fund. Then I could make convert a $500,000 mortgage fully in 5 days with a $100,000 investment. (It would be nice...)

In fact, in the example, the correct return would be higher with zero distributions. Since the distribution is paid down on the mortgage and reborrowed from the credit line, which is at a higher rate, receiving the distribution actually reduces the return of the strategy.

There is no tax advantage from investing in a ROC fund.

Yes there is. As for you creating a 100%/day ROC distribution fund. That makes no sense.

[Sanchez]

No sorry, it does not.

Yes it does - did you read the link I provided? Can you imagine how it could work any other way? Note that whether it is allowed and whether you will be immediately caught if attempt it are two different things.


As for you creating a 100%/day ROC distribution fund. That makes no sense.

It would make perfect sense if what you say is true. It would, in fact, be Canada's best tax shelter, with the ability to turn any loan into a tax-deductible one overnight.

[edrempel]

Right on, Sanchez.

The distribution from a ROC fund is just giving you some of your own money back. If you take take your investment money back, you cannot expect the loan to still be fully deductible.

Sometimes, this can still be profitable, but you should be very careful using a ROC fund. The advisor will get his commission, but it is you that will be audited at some point and have to pay back your tax refunds, plus interest and possibly penalties. If you do this, insist that the advisor do your tax return and put his name in as preparer. Then if he is wrong, you can make him liable to pay your tax on audit.

We do tax returns for free for our good clients that work 100% with us. We stand behind the recommendations we make.

Most strategies with a ROC fund either screw up the tax deductibility, or are used to imply a higher return. For example, I've seen a few SM type advisors using the Stone G&I fund with a 14% ROC distribution. It is a 2-star (below average) Canadian balanced fund that cannot possibly be expected to make 14% long term (probably 6-8%). In fact, the distribution was 12% a few months ago, but is not 14%, since the fund has gone down. A 14% distribution is not a 14% return!

My issue is that the SM requires no cash flow, so why do you need an ROC fund? The key with leverage is to invest effectively (risk/return) and use tax-efficient investments. The true return of SM is almost always higher with a zero distribution 100% tax-efficient fund.





Ed

[Da Man]

Yes it does - did you read the link I provided? Can you imagine how it could work any other way? No whether it is allowed and whether you will be immediately caught if attempt it, are two different things.




It would make perfect sense if what you say is true. It would, in fact, be Canada's best tax shelter, with the ability to turn any loan into a tax-deductible one overnight.



What link??? The one where some guy named Mouly says it is so??? Ok... I hope you don't take all your advice from him than... As for you trying to claim that a 100% ROC would be tax efficient shows me you don't have a clue what you're talking about. It is equivalent to putting in $100 today, and withdrawing $100 tommorow. What's the difference? Where's the tax benefit in recieving 100% when you have no return? Your ACB would be adjusted to reflect that. Meaning it would be nil. Meaning you get no growth after. Meaning you just recieved your money back. So you're telling me the greatest tax shelter would be equivalent to depositing your money into an account, and trying to have it redistributed, 100% return back to you?? Wow.

Right on, Sanchez.

The distribution from a ROC fund is just giving you some of your own money back. If you take take your investment money back, you cannot expect the loan to still be fully deductible.

Please quote where it claims this on CRA's website. Also please explain to me how the distribution being an ROC, would effect the ACB. Also how does it reduce the tax deductible amount of the loan if the loan was never paid back? Let's make this easier to understand than. Let's assume this was an investment loan. 100%. XYZ company gives you $100k to invest in company A. Company A, pays out a distribution to you, of $6k/year in the form of ROC, and your growth is also $6k for that year. End of the year, XYZ mails you a slip for tax purposes on the interest you paid on this investment loan which is $6k for the year. You did not pay down the loan. Company A sends you a T3 slip stating their distribution of $6k for that year as well. So again, the loan is not paid back. How does this decrease the tax deductible amount?

Sometimes, this can still be profitable, but you should be very careful using a ROC fund. The advisor will get his commission, but it is you that will be audited at some point and have to pay back your tax refunds, plus interest and possibly penalties. If you do this, insist that the advisor do your tax return and put his name in as preparer. Then if he is wrong, you can make him liable to pay your tax on audit.

Audited and pay back tax refunds for doing nothing wrong?

My issue is that the SM requires no cash flow, so why do you need an ROC fund? The key with leverage is to invest effectively (risk/return) and use tax-efficient investments. The true return of SM is almost always higher with a zero distribution 100% tax-efficient fund.

It's too speed up things if a client chooses to do so and not be a one trick pony. Show people the options they have and let them decide based on their own risk tolerance aslong as they are well educated on the risks involved. Obviously it's common sense to know that the key to leverage is to invest effectively. I've just got 1 question actually... Do you even understand how return of capital works??

[pitz]

Most strategies with a ROC fund either screw up the tax deductibility, or are used to imply a higher return. For example, I've seen a few SM type advisors using the Stone G&I fund with a 14% ROC distribution. It is a 2-star (below average) Canadian balanced fund that cannot possibly be expected to make 14% long term (probably 6-8%). In fact, the distribution was 12% a few months ago, but is not 14%, since the fund has gone down. A 14% distribution is not a 14% return!


Yeah that fund is junk and selling it borders on professional negligence. Still, although your arguments with respect to RoC make perfect sense, do you have any references or tax rulings to support such?


My issue is that the SM requires no cash flow, so why do you need an ROC fund? The key with leverage is to invest effectively (risk/return) and use tax-efficient investments. The true return of SM is almost always higher with a zero distribution 100% tax-efficient fund.


Canadian dividends can be received by many Canadian investors at 0% or even negative marginal rates. And how on earth do you actually build a 'zero distribution 100% tax efficient fund' anyways? Basically any sensible investment plan in equities is going to have some dividend income, and some foreign income, in addition to capital gains arising from the rebalancing of the portfolio.

[Sanchez]

As for you trying to claim that a 100% ROC would be tax efficient shows me you don't have a clue what you're talking about. It is equivalent to putting in $100 today, and withdrawing $100 tommorow. What's the difference? Where's the tax benefit in recieving 100% when you have no return? Your ACB would be adjusted to reflect that. Meaning it would be nil. Meaning you get no growth after. Meaning you just recieved your money back. So you're telling me the greatest tax shelter would be equivalent to depositing your money into an account, and trying to have it redistributed, 100% return back to you?? Wow.

The investment would be a tax shelter because you claim the RoC will not reduce the interest deductibility of the loan. So you take a loan, for which you need to use the money for a house, for example, invest in the RoC fund. The loan is 100% deductible. The next day the fund pays out 100% of the NAV as RoC. The NAV is now zero, and your ACB is zero, as you mention - however, you still have the loan, and it's still 100% deductible (according to you).

Since you can turn your debt into deductible debt instantly using this method, why would anyone bother with the long, slow smithman technique?

Note that you completely reverse yourself in the next paragraph, explaining exactly how RoC used incorrectly in this way allows you a tax break. Somehow using the 6% number, rather than 100% makes it clearer for you, I guess.

[pitz]

The investment would be a tax shelter because you claim the RoC will not reduce the interest deductibility of the loan. So you take a loan, for which you need to use the money for a house, for example, invest in the RoC fund. The loan is 100% deductible. The next day the fund pays out 100% of the NAV as RoC.
Since you can turn your debt into deductible debt instantly using this method, why would anyone bother with the long, slow smithman technique?


Makes sense, but such a scheme would fail on another test -- an entity that is not capitalized (ie: has paid out 100% of the NAV) cannot generate income, and thus, on that basis, the deduction must be denied.

Personally I don't invest in anything that has a distributed RoC, but people buying income trusts on margin ought to be worried if they are playing this game.

[edrempel]

Pitz,

You asked about CRA references. Check out this link: http://www.cra-arc.gc.ca/E/pub/tp/it533/it533-e.pdf . The key issue here is in sections 12 & 13 of this IT bulletin (section 20(1)(c)(i) of the income tax act). The issue is "current use" of the money. This was illustrated in several Tax Court cases, including the Shell, Bronfman, & Singleton cases. In these cases, it was up to the investor to prove to CRA that the "current use" of the borrowed money is that it is still invested.

In the example by Da Man, the fund paid out a 6% ROC distribution. This money is either used as income or is paid down on the mortgage (in the earlier example). A ROC distibution is the fund "returning your capital" - giving you your own money back.

With an investment loan of $100,000, $6,000 was returned to the investor. Since the "current use" of that money is now that it was spent or paid on the mortgage (both of which are not tax deductible), that $6,000 of the original loan is no longer deductible. Therefore, only $94,000 of the loan is tax deductible and it is up to the investor to properly calculate that only 94% of the interest paid is tax deductible.

It is only logical. If I borrow to invest and then the fund gives me my money back and I spend it, how can I still expect to claim the interest deduction on the money borrowed that I have now spent?

The $6,000 distribution will also reduce the book value of the investment to $94,000. The calculation usually used in calculating the portion of interest deduction is by using the book value of the investment divided by the original book value.

I've seen many examples with 8% or 12% ROC distributions. The distribution is paid down on the mortgage and reborrowed to invest. This process actually accomplishes nothing at all. The client still owns $100,000 of the investment (+/- the growth), since 8,000 was paid out and then bought back. The client still has $100,000 deductible loan ($92,000 of the investment loan + $8,000 in the credit line reborrowed). The only difference at all is that the client has $8,000 lower mortgage, which has been replaced by $8,000 borrowed at a higher rate (the credit line and investment loan are both at higher rates).

Therefore, having the distribution paid out has no benefits and costs the client more interest.

What is more is that, after 12 years, the book value of the investment drops to zero, and after that the distribution is fully taxable as capital gains. Note that at the same time (12 years), the investment loan has become fully non-deductible.

I'm sure thousands of leverage investors in ROC mutual funds or in income trusts have not calculated this correctly - either the interest deduction or their book value. Many of these will eventually get caught by CRA, especially if they do this over many years.

The example Sanchez and I have been tossing about with the 100%/day ROC fund would work like this. IF Da Man's interpretation was right that the investment loan would be fully deductible even though the distribution was paid, then when I put $100,000 into our 100%/day fund, it gives me the entire $100,000 back that day. I pay it down on my mortgage and reborrow to buy the fund again the next day. The fund gives me my entire $100,000 back again the next day. After 5 days, I would have $100,000 investments, but would have an entire $500,000 mortgage plus the $100,000 investment loan all tax deductible.

This is an extreme example that proves the point.


Also, Pitz, there are hundreds of mutual funds that are structured to never pay out a distribution. Most are in "corporate class" structures. There are many mutual funds that are all considered different shares of the same corporation. This means:


1. The corporation usually includes mutual funds in many different sectors, so every year something will have gone down. They can crystallize losses from somewhere every year to off-set any gains realized during the year.
2. They use any dividends or interest earned to pay costs of operating the funds (pay MER), so none of them are taxable either.
3. You can switch between them and it is not a taxable transaction.

They often include some very good fund managers. Most have never paid any distributions at all, even though they've existed for more than 15 years.

They work very well with leverage or the SM. I can invest for 30 years and pay zero on the investment growth. This means zero tax on investment growth, until I eventually start systematically selling some to pay a retirement income. Meanwhile, I can fully deduct the interest every year, plus I can compound (capitalize) the interest in an investment credit line and still deduct it all.

Any investment strategy that has any tax at all on dividends, gains on buying/selling funds, or distributions would have to make a correspondingly higher return to be as useful.






Ed

[mjdavila]

ive read most of the book.. couldnt put it down after being referred from a friend.. the same friend who has been doing it and managed to pay off his mortgage in 5 years...

i'm totally meeting his financial advisor asap and setting this up..

this works guys.. trust me.

[pitz]

Also, Pitz, there are hundreds of mutual funds that are structured to never pay out a distribution. Most are in "corporate class" structures. There are many mutual funds that are all considered different shares of the same corporation. This means:


Then the mutual fund gets to pay taxes as a corporation. Are corporate income taxes lower than personal income tax rates? Even after you take into account the double taxation that would occur by investing in such a structure?


1. The corporation usually includes mutual funds in many different sectors, so every year something will have gone down. They can crystallize losses from somewhere every year to off-set any gains realized during the year.


An investor in traditional mutual fund trusts or individual securities can (and should) do this as well. No 'corporate' structure needed.


2. They use any dividends or interest earned to pay costs of operating the funds (pay MER), so none of them are taxable either.


But Canadian dividends are tax-preferred and generally attract tax rates 10% or less for most investors. Investors who suppress their income with the Smith Manouevre might even have 0% taxation on dividends. This is superior to long-term taxation rates of capital gains in most circumstances (generally, over 20-30 years, cap gains taxation is in the 8-10%/annum range).


3. You can switch between them and it is not a taxable transaction.


Only if someone else in the fund decides to make an offsetting trade. Otherwise the fund itself gets to pay taxes.


They often include some very good fund managers. Most have never paid any distributions at all, even though they've existed for more than 15 years.


Sure....but what are the costs versus a mutual fund trust structure? On an after-tax basis? And just because they don't pay distributions doesn't mean they aren't tax efficient; to wit: they may very well be paying full corporate income tax rates on retained earnings, instead of passing them to the fund owners who might experience lower tax rates. Especially with investors with large tax deductions; ie: Smith Manouevre investors.


They work very well with leverage or the SM. I can invest for 30 years and pay zero on the investment growth. This means zero tax on investment growth, until I eventually start systematically selling some to pay a


You do realize the underlying corporation gets to pay tax, right? And you have to pay an additional management fee for the structure.


Any investment strategy that has any tax at all on dividends, gains on buying/selling funds, or distributions would have to make a correspondingly higher return to be as useful.

My taxation rate on dividends is actually negative; to wit: I have a negative marginal rate on dividends. When I toss my numbers into Quicktax, my taxes payable are actually less when I include the dividend income, than without the dividend income.

Surely a 'corporate' structure wouldn't help me, eh? Its not that my income is low or anything, its merely that my use of borrowed funds to invest creates an interest deduction that is large enough to reduce my income substantially.

[mjdavila]

ive read most of the book.. couldnt put it down after being referred from a friend.. the same friend who has been doing it and managed to pay off his mortgage in 5 years...

i'm totally meeting his financial advisor asap and setting this up..

this works guys.. trust me.


i got a few PM's for the financial planner guys contact - got some feedback already - they loved him.. here's his contact info and a little blurb he said to me:


I LOVE referrals! Please refer me to as many qualified people you can so we can spread the good word about the Turbo Charged Smith Manoeuvre.

Qualified people have:
- Good credit history
- Minimum 25% downpayment
- Taxable income
- Desire to minimize their taxes and grow their net worth

Anybody who falls into this category and referred by you or my other clients should call me for a chat. In fact, if you can spread the good word about me on-line in the chat room, I would appreciate that very much!! The advantage that our office has over any other office that does the Smith Manoeuvre is that I am BOTH a mortgage broker AND a financial planner. So I can make sure that the right mortgage is set up followed by the right investments and the client can always call us if they have any questions about the process, whether it relates to mortgage or the investments.

Kindest regards,

Arpad Komjathy, MBA, FSU
Mortgage Planner
Financial Advisor
416-410-0892

Located at 401/Port Union in GTA..

I have yet to meet him cause I'm waiting for my mortgage situation to be finalized.. but I think everyone should have a financial planner.

[vr6man25]

Arpad Komjathy, MBA, FSU
Mortgage Planner
Financial Advisor
416-410-0892

Located at 401/Port Union in GTA..

:arrowu: totally agree
very imformative guy.
Knows his stuff , unlike others that don't/can't make the time to sit down with you because they are in a rush or Rsp season.
Called today and meet him today. within the Hour.
thanks for the referral :arrowu: :cheesygri

[monomono]

So the Smith Manoeuvre helps you pay off your mortgage faster. Once you've paid it off, what should you do?

[mjdavila]

So the Smith Manoeuvre helps you pay off your mortgage faster. Once you've paid it off, what should you do?

well.. once you paid off your mortgage (bad debt will be all gone)..

but you'll still have the total debt that you invested (good debt)..

but im not sure what to do at this point... you can either pay off the debt with your investment porfolio.. or keep the debt and keep your investments..

i havent gotten past chapter 4 in the book yet... smith you around?

[FrugalTrader]

well.. once you paid off your mortgage (bad debt will be all gone)..

but you'll still have the total debt that you invested (good debt)..

but im not sure what to do at this point... you can either pay off the debt with your investment porfolio.. or keep the debt and keep your investments..

i havent gotten past chapter 4 in the book yet... smith you around?

Smith advocates keeping the debt until you die. Personally, I would consider paying down the debt once I approach retirement.

[Bick Financial Toronto]

The whole purpose of having good debt is to reduce your taxes. Once you generate no taxable income other than capital gains from your portfolio as a result of implementing the Turbo Charged Smith Manoeuvre, it is time to eliminate the debt to reduce your exposure. The capital gains taxes you pay will be minimal at that point.

[grant]

So the Smith Manoeuvre helps you pay off your mortgage faster. Once you've paid it off, what should you do?
The smith maneuvre makes your personal mortgage interest tax deductible.

This may give you the ability to pay off your mortgage faster, but that's a totally separate issue.

[grant]

The whole purpose of having good debt is to reduce your taxes. Once you generate no taxable income other than capital gains from your portfolio as a result of implementing the Turbo Charged Smith Manoeuvre, it is time to eliminate the debt to reduce your exposure. The capital gains taxes you pay will be minimal at that point.
Another valid purpose of debt is to leverage investments. The amount of interest-deductible debt a person chooses to carry is unrelated to the smith maneuvre.

[edrempel]

Pitz,

You do have a lot of points. But you are not right about the way these corporate structure funds actually work.

Then the mutual fund gets to pay taxes as a corporation. Are corporate income taxes lower than personal income tax rates? Even after you take into account the double taxation that would occur by investing in such a structure?

The mutual fund corporation is not paying any taxes either. There are always enough losses to off-set gains. The process is a bit complicated, but if an investor sells a fund at a profit, the mutual fund gets to claim a credit for the gain that the investor will claim on his taxes. This is how some mutual funds with great returns actually have loss carry-forwards.

An investor in traditional mutual fund trusts or individual securities can (and should) do this as well. No 'corporate' structure needed.

The difference is that the corporate structure funds net the gains of one class against the gains of another. Therefore, as an investor, my capital gain can be netted against a capital loss that someone else had!

But Canadian dividends are tax-preferred and generally attract tax rates 10% or less for most investors. Investors who suppress their income with the Smith Manouevre might even have 0% taxation on dividends. This is superior to long-term taxation rates of capital gains in most circumstances (generally, over 20-30 years, cap gains taxation is in the 8-10%/annum range).

While dividends have lower tax rates than capital gains in most tax brackets, capital gains can be deferred for many years. So you should compate paying dividend tax rates today vs. capital gains tax in 20-30 years.

Only if someone else in the fund decides to make an offsetting trade. Otherwise the fund itself gets to pay taxes.

Not true. Switching funds is considered to be a share exchange (like swapping class A shares for class B shares). This is not a taxable transaction, even if all the switches are one way.

Sure....but what are the costs versus a mutual fund trust structure? On an after-tax basis? And just because they don't pay distributions doesn't mean they aren't tax efficient; to wit: they may very well be paying full corporate income tax rates on retained earnings, instead of passing them to the fund owners who might experience lower tax rates. Especially with investors with large tax deductions; ie: Smith Manouevre investors.

The MER difference between a mutual fund trust and mutual fund in a corporate structure is very minor. I just looked up several to find that in one case it was .06%, one it was .01% and one the MER's were the same. Compared to the tax savings from an indefinite referral, the cost is nothing.

You do realize the underlying corporation gets to pay tax, right? And you have to pay an additional management fee for the structure.

The mutual fund corporation is not paying taxes and the MER difference is zero or essentially zero. (see above.)

My taxation rate on dividends is actually negative; to wit: I have a negative marginal rate on dividends.

Valid point. For taxable incomes below $37,000 (Ontario), the dividend tax rate is negative. This is because the stock has already paid corporate taxes at rates higher than your personal tax rate. In your case, the deferral of capital gains does not matter, because you are not paying tax now anyway.





Ed

[edrempel]

What is the "Turbo Charged Smith Manoeuvre"? Is it not just the leverage into a ROC fund described by Da Man? Using a fund with a ROC distribution is rarely necessary when you look at the SM within a comprehensive financial plan. Using a ROC fund usually reduces the potential benefit of the SM, because of the above tax disadvantages, the selection of ROC is limited and excludes most of the best funds in risk/return, and because they are not available in corporate structures.






Ed

[edrempel]

What would be the advantage of being both a mortgage broker and a financial planner? As an advisor, I've considered also being a mortgage broker, but can only see disadvantages for my clients.

Firstly, the best mortgages for the SM are not available to mortgage brokers. The few SM mortgages available to mortgage brokers either require going to a branch to increase the SM credit line, faxing instructions readvance instructions monthly, don't have a variable or 1-year rate (that save money for the client), and/or don't allow investing directly from the credit line.

All of these problems can be avoided with SM mortgages at several of the major banks.

Second, I was concerned about conflict of interest. Can I as an advisor objectively recommend the best mortgage to my clients if I am paid by some financial institutions and not others, or am paid different amounts? How will my client know if I really have their best interests at heart? This is especially true in light of the first point, that the best mortgages are not available to brokers.

For financial planners, comliance is becoming over-bearing. Yet mortgage brokers are still very much a "Wild West", with little compliance or requirement to disclose their compensation or conflicts of interest to clients. They don't have to tell you how much more they are paid for a 5-year vs. a 1-year mortgage.

Third, the compensation for mortgage brokers is skewed so that they are often paid more for products worse for the client. The main example is the "5-Year Mortgage Trap". Brokers are paid more for locking you in for 5 years, even though it costs you money. I recently saw a study going back to 1950 that shows that taking five 1-year mortgages have cost less 100% of the time compared to one 5-year mortgage. Even when rates shot up to 23% in the early 80's, you would have saved money over the 5 years by taking five 1-year mortgages.

I've only met one mortgage broker so far that didn't have some lame excuse for trying to lock as many clients as possible into 5-year fixed mortgages.

We have a wierd interest rate environment today where 5-year rates are lower than 1-year rates. However, historically, this has only happend when everyone knows rates are going down. An "inverse rate curve" indicates a slowing of the economy. This inverse curve has happened a few times in the last 50 years, and yet every single time, taking five 1-year rates saved money.

With the SM, this is sometimes a bigger issue, since one of the many advantages of the SM not mentioned in Fraser's book is that you can usually reappraise your home every 2-3 years for free and leverage the increase. This is often problematic if you are in a 5-year fixed.

Another conflict of interest is that some mortgage providers, such as Firstline, actually pay the mortgage broker more if he gets his client to take a smaller discount on their mortgage rate.

While I am concerned about the lack of competition with the few big banks we have, my main concern is getting the best mortgage for my clients. We prefer to use a readvanceable that is:

1. Variable rate between prime -.8% to prime -.9%.
2. Allows multiple credit lines (add one for emergencies or for the Cash Dam)
3. Readvances automatically
4. Allows investing directly from the credit line
5. Is fully open.
6. No fees at all - no legal, appraisal, broker, or administration fee.

None of the mortgages available to mortgage brokers have more than 2 of these 6 features.

Therefore, even though we refer about 150 mortgages/year (more than many mortgage brokers) and we could make quite a bit of money from also being a mortgage broker, I have not become one or added one to my team, since I think it is much more important for us to be completely objective in getting our clients the best possible mortgage for the SM.






Ed

[edrempel]

Gary,

Ouch, I felt that.

Ed

[Bick Financial Toronto]

Another valid purpose of debt is to leverage investments. The amount of interest-deductible debt a person chooses to carry is unrelated to the smith maneuvre.

You are exactly right Gary! It has to do with taxable income. If someone is making no taxable income or has a low income tax rate due to drawing from funds generating capital gains then it becomes a personal preference how much leverage makes sense at that poitn. Many advisors, and I am one of them, prefer to take a measured approach to leverage, and our clients are comfortable with our somewhat conservative approach.

[Bick Financial Toronto]

What would be the advantage of being both a mortgage broker and a financial planner? As an advisor, I've considered also being a mortgage broker, but can only see disadvantages for my clients.

You raised many good points Ed. Conflict of interest is always an issue to consider. When a financial planner is also an insurance agent that could be a conflict of interest. When a financial planner is also a mortgage broker that could be a conflict of interest. When a financial planner is also an accountant that could be a conflict of interest. Not to mention the banks who are a shining example of conflict of interest situations! It is next to impossible to completely eliminate conflict of interest from our financial lives.

Although conflict of interest situations are to be approached with caution, in my view often they also provide benefits to consumers. A financial planner who is also an insurance agent may have a deeper understanding of how insurance products compare to different non-insurance products. A financial planner who is also a mortgage broker is able to assist clients with the logistics of actually executing the sometimes complex steps involved in a Turbo Charged Smith Manoeuvre program to convert the mortgage into a tax deductible debt well under 10 years. In our experience many clients need help and support to do the logistics correctly and that's what we are able to provide. This step is often underestimated by many financial planners.

When a financial planner is an accountant then the benefit is that the planner is able to assist with the client's tax filing. The income tax filing is a rather important, although somewhat simple process and that's why we do not have an accountant on our team but instead we refer our clients to a number of good accounting service providers to reduce the conflict of interest.

Banks are the perfect example of conflict of interest - and maybe the worst of them all! Yet too many people use them and trust them.

Our industry has high standards in the financial planning area and we have a fiduciary duty to represent the best interests of our clients. As long as clients work with someone reputable, especially if that person was referred, I believe that the issue of conflict of interest is well contained.

Ed you are correct in an absolute sense that deep discount variable rates are better (over the long run) than going with a discounted 5-year fixed rate. Many of our clients, however, look at ways to reduce their interest rate exposure and a 5-year fixed rate mortgage - using your example - will accomplish that. It is a form of interest rate risk hedging we often use for our clients. Yet other clients may prefer to go with a deep discount variable rate and willing to endure higher interest rate variability and then we go with that product.

We are a conservative firm in our implementation of the Turbo Charged Smith Manoeuvre and we take measured risks with our clients' financial lives. There is a lot at stake for them. We don't do seminars because we don't need them: we have many referrals thanks to our happy and satisfied clients. We do provide, however, a personalized service: people can call us and we spend time with them in our office to understand their needs and answer their individual questions. Sure there are potential ways to speed up the journey to financial independence even more, but what is the point of taking the Challenger that can blow up, when we can take an airplane and get there almost as fast but a lot safer? But then again, different folks, different strokes... We just happen to believe in our approach and we do respect what others believe in...

[frankal101]

Thanks for everyone's answers - they have helped me a lot in planning to implement sound financial future. I am at the stage where I am looking to make an offer on a place that is in Quebec and implement all the things talked about in this thread.

Since I am in Quebec, I actually need some capital gains or dividends to claim the interest deduction on the investment loan. I guess my main concern is who to go with on the mortgage? I have been looking at Manuone product form Manulife for its ease of control and impementation in regards to SM. The only thing that is somewhat negative is $14 monthly fee and prime variable rate on the mortgage (although it is also prime on the investment protion). It is seems to have 5 out of 6 criteria listed by Ed above. I guess #4 and 6 is violated. But the rep told me they cover appraisal and $500 of lawyer/notary fees.

Could you guys please comment? I agree that locking up for 5 years does not make sense. Also traditional mortgages (from bmo and royal are the ones i asked) have pre-payment limitations. Can you reccomend one that has all 6 criteria discribed by Ed?

We prefer to use a readvanceable that is:

1. Variable rate between prime -.8% to prime -.9%.
2. Allows multiple credit lines (add one for emergencies or for the Cash Dam)
3. Readvances automatically
4. Allows investing directly from the credit line
5. Is fully open.
6. No fees at all - no legal, appraisal, broker, or administration fee.

None of the mortgages available to mortgage brokers have more than 2 of these 6 features.

I am also exploring options to do what Ed described above (Rempel Maximum) as it seems a more efficient version of traditional leverage (no cf out of pocket is key here!). For the Rempel maximum side of things I was looking to use Income Trust Funds - I found Brompton funds lineup to look very promising with low MER (0.45%) and diversity of passive products. Here i would choose to receive distributions as Capital gains (based on ROC discussion above and avoidance of potential hassles in the future). Probably a 50/50 mix of:
- oil and gas trust fund - equally cap weighted passive portfolio with current yield of 17%
- passive index of top 200 trusts - equally cap weighted with current yield of 10%

This gives me a weighted avg yield of 13.5% and will give me net monthly yield of 7.5% (not counting tax benefit of interesting deductability at end of year). Once again the key is no cash out of pocket. Since original mortgage loan i rate= side investment loan i rate= inside SM readvanceable portion i rate i should be ok, right. Any money that is not needed of side loan will be transefered left inside the SM and readvanced to a conservative dividend portfolio just to keep things civil (I mean, this thing can really get out of hand with 7.5% or more net annual yield distributed monthly and additional personal salary - as good as the prospect of no mortgage in 5 years sounds, I would not want a $500k side loan trust portfolio)

I am looking to play the trust carry trade on the side loan until the gov't mandated change of rules (3 and some years) and then reassess the whole situation. Any negative change in value of trust portfolio at the end would be settled with the funds in the conservative SM readvanceable side - part of the risk. In addition, any net tax liabilities (net of rrsp contribution deductions, inside Sm loan interest deductions, and side loan tax deductions) would be paid out of the inside SM nest egg as well.

That is my plan - I am in Quebec and (believe it or not) capital gains are a good thing to make this work. I do not condone anyone leveraging to buy a pure trust portfolio, but it might suit some. I am an investment professional and the asset mix would be my personal doing. I guess that is something i am prepared to face. Any comments on the specific vehicles, however would be appreciated. Also any comments on the mortgage and anything else wold really help.

Thanks this board has been great and has answered many questions of the details!

FrankAl

[cannon_fodder]

I'm pretty convinced, at least in my mathematical studies of RRSPs and mortgages, that one shouldn't contribute to a RRSP at all if they have a mortgage. Take all your free cashflow, throw it on the mortgage, and then have it re-advanced through the SM to invest in tax efficient non-registered equities.

Why? Because the investors' marginal cost of capital is reduced with the non-reg scenario, and RRSPs do not a meaningful long-term tax advantage compared to the non-reg scenario in a sufficient enough amount to outweigh the lower cost of capital associated with investment borrowing.

pitz,

Have you created a mathematical model that shows a hybrid of RRSP contribution and leveraged investing or is it only one versus the other?

[edmacdonald]

I am interested in the "constant cash flow" SM. My understanding is that you make LOC interest payments by borrowing more from the LOC. So as time goes on, some of the debt in the LOC is in investments and some of it went to servicing the "real" investment debt. In this case it doesn't seem as if the interest on the LOC would be fully deductible.

What am I missing?

Thanks,

Ed

[cannon_fodder]

For those that don't have Excel but want to try 'what if' scenarios using a SM calculator, try this:

http://www.editgrid.com/user/cannon-fodder/Smithman

It is quite slow, unfortunately. You change the values and, IF the server doesn't time out, it takes about 30 seconds to calculate. Also, for the percentages, you have to enter them as a decimal (e.g. 5.25% is 0.0525).

I have tried to save the workbook as an HTML file but it grows to a few MB and still requires you to download a 17MB Office component plugin for IE.

I'd like to find a free utility to convert the XLS to a web-based calculator but haven't found anything which can accommodate this.

[tkl]

For those that don't have Excel but want to try 'what if' scenarios using a SM calculator, try this:

http://www.editgrid.com/user/cannon-fodder/Smithman

It is quite slow, unfortunately. You change the values and, IF the server doesn't time out, it takes about 30 seconds to calculate. Also, for the percentages, you have to enter them as a decimal (e.g. 5.25% is 0.0525).

I have tried to save the workbook as an HTML file but it grows to a few MB and still requires you to download a 17MB Office component plugin for IE.

I'd like to find a free utility to convert the XLS to a web-based calculator but haven't found anything which can accommodate this.

I tried the google free spreadsheet that's suppose to read excel files and it does some but not the xls file you submitted earlier.

I also loaded xls file you submitted earlier using Quattro Pro as I don't have Excel and it seems to work but I'm not sure how accurrate the formula conversion was.

Thanks for posting it though, I'll be looking around for my old 2003 excel disk somewhere in a box.

[don242]

I tried the google free spreadsheet that's suppose to read excel files and it does some but not the xls file you submitted earlier.

I also loaded xls file you submitted earlier using Quattro Pro as I don't have Excel and it seems to work but I'm not sure how accurrate the formula conversion was.

Thanks for posting it though, I'll be looking around for my old 2003 excel disk somewhere in a box.

If you are interested I did a calculator using Quattro Pro that I could send to you. The interface is a little messy as I haven't cleaned it up yet. Essentially it compares SM with RRSP and paying off mortgage in whatever % you want. I will clean it up a bit for anyone who is interested. Again, I only have Quattro Pro so it won't work on Excel most likely.

[Bick Financial Toronto]

I am interested in the "constant cash flow" SM. My understanding is that you make LOC interest payments by borrowing more from the LOC. So as time goes on, some of the debt in the LOC is in investments and some of it went to servicing the "real" investment debt. In this case it doesn't seem as if the interest on the LOC would be fully deductible.

What am I missing?

Thanks,

Ed

You are not missing anything, you are absolutely right. The interest on borrowed funds is tax deductible and the interest incured to service the original loan is also tax deductible. You just have to keep your loan statements to document that the investment was made to "earn interest and dividend income".

[edmacdonald]

...you are absolutely right. The interest on borrowed funds is tax deductible and the interest incured to service the original loan is also tax deductible.

I guess that would make me wrong. It is logical that it would be deductible since it is a net zero manoeuvre to keep the bank happy, but being logical rarely seems to be sufficient with tax laws. It surprises me that the two transactions (borrow/payment) wouldn't trigger something undesirable since the newly borrowed money isn't invested. Similar to the fact that I can't just cash out one RRSP and put the money into another.

Thanks

[cannon_fodder]

If you are interested I did a calculator using Quattro Pro that I could send to you. The interface is a little messy as I haven't cleaned it up yet. Essentially it compares SM with RRSP and paying off mortgage in whatever % you want. I will clean it up a bit for anyone who is interested. Again, I only have Quattro Pro so it won't work on Excel most likely.

Don,

Perhaps you could send it to me and I could take a crack at converting it to Excel. If it is small enough it might be convertable to a standalone calculator that could then be hosted.

[don242]

Don,

Perhaps you could send it to me and I could take a crack at converting it to Excel. If it is small enough it might be convertable to a standalone calculator that could then be hosted.

I put the file at http://home.golden.net/~farnaway/offers/plan2.wb3 . As I said it is for Quattro Pro so not sure how many will be able to use it. It may convert to Excel but my experience shows that it usually doesn't work. The file is about 8MB to download.

General comments and isntructions:

1. The spreadhseet is flexible in many ways allowing you to choose between mortgage paydown and RRSP contribution. It allows you to do the SM or not. You can compare 3 scenarios at a time over a 25 year period (results shown in 5 year intervals). However, it is also inflexible in many ways since the investing strategy is limited.

2. The basic premise is this. You have required monthly payments on your mortgage and a seperate amount for adding to "savings" either monthly or annually. Those savings can be broken up into RRSP or mortgage paydown. Once the mortgage is piad off, the full amount (minimum required payment and savings put toward mortgage) are automatically put into your RRSP. Once your RRSP contribution limit is reached, the savings are invested outside RRSP and taxed accordingly. All tax refunds from RRSP contributions (or using SM) are either directed towards mortgage pay down or RRSP investments depending on settings.

3. There are some minor flaws due to logistics but they have little impact on the final numbers. There is some research required to determine your own marginal tax rate and provincial dividend tax credits. For Ontario the current tax credit is 6.05%. I realize this number is changing every year over the next few years but unfortunatley I haven't added this to the sheet.

4. As with most finances, there is endless possibilities so it is hard to derive a scenario that can encompass them all. This was mostly developed for my own personal use so it caters towards comparing relevant scenarios to my situation.

Let me know if there is anything I can help with or explain and I will do my best.

[vr6man25]

Hey Arpad can you check your private messages please.
Thanks.



You are not missing anything, you are absolutely right. The interest on borrowed funds is tax deductible and the interest incured to service the original loan is also tax deductible. You just have to keep your loan statements to document that the investment was made to "earn interest and dividend income".

[Bick Financial Toronto]

It surprises me that the two transactions (borrow/payment) wouldn't trigger something undesirable since the newly borrowed money isn't invested. Similar to the fact that I can't just cash out one RRSP and put the money into another.

The rationale is that when you borrow money to invest and then borrow money to support the loan that was used for investment purposes, you are indirectly supporting the investment that was originally made.

[decroded]

Hi all,

I'm starting a new mortgage and have 25% down, but I'm planning to do the SM with my mortgage with Manulife One. Do you all think it's worth it to eat the CMHC premium and go with a high ratio mortage at 90% LTV, so that I can take the extra 15% and kick start the SM right away?

Crunching the numbers on an approx. $300k mortgage, it looks like the CMHC fees would be about $5500. This would let me put about $45k into deductible investments, which would incur interest of about $2800. This would net me a deduction of about $1000 in the 40% bracket.

So it would seem to come down to whether the $45k in play could produce dividends of more than $2800 and amortize the CMHC fee in a reasonable amount of time. This seems doable.

But if this is the case, aren't all SM mortgages best off starting with as high an LTV as possible?

Comments much appreciated. Thanks.

[cannon_fodder]

What would be the disadvantages to using the Horizons BetaPro S&P/TSX (HXU) ETF as part of the investment for the SM? I would imagine it still would distribute some measly dividends/capital gains income but, if you are long term bullish on the TSX, you would get 200% exposure (minus the MER which is somewhat high at 1.15%).

If you think the TSX would go experience 7% CAG over the next 10 years, buying and holding would get you a bit less than 13%.

[grant]

Do you all think it's worth it to eat the CMHC premium and go with a high ratio mortage at 90% LTV, so that I can take the extra 15% and kick start the SM right away?
No i don't think it's worth it.

but more importantly, you can't just take a larger mortgage and claim a portion of its interest as a deductible expense... because the entirety of the mortgage funds are traced to you purchasing your personal residence.

But if this is the case, aren't all SM mortgages best off starting with as high an LTV as possible?
SM means your mortgage interest is deductible. Nothing more.

What you are contemplating is leveraged investing. That's a totally different topic.

If you really want to get involved with leveraged investing, I suggest you get a conventional mortgage and then pursue a secured line of credit. Many banks will offer the LOC on the equity from 75% -> 85% (i.e., you can borrow 10% the value of your home on top of the mortgage).

This will have no effect on the tax deductibility of your original mortgage (i.e., it's not SM) but of course it puts you in a great position to increase the deductible LOC as repay the non-deductible mortgage faster than amortized, which IS the smith maneuvre.

[KEH]

Hi all,

I am currently considering TSM on my current mortage (in which I have 50% equity) and so this blog has been extremely useful. However, I would like more information on how effective TSM is if you use the mortgage principal re-advancement to invest in rental property rather than a portfolio. I am considering purchasing a rental property and wonder if it would be better to use TSM on my existing home mortgage to put the 50% equity towards the purchase of the rental property (and thus tax deductible interest) or carry out TSM in the normal way to get tax deductible financing for an investment portfolio and then just take out a separate mortgage for the rental property (which will have tax deductible interest anyway). Also, is the interest on a rental mortgage immediately tax deductible from the date of purchasing the property or only from the date you start renting out the property?

The cost of the current and rental properties are around $300k each.

Many thanks,

KEH

[Bick Financial Toronto]

Hi all,

I'm starting a new mortgage and have 25% down, but I'm planning to do the SM with my mortgage with Manulife One. Do you all think it's worth it to eat the CMHC premium and go with a high ratio mortage at 90% LTV, so that I can take the extra 15% and kick start the SM right away?

On the surface if you just look at mathematics it may make sense. You would be able to set up the mtg with 90% HLOC then dump the money back into one of the sub accounts so you can reborrow it. This way you would have two separate accounts: one for the regular non-tax deductible mortgage and one for the investment with the tax deductible interest.

The second issue that you may want to consider is where you invest the money. Earning a taxable interest income of $2,800 (or whatever) may not be the be the best use of the funds.

The third issue is the fact that Genworth or CMHC insured 90% HELOCs are interest only for 5 or 10 year and then you have to amortize the mortgage over the next 20 or 15 years to complete the mortgage pay-off within 25 years. Of course you can refinance later to get out of the high ratio insured HELOC structure but it is an added risk that you would be facing: what if the housing markets do turn down? It have happened before - see 1990 to 1995. You do not run into this potential complication with a conventional HELOC set-up.

[Bick Financial Toronto]

Hi all,

I am currently considering TSM on my current mortage (in which I have 50% equity) and so this blog has been extremely useful. However, I would like more information on how effective TSM is if you use the mortgage principal re-advancement to invest in rental property rather than a portfolio. I am considering purchasing a rental property and wonder if it would be better to use TSM on my existing home mortgage to put the 50% equity towards the purchase of the rental property (and thus tax deductible interest) or carry out TSM in the normal way to get tax deductible financing for an investment portfolio and then just take out a separate mortgage for the rental property (which will have tax deductible interest anyway). Also, is the interest on a rental mortgage immediately tax deductible from the date of purchasing the property or only from the date you start renting out the property?

The question is diversification by asset class more than anything else in my view. You already own real estate so now you have a sizable exposure to that asset class, so it may not make sense to own more real estate to have an even bigger exposure to that same asset class and have no exposure on stocks and bonds. Plus, you get one bad tenant and then you are at a major loss once you factor in property damage as well. Plus the associated costs of managing the property when somethings goes wrong... It is pain in the neck for most people who do not do property management as a full-time profession. But if real estate is your thing...

[gwexco]

I am still a little confused by the ROC versus Corporate Class debate. I realize ROC fund is probably not the most desirable due to the reduced interest deductability based on a reduced investment, however is a Corporate Class Mutual fund an investment that revcan considers viable. Is there an intention to have income, from what I can see it is structure not to return any income, interest or dividend or roc. Just interested if revcan has made any statement on that type of investment being eligible for interest deductability.

What are peoples view on the TD HELOC? The rate I was quoted for the variable was only prime. It readjusts automatically and they are willing to cover all costs.

[KEH]

The question is diversification by asset class more than anything else in my view. You already own real estate so now you have a sizable exposure to that asset class, so it may not make sense to own more real estate to have an even bigger exposure to that same asset class and have no exposure on stocks and bonds.


Thanks Bick FT. To add a bit more to my scenario, I do also have exposure to stocks and bonds through my RRSP and through other non-registered investments. I would also gain additional exposure if I used SM on my non-deductible mortage to invest in more stocks. Any more thoughts?

[tkl]

I put the file at http://home.golden.net/~farnaway/offers/plan2.wb3 . As I said it is for Quattro Pro so not sure how many will be able to use it. It may convert to Excel but my experience shows that it usually doesn't work. The file is about 8MB to download...............

Thank you very much for posting it. I've downloaded it and will check it out when I can.

[IshDisturber]

Admittingly, I have not read all the posts in this thread and am not an expert in the SM, so I apologize in advance if this has already been addressed....

Can one not get the same effect by purchasing their home on a LOC vs. a conventional mortgage and then using the $ one has paid off the principal to invest?

I have owned my home for just under 2 years. I was able to put down a 40% DP. I financed the balance with the following blend:

1. 1/3 in a conventional, 2-year fixed @ 3.65%
2. 2/3 in an open LOC, variable rate.

Now with this structure, I have been able to pay down my principal at a much larger pace than I could have with a conventional mortgage (30% of the amount of the LOC). IOW, every single penny from my pay check goes towards my LOC. When I need cash to pay bills etc, I just draw off the line. In addition, I have also re-invested about 50% of the 30% that I have paid off on the LOC. Thankfully, I have made some gains...and the best part is that the interest is tax-deductible.

The other 1/3 of my house debt is paid in bi-weekly payments as per a normal mortgage.

So far this has worked great for me.... just thought I'd share this you all.

[ninja6o4]

Admittingly, I have not read all the posts in this thread and am not an expert in the SM, so I apologize in advance if this has already been addressed....

Can one not get the same effect by purchasing their home on a LOC vs. a conventional mortgage and then using the $ one has paid off the principal to invest?

I have owned my home for just under 2 years. I was able to put down a 40% DP. I financed the balance with the following blend:

1. 1/3 in a conventional, 2-year fixed @ 3.65%
2. 2/3 in an open LOC, variable rate.

Now with this structure, I have been able to pay down my principal at a much larger pace than I could have with a conventional mortgage (30% of the amount of the LOC). IOW, every single penny from my pay check goes towards my LOC. When I need cash to pay bills etc, I just draw off the line. In addition, I have also re-invested about 50% of the 30% that I have paid off on the LOC. Thankfully, I have made some gains...and the best part is that the interest is tax-deductible.

The other 1/3 of my house debt is paid in bi-weekly payments as per a normal mortgage.

So far this has worked great for me.... just thought I'd share this you all.


Yes, the SM is the intention of converting as much of your mortgage interest as possible into an interest deductible investment. All gains would go into the mortgage to reduce non-deductible tax and then you'd turn around and withdraw that gained equity to put back into your investment, increasing your deduction, and thus your gains.. wash, rinse, repeat.

[Spazmogen]

Well, this has been a very interesting read.

So much so, that I bought Fraser's book & CD-ROM combo.

I look forward to working out the numbers.

I just need to find a way to get the wife to agree to this, all she knows is what worked for her parents.

[edrempel]

I am still a little confused by the ROC versus Corporate Class debate. I realize ROC fund is probably not the most desirable due to the reduced interest deductability based on a reduced investment, however is a Corporate Class Mutual fund an investment that revcan considers viable. Is there an intention to have income, from what I can see it is structure not to return any income, interest or dividend or roc. Just interested if revcan has made any statement on that type of investment being eligible for interest deductability.

Hi, gwexco,

RevCan has had no issue with corporate class mutual funds. They've been around for about 15 years. The issue is not whether they pay taxable distributions, but whether they COULD pay them, which is theoretically possible. In practice, RevCan has not had any concern with any equity type mutual funds.

What are peoples view on the TD HELOC? The rate I was quoted for the variable was only prime. It readjusts automatically and they are willing to cover all costs.

TD HELOC works quite well for the SM. Prime is the variable part, but you would have to lock in the main portion at a fixed rate. Don't get sucked into a long term fixed rate at the peak of the market. TD unfortunately does not have a variable option for the fixed portion of their HELOC.





Ed

[edrempel]

I just need to find a way to get the wife to agree to this, all she knows is what worked for her parents.

Hi, Spaz,

Is that picture you or your wife???

Yes, getting a partner that is not interested in finances to agree is a challenge. Her parents would obviously have taught her the "Sacred Cow". Education or trusting you are the only options. Suggest she read the book or go to a seminar.



Ed

[edrempel]

I financed the balance with the following blend:

1. 1/3 in a conventional, 2-year fixed @ 3.65%
2. 2/3 in an open LOC, variable rate.

Now with this structure, I have been able to pay down my principal at a much larger pace than I could have with a conventional mortgage (30% of the amount of the LOC). IOW, every single penny from my pay check goes towards my LOC. When I need cash to pay bills etc, I just draw off the line. In addition, I have also re-invested about 50% of the 30% that I have paid off on the LOC. Thankfully, I have made some gains...and the best part is that the interest is tax-deductible.

The other 1/3 of my house debt is paid in bi-weekly payments as per a normal mortgage.

So far this has worked great for me.... just thought I'd share this you all.

Hi, Ish,

How are you tracking what part of the credit line is tax deductible? Only the amount you can prove was invested and is still invested is tax deductible. It sounds like you have mixed deductible and non-deductible transactions into the same LOC, which means you need to maintain a record of all transactions to prove deductibility and always calculate the deductible portion. CRA can also assume a part of any payment is paid down on the deductible portion, if you cannot prove otherwise.

This will also make it difficult for you to capitalize the interest, since you have to calculate the deductible portion first.

I would suggest having 2 linked credit lines to separate the deductible from the non-deductible. As you pay your non-deductible LOC down, you can reborrow in the deductible LOC to invest.





Ed

[pitz]

The mutual fund corporation is not paying any taxes either. There are always enough losses to off-set gains. The process is a bit complicated, but if an investor sells a fund at a profit, the mutual fund gets to claim a credit for the gain that the investor will claim on his taxes. This is how some mutual funds with great returns actually have loss carry-forwards.


But eventually all asset classes will be subject to inflation, and taxable capital gains will be accumulated in the structure internally.

A flow-through entity can distribute those capital gains to the investor, who in turn, is taxed at his/her own tax rates, which are often less than corporate rates. A 'corporate class' mutual fund has to pay those capital gains taxes in the hands of the corporation itself. In the absence of offsetting losses within other asset classes represented inside the investment corporation, the corporation will have no choice but to declare a capital gain.

Basically the structure only works because, in the relatively short term, there are enough losing positions in the overall portfolio of the corporation to offset the realized gains in the winning portions of the portfolio. However, this is a short-term strategy, and I am not at all convinced it can stand up to longer term scrutiny, especially if the fund's underlying assets become allocated in a way that is completely inconsistent with the demand by the underlying investors/unitholders/shareholders.


The difference is that the corporate structure funds net the gains of one class against the gains of another. Therefore, as an investor, my capital gain can be netted against a capital loss that someone else had!


And you can do the same with flow-through funds (ie: traditional mutual funds). A popular transaction has been to sell shares in Nikkei (Japan) based funds, and use those capital losses to offset gains in North American equities throughout the 90s. Accomplishes the same goal, provides much more operational flexibility and predictability for the individual investor, costs less, and carries far less fund manager specific risk.


While dividends have lower tax rates than capital gains in most tax brackets, capital gains can be deferred for many years. So you should compate paying dividend tax rates today vs. capital gains tax in 20-30 years.


The underlying corporation will still be paying dividend tax rates on dividend income derived by the underlying portfolio. The first $60k of Canadian dividends, if its one's only source of income, is almost tax-free.


Not true. Switching funds is considered to be a share exchange (like swapping class A shares for class B shares). This is not a taxable transaction, even if all the switches are one way.


You have to consider the underlying portfolios held by the fund itself. If you want to move all your assets from a Canadian Equity allocation to a Japanese Equity allocation, and if the fund has no 'float' of Japanese Equity allocation to swap your share units into, then the fund will have to incur a capital transaction to sell some Canadian Equity, to buy Japanese Equity. These imbalances create capital transactions for the investment corporation/fund itself, and give rise to a current capital gains liability.

Just because its not taxable for *you* specifically doesn't mean its not taxable at all. The big issue is that you are paying for this so-called tax-efficiency by having the fund itself pay the taxes for you (actually you get double-taxed, as you have to pay capital gains tax when you actually sell appreciated units, so capital gains tax is both paid at the investment corporation level, as well as at the individual level).


The MER difference between a mutual fund trust and mutual fund in a corporate structure is very minor. I just looked up several to find that in one case it was .06%, one it was .01% and one the MER's were the same. Compared to the tax savings from an indefinite referral, the cost is nothing.


Its *not* an indefinite deferral. Investing through a corporation is just wrapping a veil around an investment portfolio, but such veil is still subject to taxation under certain circumstances. Another large risk, at least from a younger investors' point of view, is that such an entity will incur large internal portfolio changes to match the demographic make-up of its investors. What might start out as an overall portfolio that is heavily represented in equities, might migrate into a portfolio that is bond-heavy as investors in the overall pool alter their risk tolerances.

Why is that a concern? After all, you say, each investor has its own allocation of assets within the investment corporation? Its a concern because the overall fund will have to liquidate (and incurr capital gains upon) a good chunk of its equity allocation, in order to buy less risky securities. Even if you maintain your 100% equity allocation within the portfolio, capital gains taxes paid by the corporation get allocated to your 100% equity allocation. You could essentially end up paying a good chunk of Grandma's taxes if you buy a corporate class fund in your younger years, and hold for 20-30 years.


The mutual fund corporation is not paying taxes and the MER difference is zero or essentially zero. (see above.)


Not true. Mutual fund corporations are subject to taxes, just like any other corporation. Flow-through entities such as Mutual fund trusts are exempt on taxes on income that is distributed and attributed to unitholders.


Valid point. For taxable incomes below $37,000 (Ontario), the dividend tax rate is negative. This is because the stock has already paid corporate taxes at rates higher than your personal tax rate. In your case, the deferral of capital gains does not matter, because you are not paying tax now anyway.


I very strongly urge you to receive professional accounting advice if you are selling corporate class products to your client on the basis of tax efficiency alone. If you are an advisor, you really have a fiduciary duty to your clients to become properly educated on these issues so you can provide appropriate advice.

Also I would urge you to contemplate the specific case where a 'corporate class' fund starts shrinking in size, or stops growing in terms of new money contributed. This is the scenario in which the feces really hits the fan in terms of tax efficiency, as then, under such a scenario, every transaction by a shareholder would require a reallocation of the underlying portfolio, which gives rise to churn and taxes.

[pitz]

I am still a little confused by the ROC versus Corporate Class debate. I realize ROC fund is probably not the most desirable due to the reduced interest deductability based on a reduced investment, however is a Corporate Class Mutual fund an investment that revcan considers viable. Is there an intention to have income, from what I can see it is structure not to return any income, interest or dividend or roc. Just interested if revcan has made any statement on that type of investment being eligible for interest deductability.


In addition to my very serious reservations about the long-term efficacy of 'corporate class' funds (after all, for the SM, you want an investment product that you can likely hold tax-efficiently for 30-40 years, or as Smith puts it in his interviews, "till I'm dead"), corporate class funds would have issues in Quebec where tax deductibility, for the purposes of Quebec personal income tax, is limited to the amount of actual investment income received on a cumulative basis.

Overcoming these issues is where a portfolio of exchange traded funds really shines (ETFs). You get a stream of (growing) dividends, rebalancing flexibility, a high degree of tax efficiency, low ongoing costs, and potentially the ability to remove assets from management (ie: ETF 'in-kind' redemption) or to switch asset managers in the future*.


* I am referring to the fact that, with ETFs, if you own enough units, and don't like the investment philosophy of the ETF, you can redeem your ETF units for the underlying stocks, without incurring a capital transaction or taxes. Whereas with traditional mutual funds, you are making a very, very long term committment that is almost impossible to break without very punitive levels of tax.

[Sanchez]

I am referring to the fact that, with ETFs, if you own enough units, and don't like the investment philosophy of the ETF, you can redeem your ETF units for the underlying stocks, without incurring a capital transaction or taxes.

Except for HOLDRs, isn't this only true for institutional-level investors?

[pitz]

Except for HOLDRs, isn't this only true for institutional-level investors?

No. Its true for anyone who holds enough ETF units. And with technology, and splits in the future, its conceivable that the thresholds for redemption will be lower.

[monomono]

Has anyone looked at RBC's "HomeLine" product for the SM?
http://www.rbcroyalbank.com/RBC:Re2aBo71A8cAAoSqfs4/products/mortgages/homeline_plan.html

An RBC rep was explaining it to me. Basically they put a lien on 75% of your home. Then within that 75% you can put up to 5 secured loans, either mortgages or SLOCs. E.g. you can have 1 mortgage and 1 SLOC, and can set the SLOC credit limit to automatically increase monthly as you pay off your mortgage.

[edrempel]

Hi, Pitz,

That was quite a thorough analysis. However, there are a couple of things you need to understand about Corporate Class mutual funds. Also, you are confusing corporations in general with Corporate Class funds. And I don't need to get accounting help, since I am both an accountant and a financial advisor and understand the tax issues.

The policy of the corporate class mutual funds is to be flow-through vehicles, just like other mutual funds. Their policy is to never pay taxes at the corporate level - but to pass all taxable income through to the investors. So, your fear of double taxation doesn't actually happen. They also generally only include equity and balanced funds, so going to all bonds won't happen either.

You make a few good points in theory, but if you look at these funds, most have never or almost never paid a distribution (even though they have been around about 15 years) and most have large loss carrry-forwards on their books now.

These funds do several things that are somewhat technical in nature, but are behind much of the tax efficiency. In addition to the strategies individual investors can do, such as off-setting gains with losses and selling some holdings with to claim losses before year-end, they also:

1. Net any investment income against their MER's first. So, if the MER is 2.5%, then the first 5% of net capital gains realized by selling holdings in the portfolio won't attract any tax. Note this only includes any stock held inside the mutual fund actually sold during the year.
2. Claim losses whenever gains are claimed by investors. For example, if I sell my fund and have a capital gain of $10,000, then the fund claims a credit for $10,000 against any capital gains realized. It would be double tax to have the fund and the investor both claim the gain, so the fund gets to claim a credit. Therefore, investors that sell their holdings in the corporate class group of funds help out those that stay invested.
3. Off-set my gain with someone else's loss (as mentioned in a previous post). For example, I sell my resource fund at a profit and the corporate class of funds nets it against the loss someone else incurred by selling their tech fund, so the fund incurs no capital gain to pass through to me on my profit.

These 3 points are quite techinical, but are some of the main reasons why the corporate class mutual funds often maintain large loss carry-forwards for many years even in rising markets.

The other large factor, however, is the reliable bad investing of average investors, including most advisors and brokers. Average investors tend to all pile into whatever sector has been hot (buy high) and then dump them as soon as they decline (sell low). I've noticed over the years that average investors nearly all buy the same stocks and mutual funds at the same time. This "buy high and sell low" of average investors is very reliable and produces lots of losses for the fund to carry forward.

For example, in the late 90's, everyone bought tech funds, so the tech funds within the corporate class were a disproportionately large part of the fund near the market peak. In some cases, this did result in a taxable distribution in 1999 (for example), but the large tech losses now are large loss carry-forwards within the corporate class of funds.

Lately, everyone has been piling into income trusts (their bubble has burst), resources & gold (possibly in the process of bursting), and Canadian banks. You can always count on most holders of corporate class funds (like most investors in any invesment) to buy high and sell low, which creates a steady supply of loss carry-forwards. So, even if we are not over-weight in the latest fad, our fund will get tax credits because other investors are.

While some of the corporate class funds have much larger loss carry-forwards than others, choosing them properly should allow you to defer tax on your investment growth nearly indefinitely. Even where they are not 100% tax-efficient, they are almost always much more tax-efficient than other mutual funds.

I should add 2 things here, though. One is that, of course, any tax at all on your investments does reduce your long term return. However, there is often a tendency to have tax strategy drive investment strategy - which is a mistake. Having a 100% tax-efficient investment is only useful if it also has a good return and reasonable risk.

Therefore, it is still most important to choose investments and design your portfolio based on risk/return factors, with the tax-efficiency of your investments being only one of the factors you should look at.







Ed

[pitz]

That was quite a thorough analysis. However, there are a couple of things you need to understand about Corporate Class mutual funds. Also, you are confusing corporations in general with Corporate Class funds. And I don't need to get accounting help, since I am both an accountant and a financial advisor and understand the tax issues.


Sorry if my tone was perhaps a bit on the nasty side.


The policy of the corporate class mutual funds is to be flow-through vehicles, just like other mutual funds. Their policy is to never pay taxes at the corporate level - but to pass all taxable income through to the investors. So,


But can they actually pass taxable income through? Correct me if I am wrong, but this is an attribute of an entity that is formed through an indenture of trust, not an incorporated entity.

Of course, they can declare dividends, but unless an authorization from the CRA is received to 'reduce the amount of stated capital', such a dividend distribution comes directly from after-tax income of the mutual fund corporation itself, and is subject to whatever taxes an individual investor faces on dividend income.


your fear of double taxation doesn't actually happen. They also generally only include equity and balanced funds, so going to all bonds won't happen either.


In all fairness, the structure has only been around for 15 years or so, during a period of substantial dichotomy in the world markets (Japanese funds, and earlier, resource funds, have been a reliable source of losses in the past 15 years). Further, they all have been growing through new contributions for the past 15 years through new contributions -- new contributions which are directly used to purchase new holdings. I challenge anyone to show me examples of 'corporate class' funds that have remained stagnant in size, or even shrunk, that have not incurred substantial realized tax drags.


These funds do several things that are somewhat technical in nature, but


I'm a technical kind of guy, got any good references or further information on these moves?


1. Net any investment income against their MER's first. So, if the MER is 2.5%, then the first 5% of net capital gains realized by selling holdings in the portfolio won't attract any tax. Note this only includes any stock held inside the mutual fund actually sold during the year.


Sure, and an individual investor can do this by buying F-class mutual funds or ETFs and writing a cheque seperately to their advisor/broker. More efficient, IMHO, to be taking these tax offsets on one's own personal balance sheet, rather than taking them on the balance sheets of the underlying investments.


2. Claim losses whenever gains are claimed by investors. For example, if I sell my fund and have a capital gain of $10,000, then the fund claims a credit for $10,000 against any capital gains realized. It would be double tax to have the fund and the investor both claim the gain, so the fund gets to claim a credit. Therefore, investors that sell their holdings in the corporate class group of funds help out those that stay invested.


I will definitely have to study this mechamism. Is this accomplished through a reduction to the stated capital of the mutual fund corporation?


3. Off-set my gain with someone else's loss (as mentioned in a previous post). For example, I sell my resource fund at a profit and the corporate class of funds nets it against the loss someone else incurred by selling their tech fund, so the fund incurs no capital gain to pass through to me on my profit.


Yeah that's a legitimate point, distribute your tax liability across the entire pool of investors.

However, how do these funds value tax liabilities/assets? Or do investors who are invested in the corporations into poorly performing asset classes (ie: Japan equity, tech) end up losing the benefit of the tax assets their investments have generated?


These 3 points are quite techinical, but are some of the main reasons why the corporate class mutual funds often maintain large loss carry-forwards for many years even in rising markets.


Sure. Longer-term portfolios tend to be more aligned with the buy-and-hold philosophy, and its not hard for a buy and holder to build up a significant accumulation of carry-forward losses, and deferred capital gains.


For example, in the late 90's, everyone bought tech funds, so the tech funds within the corporate class were a disproportionately large part of the fund near the market peak. In some cases, this did result in a taxable distribution in 1999 (for example), but the large tech losses now are large loss carry-forwards within the corporate class of funds.


Just like they are in my personal portfolio of individual stocks and flow-through funds ;). I've never paid a dime in CG taxes in my life ;).


Therefore, it is still most important to choose investments and design your portfolio based on risk/return factors, with the tax-efficiency of your investments being only one of the factors you should look at.


Good point, and being mutual funds, actively managed ones at that, they are still subject to all of the usual criticisms of actively managed funds.

[FrugalTrader]

Has anyone looked at RBC's "HomeLine" product for the SM?
http://www.rbcroyalbank.com/RBC:Re2aBo71A8cAAoSqfs4/products/mortgages/homeline_plan.html

An RBC rep was explaining it to me. Basically they put a lien on 75% of your home. Then within that 75% you can put up to 5 secured loans, either mortgages or SLOCs. E.g. you can have 1 mortgage and 1 SLOC, and can set the SLOC credit limit to automatically increase monthly as you pay off your mortgage.

Hi Monomono,

Yes, the RBC homeline mortgage is definitely a candidate for the Smith Manoeuvre. Check out my review of the SM for more options.
http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-1.htm

[Huestar]

Hi,

I've been looking through this thread for a while and I recently decided to take the plunge and make a home purchase.
Since I'm relatively young and my girlfriend and I have outstanding student loans, we are only putting 5% down on the home and then using the remainder of our down payment to pay off our student loans.

So my question to the board is, is it possible to perform the smith manoever right out of the gates such as where I am?
The house is brand new and has yet to be built (closing date is July 2008) it will cost 425000 minus 22000 down payment (5%).

I've seen mention of a min. of 25% but no one has explicitly said that you absolutely need this. I would think that there must be a way start with less equity.

Thanks for all of the advice thus far!

[don242]

Hi,

I've been looking through this thread for a while and I recently decided to take the plunge and make a home purchase.
Since I'm relatively young and my girlfriend and I have outstanding student loans, we are only putting 5% down on the home and then using the remainder of our down payment to pay off our student loans.

So my question to the board is, is it possible to perform the smith manoever right out of the gates such as where I am?
The house is brand new and has yet to be built (closing date is July 2008) it will cost 425000 minus 22000 down payment (5%).

I've seen mention of a min. of 25% but no one has explicitly said that you absolutely need this. I would think that there must be a way start with less equity.

Thanks for all of the advice thus far!

You are a ways away from being able to do this. The basic idea is that you are getting a HELOC from which you borrow money to invest. The HELOC can be up to 75% of the value of your home. This means you don't get any line of credit until the first 25% is paid for.

[dark169]

Hi,

I've been looking through this thread for a while and I recently decided to take the plunge and make a home purchase.
Since I'm relatively young and my girlfriend and I have outstanding student loans, we are only putting 5% down on the home and then using the remainder of our down payment to pay off our student loans.

So my question to the board is, is it possible to perform the smith manoever right out of the gates such as where I am?
The house is brand new and has yet to be built (closing date is July 2008) it will cost 425000 minus 22000 down payment (5%).

I've seen mention of a min. of 25% but no one has explicitly said that you absolutely need this. I would think that there must be a way start with less equity.

Thanks for all of the advice thus far!

you can have a HELOC for more then 75% of the value but you endup getting hit with CMHC fees on the portion above 75%. So even if you could get the line of credit the gains are quickly wiped out by those fees and higher interest rates.

Have you run the numbers on your plan, if you have enough for 10 or 15% down and keeping the student loans that may make more sense as you'll save a pile of CHMC fees and your student loan's interest is tax deductible. CHMC fees are reduced every 5% more you put down.

[gwexco]

I also understand that I can't capitalize the interest on the investment LOC in Ontario. Therefore I will have to pay the interest on that portion, which presents a challenge if using Corporate Class funds instead of a Canadian Dividend ETF. I have heard of 'Gorilla Capitalization' but am a little unsure what that entails. RealEstate may be the best cash flow option but then it puts a lot of eggs in one basket. Thoughts?

[pitz]

I also understand that I can't capitalize the interest on the investment LOC in Ontario. Therefore I will have to pay the interest on that portion, which presents a challenge if using Corporate Class funds instead of a Canadian Dividend ETF. I have heard of 'Gorilla


But you can use a margin account in addition to the investment LOC, and simply make the payments from the margin account, to the LOC.

Of course, in the margin account, you would need marginable securities, ie: ETFs.

[edrempel]

we are only putting 5% down on the home and then using the remainder of our down payment to pay off our student loans.

So my question to the board is, is it possible to perform the smith manoever right out of the gates such as where I am?
The house is brand new and has yet to be built (closing date is July 2008) it will cost 425000 minus 22000 down payment (5%).

I've seen mention of a min. of 25% but no one has explicitly said that you absolutely need this. I would think that there must be a way start with less equity.


Hi Huestar,

The first step in the SM is to get a readvanceable mortgage. Most financial institutions that have an SM mortgage require 25% down to get it. A couple will do it with only 10% down. None will do it with 5%.

I agree with Dark. Put at least 10% down on your home and keep some of the student loans. Considering how much you will save in CMHC by paying more down, you may be better off paying nothing on the student loans and putting all available cash down on your home. The exception may be if you can pay one student loan off completely, and then use that payment to increase your mortgage payment.






Ed

[edrempel]

I also understand that I can't capitalize the interest on the investment LOC in Ontario. Therefore I will have to pay the interest on that portion, which presents a challenge if using Corporate Class funds instead of a Canadian Dividend ETF. I have heard of 'Gorilla Capitalization' but am a little unsure what that entails. RealEstate may be the best cash flow option but then it puts a lot of eggs in one basket. Thoughts?

Hi gwexco,

There is no problem capitalizing interest in Ontario. Who told you that? "Guerilla capitalization" is just capitalizing it manually, since none of the banks will allow a credit line to pay its own interest.





Ed

[grant]

you can have a HELOC for more then 75% of the value but you endup getting hit with CMHC fees on the portion above 75%.
Only mortgages require insurance (eg., CMHC) but many banks are happy to offer a HELOC on top of a 75% mortgage, which does not require any insurance.

For example HSBC gave me a 75% open variable mortgage and then a 10% HELOC in addition. I told my rep i plan to use the 10% as part of my down payment and she shrugged it off.

[Bick Financial Toronto]

Thanks Bick FT. To add a bit more to my scenario, I do also have exposure to stocks and bonds through my RRSP and through other non-registered investments. I would also gain additional exposure if I used SM on my non-deductible mortage to invest in more stocks. Any more thoughts?

If asset diversification between real estate and stocks/bonds is not an issue then the next consideration could be your expected return and your personal preference. You can buy a rental property with very little money down, but you can also leverage an investment portfolio as well. So from a leverage standpoint the two options will be fairly close. A leveraged investment portfolio in general is more transparent from a transaction cost and return standpoint (at least on the long run). Real estate is more "hands on" unless you outsource the property management and repairs, and in turn incur higher costs. With real estate you really have calculate/estimate your return - income from ppty, expected appreciation less expenses less additional capital investments if required.

There are a lot of factors that could make real estate better in certain times and a long term portfolio better in other times. I like investment portfolios better because they are liquid and require little on-going management, but there are people who enjoy real estate - it is a very tangible asset class.

[Spazmogen]

I just want to clarify this with you guys:

I'm looking at the RBC Homeline Plan (http://www.rbcroyalbank.com/RBC:Rf6hdI71A8cAA@@w54c/products/mortgages/homeline_plan.html) for the SM. I read about 4 posts above that its fine with the SM.

Because the big banks will not allow the credit line to pay its own interest (capitalization) I'll have to set up the Guerrilla Capitalization as described on page 77 of the SM book. I'll just have to move the money between the secured credit line which is part of the RBC Homeline Plan to the smaller unsecured credit line and back as needed.

Is that right ?

I'm getting set to do this just after April 4th 2007.

The Smithman Calculator was an excellent purchase with the book. Well worth the $58 in total for both.

[edrempel]

I just want to clarify this with you guys:

I'm looking at the RBC Homeline Plan (http://www.rbcroyalbank.com/RBC:Rf6hdI71A8cAA@@w54c/products/mortgages/homeline_plan.html) for the SM. I read about 4 posts above that its fine with the SM.

Because the big banks will not allow the credit line to pay its own interest (capitalization) I'll have to set up the Guerrilla Capitalization as described on page 77 of the SM book. I'll just have to move the money between the secured credit line which is part of the RBC Homeline Plan to the smaller unsecured credit line and back as needed.

Is that right ?


Hi Spaz,

Right on. The RBC Homeline is one of the better SM mortgages available. The main shortcoming is that it does not allow investing directly from the credit line with each mortgage payment. This just means a manual transaction every 2 weeks or monthly, though.

Not all banks will allow you to pay the interest from another credit line. However, if they charge it to your chequing, then you can do your Guerilla capitalizing by just withdrawing the exact amount from the SM credit line and putting it back into your chequing, so your cash flow won't be affected.





Ed

[cannon_fodder]

Hi Spaz,

Right on. The RBC Homeline is one of the better SM mortgages available. The main shortcoming is that it does not allow investing directly from the credit line with each mortgage payment.

Ed

Ed,

Do you have a list of questions/criteria that you would use to evaluate the various SM mortgages? If so, is this something you would be willing to share?

[edrempel]

Ed,

Do you have a list of questions/criteria that you would use to evaluate the various SM mortgages? If so, is this something you would be willing to share?

Hi Cannon fodder,

Sure. I provided this list earlier in this blog, but I'll add a bit of info. We prefer to use a readvanceable mortgage that has the following:

1. Variable rate between prime -.8% to prime -.9%.
2. Allows multiple credit lines (add one for emergencies or for the Cash Dam).
3. Readvances automatically.
4. Allows automatic investing directly from the credit line.
5. Is fully open - no penalties to break the mortgage or refinance under any conditions.
6. No fees at all - no legal, appraisal, broker, or administration fee.
7. Can go in 2nd position if your current mortgage is not due yet and worth keeping.
8. No legal or appraisal fees to have the home reappraised every year or 2 and the credit line limit increased, so we can increase the SM as the home value rises.

None of the mortgages available to mortgage brokers have more than 4 of these 8 features. You can get most or all of these from several of the major banks.





Ed

[Spazmogen]

Quick question about the SM & your credit rating.

I checked my credit rating, and its fine, I did not do my wifes, but she'll be in a better position than I am. She makes more than I, and most of the credit cards are in my name:lol:

Being that mortgages do NOT appear on your credit rating report, but your line of credit DOES, does the SM kill your credit rating, even though its a very smart thing to be doing with the mortgage ?

I'd hate to run into trouble qualifing for vehicle financing because of "too much debt". Dodge has 0% financing on 1500 series quad cab trucks, and Spaz wants a Hemi !

[vr6man25]

anyone here buy the Calculator from
the smithman.net website.
I'd like to know how detailed is it maybe someone could post a picture of it.
thanks

[Spazmogen]

anyone here buy the Calculator from
the smithman.net website.
I'd like to know how detailed is it maybe someone could post a picture of it.
thanks

I bought both the book and calculator software.


I'm @ work. I'll post it in the morning when I get home. I already have a screen capture of it.

[Spazmogen]

As promised. I highly recommend you buy the calculator software. You can tweak your numbers in many possibly ways and see the results in 2 seconds!

Yes, the numbers input really are my family's situation.
I opted to not include the $400/month RRSP contribution ($200 each) that we do each month. So I could shorten this by 2 more years...but I prefer to have 3 income streams going into retirement: pension via work, RRSP & SM. I am not counting on Canada Pension Plan at all. Spazette and I are both civil servants, so the pensions are excellent as well as the health benefits for life with our plan. I am 39 and she is 36. I should have this completed when I am 52. I retire at 58.

http://www.geocities.com/brad.ormsby@rogers.com/153k.jpg

and the graph for that:

http://www.geocities.com/brad.ormsby@rogers.com/smithman1.jpg


The horizontal black dotted line is total debt. Its flat, and remains flat.

The black line going from $153K down to the 15 year is the normal mortgage.

The blue line right beside the normal mortgage is the SM in action. It shaves years off the normal mortgage.

The bright red line going up like a rocket over 15 years is the investments that were bought and earning 8% in my case.

The purple line that goes up with the investments is your new line of credit, and it flat lines at $153K in my case. It will only ever go as high as the original mortgage.

[Guest8223]

When utilizing this approach on a jointly held house and mortgage how do you determine which spouse claims the interest expense? I would think the higher income spouse gains the greatest benefit by claiming all of the interest but I suspect our friends at CRA would not agree with this approach. Is the deduction split 50%/50% or "x"% based on income or ?? Great thread!

[edrempel]

anyone here buy the Calculator from
the smithman.net website.
I'd like to know how detailed is it maybe someone could post a picture of it.
thanks

Hi Gary,

The calculator is quite detailed and accurate for the "Plain Jane" Smith Manouevre. It is also accurate for versions of the "Flintone Flip", in which you pay down non-registered investments or monthly purchases into non-registered investments onto your mortgage and reborrow the same amounts to invest.

It also compares the SM to David Chilton's method (the "Wealthy Barber"), which is regular investing without leverage, and with Garth Turner's method (pay off the mortgage, and then borrow to 75% to invest).

I've verified the numbers and they are accurate. It does not work for any of the enhancements to the SM, which would involve additional leverage. It doesn't work for topping up your mortgage to 75%, the Smith/Snyder or the Rempel Maximum. Fraser is apparently coming out with a new version that should work with some of these enhancements. He sent me a Beta version, but it still did not have these. It only had the "Cash Dam" added.

If you are working with a financial advisor, you don't really need to buy it, since the advisor should be able to run it for you. For your situation, you will probably only need to run one or 2 scenarios with it.






Ed

[max88]

When utilizing this approach on a jointly held house and mortgage how do you determine which spouse claims the interest expense? I would think the higher income spouse gains the greatest benefit by claiming all of the interest but I suspect our friends at CRA would not agree with this approach. Is the deduction split 50%/50% or "x"% based on income or ?? Great thread!

Interest expense is claimed by the spouse who has taken the loan to invest and will claim gain/loss from the investment. Income percentage does not matter in this case. (Though the conventional income splitting strategy is that lower income spouse invest most if not all income, while higher income spouse takes care of all expenses including mortgage and possibly borrow to invest if leverage is desired.)

[Spazmogen]

Interest expense is claimed by the spouse who has taken the loan to invest and will claim gain/loss from the investment. Income percentage does not matter in this case. (Though the conventional income splitting strategy is that lower income spouse invest most if not all income, while higher income spouse takes care of all expenses including mortgage and possibly borrow to invest if leverage is desired.)

I was wondering that too.

Everything we have is joint. Lines of credit, mortgage etc. Everything.

Spazette lets me do the finances because she finds it confusing, yet she makes $80K and I make $62K. I assumed she would be getting the best tax reduction by claiming the investment loan interest. I believe we're both in the top tax bracket now.

[max88]

Investment gain/loss and loan interest will be split 50/50 if held in joint investment account. You cannot arbitrarily claim gain/loss or loan interest by one spouse over the other.

Individually you are not in top tax bracket... but a combined $140K income should provide comfortable living. And with some planning, you should be able to achieve optimal income splitting for 80K+62K.

[edrempel]

I was wondering that too.

Everything we have is joint. Lines of credit, mortgage etc. Everything.

Spazette lets me do the finances because she finds it confusing, yet she makes $80K and I make $62K. I assumed she would be getting the best tax reduction by claiming the investment loan interest. I believe we're both in the top tax bracket now.

Hi Spaz,

I have good news and 2 pieces of bad news for you.

First the good news. Tax ownership and legal ownership can be different. Even though it is registered jointly, you can claim the deduction and investment profits under either or both of you. However, the deduction and the taxable investment income need to be claimed the same way, and consistently from year to year. So, figure out once which is better for this year and future years and claim it that way, both for tax benefits and for tax consequences after you retire.

Now the bad news(s). You aren't in the top tax bracket (starts about $118K) and Spazette is in a higher bracket than you. The 32-34% brackets end about $73K. So, you are in a marginal bracket about 33%, but Spazette is in the 42% bracket. Wouldn't it be a pain to be keen on the SM, but have to claim none of it on your own return?

Spazette is only $7K into the higher bracket, so if she makes some RRSP contributions, then it is probably best to claim everything joint (without knowing the future or your incomes or how each of your incomes will look in retirement).






Ed

P.S. I've been dying to ask - whose picture is that - Spazette?

[grant]

Investment gain/loss and loan interest will be split 50/50 if held in joint investment account. You cannot arbitrarily claim gain/loss or loan interest by one spouse over the other.
It's not arbitrary & it's not necessarily 50/50. It's pro-rated by contributions.

[notanexpert]

OK, but if all accounts are joint, who is to say how much is contributed by each party?
I think CCRA will let you claim whatever you want, as long as it is consistent when later paying taxes on gains, and reasonable - i.e. your contribution to the investment does not exceed your income and/or borrowing means, etc.
m

Quote:
Originally Posted by max88
Investment gain/loss and loan interest will be split 50/50 if held in joint investment account. You cannot arbitrarily claim gain/loss or loan interest by one spouse over the other.

It's not arbitrary & it's not necessarily 50/50. It's pro-rated by contributions.

[Krox]

I have been casually following this thread for the last little while. The idea of the SM intrigues me and I have talked to partner about it. I do have one question and I apologize if it has been covered (this thread is very long). Is the SM beneficial if you foresee moving in the future. Or to put it another way, how long should you stay in one house in order to benefit from the SM? I would imagine it would be costly everytime you moved b/c you would have to cash in your investments.

[Spazmogen]

Hi Spaz,

I have good news and 2 pieces of bad news for you.

First the good news. Tax ownership and legal ownership can be different. Even though it is registered jointly, you can claim the deduction and investment profits under either or both of you. However, the deduction and the taxable investment income need to be claimed the same way, and consistently from year to year. So, figure out once which is better for this year and future years and claim it that way, both for tax benefits and for tax consequences after you retire.

Now the bad news(s). You aren't in the top tax bracket (starts about $118K) and Spazette is in a higher bracket than you. The 32-34% brackets end about $73K. So, you are in a marginal bracket about 33%, but Spazette is in the 42% bracket. Wouldn't it be a pain to be keen on the SM, but have to claim none of it on your own return?

Spazette is only $7K into the higher bracket, so if she makes some RRSP contributions, then it is probably best to claim everything joint (without knowing the future or your incomes or how each of your incomes will look in retirement).






Ed

P.S. I've been dying to ask - whose picture is that - Spazette?




Ed:

I sent you a private message.


I assume I'll have to give the tax deduction to my wife in this year and all future years, she will always make more than I do. She's a cop. I'm a dispatcher.

Now, can I sign the investment cheques or must it be her ? I'll be looking after all of this anyway...but it shaves the most off her income according to Quick Tax.

My avatar picture is in the private message I sent you.

[don242]

I have been casually following this thread for the last little while. The idea of the SM intrigues me and I have talked to partner about it. I do have one question and I apologize if it has been covered (this thread is very long). Is the SM beneficial if you foresee moving in the future. Or to put it another way, how long should you stay in one house in order to benefit from the SM? I would imagine it would be costly everytime you moved b/c you would have to cash in your investments.

You benefit from the SM immediatley and doesn't really matter how long you stay in your home for. I would imagine, if you move, you just take the credit line with you and put it against your new home. You shouldn't have to sell your investments as basically your "new" HELOC would just be used to pay back the "old" HELOC. The only time there would be a problem is if you move and have to renegotiate your mortgage and HELOC, that your financial situation has changed and it isn't possible to get approved.

[shassy63]

Hello everyone,

I understand that the LOC has to be invested in investments that return (or have the reasonable expectation of returning) dividend or interest income and not capital gains. I'm just wondering if, 10 years down the road, your investments aren't returning what you would like and you want to change them. Obviously selling them to buy new ones would create capital gains. Does the CRA then claw back all the deductions you used to buy them in the first place?

I"d hate to be locked into an investment for life.

shassy63

[Sanchez]

Does the CRA then claw back all the deductions you used to buy them in the first place?

No.

[shassy63]

No.

OK, I figured that must be the case, but then how does that work? Surely you can't take the LOC, buy a mutual fund (or stock), then sell it 2 months later for a gain, and buy something else. That would basically be trading, which isn't an allowable interest expense. How is the determination made?

[Sanchez]

OK, I figured that must be the case, but then how does that work? Surely you can't take the LOC, buy a mutual fund (or stock), then sell it 2 months later for a gain, and buy something else. That would basically be trading, which isn't an allowable interest expense. How is the determination made?

There is no hard and fast rule that is going to allow you to look at a particular investment strategy and understand whether it is acceptable under the letter of the law. Basically, the test is an "expectation of profit" - so your 10 year scenario above is probably fine. Trading in and out every two months chasing capital gains probably would not.

Everything in between, it's just a matter of whether CRA decides to challenge it or not.

[cannon_fodder]

Some good questions were sent to me as a result of playing around with the Excel SM spreadsheet I created and posted. They might help others (as it helped me understand Smith's concept) so I thought I'd share them.

But for the years remaining after you've finished paying your mortgage, the "$ to invest" column still shows an amount. Where does this money come from, if you've finished paying your mortgage and you aren't making any additional payments?

You continue to make your same "mortgage" payments, some of which goes to pay the LOC interest and the rest which goes into investments. You don't HAVE to do it this way but if you have lived for X years making those payments to pay down the P&I why not continue to make them to pay the LOC interest and increase your investments? The best move would be to not pay down the principal on the LOC - until your estate does. If, however, you wanted to liquidate your entire investment portfolio to buy that condo down in Florida, you would likely want to discharge the LOC as you would not be able to deduct the interest expense any longer.

You certainly could move to interest only payments once you have converted all of the non-deductible debt to deductible debt and then use the difference to do other things (e.g. vacations, new car, etc). It made sense to me (and I believe others who believe in the SM) that you would continue to funnel that money to investments. After all, on every payment up to then you are always investing something!

The portfolio amount after the mortgage is paid off seems to grow at the "earning rate" + the "$ to invest" amount and without regard to the "Interest Expense", which in this case is the interest on the original mortgage amount. How is the on going {LOC} interest paid for?
I will assume that the explanation above shows you why you continue to make your regular scheduled payments. You will continue to pay the interest on the LOC (which is maxed at the original amounts of Mortgage and LOC) flowing to investments and LOC interest even after the "mortgage" is paid off. This allows you to continue to deduct interest and not have to liquidate any of your investments and in fact continue to put new $ towards your investments.

[don242]

I understand that the LOC has to be invested in investments that return (or have the reasonable expectation of returning) dividend or interest income and not capital gains. I'm just wondering if, 10 years down the road, your investments aren't returning what you would like and you want to change them. Obviously selling them to buy new ones would create capital gains. Does the CRA then claw back all the deductions you used to buy them in the first place?

I"d hate to be locked into an investment for life.



Even the CRA knows that proper investing includes selling investments and buying different ones at time. I don't think it is unreasonable to redistribute your investments from time to time.

[notanexpert]

OK, I figured that must be the case, but then how does that work? Surely you can't take the LOC, buy a mutual fund (or stock), then sell it 2 months later for a gain, and buy something else. That would basically be trading, which isn't an allowable interest expense. How is the determination made?

The CRA will have no issues with you deducting your interest payments as long as you show that income is being generated from these investments, it can be 'other' income or dividends, as long as its taxable, they like you. If you only show capital gains, the rules are not clear, they may not like you and disallow your interest expense deduction. Dividend income would be the best from a tax perspective, if you make less than 118k per year, that's the most tax-efficient type of income I believe.

[escompton]

I have been following this thread and reading about the SM for a while now.

Then I see the other day that the Lipson case appeal was denied.

Anyone have any comments on this news with respect to the SM?

Comment on the original Lipson case from June 2006 here (see page 8 of document for summary):
http://www.marcil-lavallee.com/english/Documents/JUNE2006.pdf

The full Lipson appeal case is here:
http://www.canlii.org/en/ca/fca/doc/2007/2007fca113/2007fca113.html

[don242]

I have been following this thread and reading about the SM for a while now.

Then I see the other day that the Lipson case appeal was denied.

Anyone have any comments on this news with respect to the SM?

Comment on the original Lipson case from June 2006 here (see page 8 of document for summary):
http://www.marcil-lavallee.com/english/Documents/JUNE2006.pdf

The full Lipson appeal case is here:
http://www.canlii.org/en/ca/fca/doc/2007/2007fca113/2007fca113.html


Looks like a good try but it was obvious they were trying to avoid paying tax rather than proper tax planning. What I see in this situation is:

1. They took out the mortgage to pay off a loan. The original loan may have been for investments but the mortgage was not therefore no deduction.

2. The interest loss was greater than the income earned on the investment. No reasonable expectation of profit when the investment is paying out low dividends. Therefore again no deduction.

3. Investing in your own business and then using that as a personal benefit is going to always open up questions from the CRA.

The interest on the original loan may have been deductible if they invested the money from the original loan into something that would produce a profit greater than the interest expense. What they did was purely tax avoidance.

[Bick Financial Toronto]

anyone here buy the Calculator from
the smithman.net website.
I'd like to know how detailed is it maybe someone could post a picture of it.
thanks

I have it at my office. Next time you come by we can go through it. It is pretty basic but it confirms the validity of the concept and therefore it is a useful illustration tool.

[sweedy]

Started Smith Manoeuvre last month using STEP with Scotia Bank. As Ed mentioned earlier, STEP is the most awkward way to do it. I have to go to the branch every time I want to increase the credit limit. My mortgage will renew in 2009 and I will try to switch to one of the other banks.

My question is: how to make sure that the paper trail is still clear when I switch? Do I have to pay off the HELOC in Scotia Bank when I switch? Would that create problem in paper trail?

[Bick Financial Toronto]

Started Smith Manoeuvre last month using STEP with Scotia Bank. As Ed mentioned earlier, STEP is the most awkward way to do it. I have to go to the branch every time I want to increase the credit limit. My mortgage will renew in 2009 and I will try to switch to one of the other banks.

My question is: how to make sure that the paper trail is still clear when I switch? Do I have to pay off the HELOC in Scotia Bank when I switch? Would that create problem in paper trail?

Good question Sweedy. You will have to pay off the HELOC from BNS and that's the case for all HELOCs when someone tries to replace the 1st mortgage. Paying off BNS will not create a problem in your papertrail as long as the new 1st mortgage and the HELOC that sits as 2nd will be for the same amounts. You won't need an accountant to sort this out, just keep all your documents on file related to the transactions.

[pitz]

Surely you can't take the LOC, buy a mutual fund (or stock), then sell it 2 months later for a gain, and buy something else. That would basically be trading, which isn't an allowable interest expense. How is the determination made?

Actually such a situation would be allowable for the purposes of the interest deduction, providing that the mutual fund/stock itself produces, or has the potential to produce income or dividends from its activities at some point in the future. Note that 'future' can mean very distant future, ie: 50 years from now.

Even a daytrader that borrows heavily to daytrade can deduct their margin interest, providing that they purchase securities that have the ability, at some point in the future, of producing income or dividends. The daytrader may be forced to treat all gains in such securities as 'income' however, and would not receive preferrable capital gains treatment.

Examples of investments that would not be eligible:

Commodities, such as gold bullion, silver, copper.
Commodity futures.
Commodity ETFs (ie: GLD, SLV, USO) or claims such as certificates
Index futures
Options
Raw land
Mineral rights/leases
Timberlands/timber
Ore bodies

What do all of these investments have in common? They are not functioning, active businesses, they are not capable of generating income, and the only way you can make money on them is through capital appreciation.

So, if you use borrowed money to buy a precious metals fund, you probably should worry about being challenged by the CRA. Even royalty trusts could be challenged on the basis that much of the investment is based upon the ownership of an ore body, and not that of an active business, even though a royalty trust such as Fording Coal combines both an active business (coal mining), and the ownership of ore bodies.

[Rocky Mountains]

Also, for day traders, they are likely to be claiming their stock trades as business income/loss (and if not, CRA may deem it so). If that is the case, then the interest charges will also be deductible as a business expense.

[CoolEddie]

Perhaps a bit off topic, but on which line, or where would report the interest from your investment loan on your tax return?

[grant]

Perhaps a bit off topic, but on which line, or where would report the interest from your investment loan on your tax return?
It would be an interest expense for whatever you decide to use the money for.

for your personal business, it's an interest expense on your books.
for your real estate investment, it's an interest expense on on your sched 776.
etc.

[florch]

Thanks to Cannon_Fodder for the excel program. Wa wa woo wa!

I plugged in different values to see whether or not it pays to upgrade the digs. Not yet, but I'm going to play with it to see if or when it works out or at least causes the least penalty.

[Bick Financial Toronto]

Perhaps a bit off topic, but on which line, or where would report the interest from your investment loan on your tax return?

This is an excellent question CoolEddie. Sometimes people think that you need an accountant to take care of this detail, but usually that's not the case. If you borrow money to purchase securities to earn interest and dividend income, you could claim the interest expense in Schedule 4 of the T1 General in Section IV. Our clients just enter the interest expense (it has to be well documented), enter the explanation to specify what it was and keep all supporting documentation on file. You could get this done at accounting firms like H&R Block (we supply a sample Schedule 4 form to our clients to help out the folks at H&R Block) or if you use an accounting software then you could do it yourself.

I hope this helps.

[frankal101]

here is a question about the investment side of the SM - I am looking to use a low cost income trust sector index fund for a portion of my portfolio ( i love the yield and its future prospects). This vehicle pays out all the distributions in the form of capital gains. There is also another version of the same vehicle that pays out the distributions in the form of ROC.

I have read about the concerns some have voiced about ROC in the SM (portion of LOC inside SM becomes non-tax deductible as more ROC is earned), and would rather avoid potential future headaches, so I am leaning with the cap gains version of the vehicle. Will i get in trouble for deducting interest on my LOC if it is used to buy a vehicle that only produces cap gains in a predictable fashion (ie - buy and hold no frequent trading in and out of a vehicle)?

Anyones help would be greatly appreciated. This is a big point for me, since i am in Quebec and need returns to claim the interest tax-deductibility...

Thanks

[Bick Financial Toronto]

Will i get in trouble for deducting interest on my LOC if it is used to buy a vehicle that only produces cap gains in a predictable fashion (ie - buy and hold no frequent trading in and out of a vehicle)?

Anyones help would be greatly appreciated. This is a big point for me, since i am in Quebec and need returns to claim the interest tax-deductibility...

If you are buying the vehicle as a collector then all you can expect from the investment is capital gains and therefore the interest expense on the LOC you used to buy the investment is not tax deductible.

If you are buying the vehicle as part of your business then the interest expense on the LOC you used to buy the investment is tax deductible.

As to when you will get into trouble depends on when they audit you. The CRA is profit oriented. Big fish and greedy fish gets audited mostly and they never audit for one year but usually for three. From a practical standpoint you want to plan for an audit when you start to become a big fish.

[dark169]

If you are buying the vehicle as a collector then all you can expect from the investment is capital gains and therefore the interest expense on the LOC you used to buy the investment is not tax deductible.

If you are buying the vehicle as part of your business then the interest expense on the LOC you used to buy the investment is tax deductible.

As to when you will get into trouble depends on when they audit you. The CRA is profit oriented. Big fish and greedy fish gets audited mostly and they never audit for one year but usually for three. From a practical standpoint you want to plan for an audit when you start to become a big fish.

I think he was using the word vehicle in the finical vehicle, not a motor vehicle.

To the question, my understanding is as long as theres a reasonable expectation of future earnings your ok.

[Bick Financial Toronto]

I think he was using the word vehicle in the finical vehicle, not a motor vehicle.

To the question, my understanding is as long as theres a reasonable expectation of future earnings your ok.

Yes, of course, my wrong. Pretty funny actually.

Corporate Class/Capital Class mutual funds fall into the category of producing capital gains (mostly) and the interest on the LOC would be tax deductible. It sounds like your income trust index with capital gains distribution is similar to that concept.

[florch]

OK, I'm sold on the SM, I believe I have my head wrapped around the concept and execution, I have my mortgage set to switch over to a readvancable LOC, and I am ready to kiss my non RRSP (stock) investments good bye, to re-emerge bigger and better on the tax deductible side.

Now I have to decide what to invest in. I would normally consider rental real estate (runs in the family) as part of the portfolio, but don't believe that the current ROI's justify the PITA factor. Maybe in the future.

I'm leaning towards ETF's. From what I've read fixed income is out (who cares), and so are foreign dividends. This narrows the search considerably if I want to stay on CRA's sunny side, and have dividend producing investments. There are about a dozen Barclays ETF's that fit the bill (among others, but for this example...), but would leave the diversification a little narrow for my liking being entirely Canadian in content. There are 2 (Barclay's) international choices that used to be considered Cancon for the RRSP back when that mattered. Does anyone have an educated view if they could be considered Canadian for the purposes of being a Canadian dividend producing investment?

Thanks in advance

[houska]

This narrows the search considerably if I want to stay on CRA's sunny side, and have dividend producing investments. There are about a dozen Barclays ETF's that fit the bill (among others, but for this example...), but would leave the diversification a little narrow for my liking being entirely Canadian in content. There are 2 (Barclay's) international choices that used to be considered Cancon for the RRSP back when that mattered. Does anyone have an educated view if they could be considered Canadian for the purposes of being a Canadian dividend producing investment?


Depends on the size of your investable assets overall, but you might want to overweight Canadian in your SM investment and overweight foreign in your RRSP. You don't necessarily want to be exposed to currency risk on the spread between your HELOC (and house) on one side, and your investments on the other. All this needs to be balanced against the diversification potential of some foreign in your portfolio as an uncorrelated asset class.

Doesn't negate what you said, just balance of factors may be a bit different than without SM.

[pitz]

Depends on the size of your investable assets overall, but you might want to overweight Canadian in your SM investment and overweight foreign in your RRSP. You don't necessarily want to be exposed to currency risk on the spread between your HELOC (and house) on one side, and your investments on the other. All this needs to be balanced against the diversification potential of some foreign in your portfolio as an uncorrelated asset class.


Nothing is stopping one from taking out a portion of the loan for a leveraged investment (such as the SM) in foreign currency. For instance, once you've built up some margin with a broker, they will advance you foreign currency secured with your Canadian-dollar based investments.

Borrowing in a foreign currency like US dollars also has some other advantages. US interest rates are higher, so the tax deduction is larger. And you don't have to convert currencies when you borrow in the native currency.


Doesn't negate what you said, just balance of factors may be a bit different than without SM.

I'd be looking at the Canadian indicies and asking myself, "which sectors are not represented here". Ostensibly, the answers will lead to consumer staples and consumer goods, technology, pharmaceuticals, entertainment, manufacturing/industrial, advanced materials, semiconductors, software, defense, and healthcare.

So basically you'd want to add funds/components/geographies where these sectors are heavily represented, of course, being mindful that sector funds have excessive fees that are to be avoided.

[florch]

Pitz

So you can do this with Vanguards or ETF's and still be eligible to write off interest?

(I have a thick skull...I really did read the whole thread +++)

Florch

[pitz]

So you can do this with Vanguards or ETF's and still be eligible to write off interest?


Absolutely! You can invest in practically any functioning business on the planet and still deduct interest expense as an individual.

If the cost of your foreign investments, including re-invested dividends, exceeds $100k Canadian, you will have to file some additional paperwork with the CRA when you do your taxes. And you have to claim foreign tax credits. And you might be subject to estate taxes in some countries such as the United States. But otherwise... (and yeah...Vanguard+++ ;))

[edrempel]

Hi Florch,

I have good news for you. You are worried about a bunch of things that are not issues. CRA's requirements are that an investment have a "reasonable expectation of profit" and invested for the "purpose of earning income". Note there is no requirement to earn a "net income" - just that it is for the purpose of earning income.

This means that all you need is an investment that COULD pay income. Some of our clients have 100% global investments that are 100% tax-efficient. We expect they will have little or no taxable income on the investments until they retire in 15-20 years - and they will only get capital gains and they will all be foreign.

But the COULD pay income, since they are invested in many stocks that COULD pay income. That is all you need. CRA has consistently accepted global, tax-efficient mutual funds.

Therefore, essentially any ETF or mutual fund would be fine for the SM. All your worries are not necessary.

In your investment decisions, ignore all these issues. Just invest in whatever will give you the best return within your risk tolerance, and try to be tax-efficient. And most importantly, buy something you can stick with for many years.

While I would never buy them myself, if you are a do-it-yourslefer (DIYer), then ETF's are a good choice. By definition, any index investment is "average returns at low cost". Studies consistently show that at least 80-90% of DIYers earn far below average returns in the long run. This is because the human brain is conditioned to consistently do bad market timing.

If you are convinced you will make a profit in the long run and your investment COULD possibly some day maybe pay some income, then the interest is deductible.





Ed

[pitz]

Therefore, essentially any ETF or mutual fund would be fine for the SM. All your worries are not necessary.


Just to slightly expand on the above; the only ETFs that I am aware of that would not be eligible:

GLD/IAU --> ineligible because they are merely claims on physical gold bullion.
USO --> just transacts in commodity futures
SLV --> ineligible because this just represents claims on silver bullion
U --> Uranium Participation --> an ETF with claims on uranium yellowcake U308

Basically, stay away from pure investments in commodities, and you'll do just fine.

Precious metals funds might attract scrutiny from the CRA as well, for the same reasons as above. In theory, the CRA could deny the portion of the interest deduction used to purchase a portion of a precious metals fund that stores value in actual precious metals, rather than actual functioning miners and processors.

[pitz]

Mr. Rempel, whats your view of obtaining USD$-denominated financing for a portion of the Smith Manouevre and investing directly into US-based instruments/funds, instead of paying someone (like Barclays) significant fees to do it for you here?

My relatives who are doing the SM (or versions thereof) really like it because the dividends give them US cash (and Euros) every year to spend on holidays without having to lay out a fortune on bank service charges and forex fees.

Does a wise user of the SM diversify not only the currencies of investments, but also the currencies of borrowing?

[samson]

I have been reading about SM for over a week now and would like to see how this would help me. After reading through this entire post, i noticed there are some financial planners on board who use different techniques. Is there anyone on here willing to run my numbers (privately of course) and tell me what technique they find the most suitable for my situation. I am not sure if there are initial consultation fees associated with your practise but I would like a high level briefing. Btw, I do fulfill the qualifications that are required.

Let me know via PM. Thanks

[vr6man25]

:arrowu: pm Bick Financial

[mark89]

A great thread on an intriguing subject ...

A simple question about the 'Plain Jane' SM:

How do I service an amortized mortgage payment and an ever increasing investment loan without increasing my cash flow commitment? and without relying on investment income to service the investment loan?

example:

current mtg
-----------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment

with SM
--------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment (P+I)
and then each month, borrow the equivalent of the principal (P) payment
above and invest it

investment loan @ 6.00%

month 1 (borrow $459)
month 2 (borrow $464)
month 3 (borrow $498)
... and so on

by the end of the first year, my balances look like this:

mtg balance = $194,151
investment loan = $5849

mtg payment is still $1342 per month (will remain the same until mtg is paid off)

investment loan is now costing $29.45 (will increase each month as additional funds are borrowed to invest)

My cash flow commitment will continually increase month by month, even though my debt level remains the same.

[BatKid]

The official answer is to re-capitalize the interest, so take out the money from your LOC and deposit it back into the account as an interest only payment.

[FrugalTrader]

If you guys are interested, I have a new article on my site today that runs through some of the numbers of using the Smith Manoeuvre in my personal situation.

http://www.milliondollarjourney.com/using-the-smith-manoeuvre-my-scenario.htm

[mensrea]

Some really good reading... this really fascinates me but can someone with no prior knowledge of investing jump into something like the SM?

We are moving into our next home in Feb and the mortgage should be around 190-200k while the value of the house will be well over 300k. We have no other investments and a small savings. Would we be able to do the SM? Has anyone here lost money because of the SM??

[grant]

We have no other investments and a small savings. Would we be able to do the SM? Has anyone here lost money because of the SM??
No one has ever lost money because they legally made a previous undeductible expense tax deductible!

[FrugalTrader]

Some really good reading... this really fascinates me but can someone with no prior knowledge of investing jump into something like the SM?

We are moving into our next home in Feb and the mortgage should be around 190-200k while the value of the house will be well over 300k. We have no other investments and a small savings. Would we be able to do the SM? Has anyone here lost money because of the SM??

The SM is both a tax and investment strategy. If you don't have investment knowledge, you should consult a financial advisor to help you out. Remember, when you borrow to invest, you magnify your gains AND losses. So, you have to ask yourself, if your portfolio returns turn negative, will you still be able to sleep at night knowing that you have borrowed against your home to invest? Everything "should" turn out ok if you're in it for the long term, but can you stomach the potential loss?

Those are the questions you have to ask yourself before using leveraged investing.

[mjohare]

A great thread on an intriguing subject ...

A simple question about the 'Plain Jane' SM:

How do I service an amortized mortgage payment and an ever increasing investment loan without increasing my cash flow commitment? and without relying on investment income to service the investment loan?

example:

current mtg
-----------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment

with SM
--------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment (P+I)
and then each month, borrow the equivalent of the principal (P) payment
above and invest it

investment loan @ 6.00%

month 1 (borrow $459)
month 2 (borrow $464)
month 3 (borrow $498)
... and so on

by the end of the first year, my balances look like this:

mtg balance = $194,151
investment loan = $5849

mtg payment is still $1342 per month (will remain the same until mtg is paid off)

investment loan is now costing $29.45 (will increase each month as additional funds are borrowed to invest)

My cash flow commitment will continually increase month by month, even though my debt level remains the same.

This is exactly the the same concern I have with the SM.

In his book Fraser Smith spends almost 50 pages going on and on like a freaking broken record about the virtues of the manoeuvre before finally addressing the elephant in the room (how to service the interest on the new investment loan). When at last he does address this problem he rather glosses over it by breifly discussing interest capitalization. He completely fails to point out that any money used to capitalize interest is now unavailable for investing. I havent' gone over his numbers closely or developed my own calculations, but I would not be surprised if his calculations include this 6% in the investments.

The SM might indeed be a very smart financial decision. But the sleezy sales pitch tone of the book and the near complete lack of critisism of the SM in this thread leaves me rather suspicious. Doesn't anyone else think there is problems with this manoeuvre?

[notanexpert]

This is exactly the the same concern I have with the SM.

In his book Fraser Smith spends almost 50 pages going on and on like a freaking broken record about the virtues of the manoeuvre before finally addressing the elephant in the room (how to service the interest on the new investment loan). When at last he does address this problem he rather glosses over it by breifly discussing interest capitalization. He completely fails to point out that any money used to capitalize interest is now unavailable for investing. I havent' gone over his numbers closely or developed my own calculations, but I would not be surprised if his calculations include this 6% in the investments.

The SM might indeed be a very smart financial decision. But the sleezy sales pitch tone of the book and the near complete lack of critisism of the SM in this thread leaves me rather suspicious. Doesn't anyone else think there is problems with this manoeuvre?

I don't think there are problems with the manouver. If you have no financial "manouvering" room, then no "manouver" is doable for you.
The interest you pay against your investment loan is no more than the interest that you are saving every month on your mortgage because you are paying it down. Some of it can be covered by dividends you receive from your investments, some can be capitalized if you wish to do that (I don't - I just pay it out of money I would have otherwise used to pay down the mortgage).
And yes, you are leveraging to buy investments, with all the risks and benefits of doing that. When people make huge highly leveraged bets on real estate they don't cry about risk nearly as much as they do when the bet is on equity markets, even though equities have over the long term performed much better than real estate (on average about 5% per year better, over the past 50 years or so). Maybe this is because you can get a quote on your equity profolio any minute while you can't check the value of your real estate every minute? :confused:

[fsmontenegro]

This is exactly the the same concern I have with the SM.

In his book Fraser Smith spends almost 50 pages going on and on like a freaking broken record about the virtues of the manoeuvre before finally addressing the elephant in the room (how to service the interest on the new investment loan). When at last he does address this problem he rather glosses over it by breifly discussing interest capitalization. He completely fails to point out that any money used to capitalize interest is now unavailable for investing. I havent' gone over his numbers closely or developed my own calculations, but I would not be surprised if his calculations include this 6% in the investments.

The SM might indeed be a very smart financial decision. But the sleezy sales pitch tone of the book and the near complete lack of critisism of the SM in this thread leaves me rather suspicious. Doesn't anyone else think there is problems with this manoeuvre?

I've been implementing the SM since earlier this year. I've read the book and I agree that there is a "broken recordness" to it... After reading the book, I'll say that most of the really useful information I got on the SM came from this forum and from an early collaboration with cannon_fodder on the spreadsheet.

Besides the issue of the extra cash flow for the interest on the LoC, my other concern is that the SM assumes that the investment portfolio will deliver a return greater than the LoC interest costs. This can be a significant issue if the markets go south...

There is plenty of criticism of the SM on Canadian blogs. See the comments on http://www.milliondollarjourney.com/anti-smith-manoeuvre.htm as an example.

My personal take on it is that it is not a "sure thing" (especially if markets go down) but it is a sensible approach to converting "bad debt" to "good debt". If nothing else, the SM reminds us that one must consider one's ENTIRE financial picture - investments, taxation, insurance, cash flow, etc... - when thinking about finances...

Hope this helps.

[fsmontenegro]

Hi!

As I mentioned earlier, I've been using the SM since earlier this year. My original plan was to hold dividend-paying Canadian and foreign equities in a non-registered account. I've accomplished this so far with an account at Interactive Brokers and positions in dividend-focused ETFs such as XDV and CDZ. (I hope I'm not violating RFD's terms by mentioning these securities. This is not a recommendation, merely a description of my scenario...)

As life throws us a few curve balls, I find myself needing to review the investments I planned...

Can anyone comment if I can still deduct interest from investment loans if I use the loan to purchase foreign real estate and collect rent on it?

Thanks!

[notanexpert]

The SM might indeed be a very smart financial decision. But the sleezy sales pitch tone of the book and the near complete lack of critisism of the SM in this thread leaves me rather suspicious. Doesn't anyone else think there is problems with this manoeuvre?
There are criticisms of the SM!
There was a thread on this recently, and I did make a post about a long term bear market in equities. If there is a decade of negative equity returns (as in the 70's) then yes, anyone making the SM will have a whole bunch of nasty things to say about it. What are the chances of a long bear market? With the demographics as they are, very low.

[florch]

Thanks all, especially edrempel and Pitz. I appreciate the dialogue and advice.

In my particular experience, the worst I've done with my money was when I was starting out and trusted it to a commission based mutual fund salesman. (I refuse to call someone of his ilk a financial planner.) I've done much better since I've been self directed - learning curve and all. I have had good access to mentors and role models. The best have been my parents who have retired early thanks to real estate.

In my career I'm away a lot but have lots of down time in hotels. This makes RE hard and stocks easy to research.

There was never a doubt as to whether I would leverage to invest, the question was always how. I haven't ruled out a fee based planner, but I will only invest in etf's and stocks. Mutual's with high MER's are the bain of the small investor as far as I'm concerned. I'm sure a few can outperform, but I don't trust any one to pick which ones.

Fortune favours the bold, and the biggest risk of all is never taking any. Over the long term I'd rather retire in 15 years than 30.

Cheers
Florch

[cannon_fodder]

A great thread on an intriguing subject ...

A simple question about the 'Plain Jane' SM:

How do I service an amortized mortgage payment and an ever increasing investment loan without increasing my cash flow commitment? and without relying on investment income to service the investment loan?

example:

current mtg
-----------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment

with SM
--------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment (P+I)
and then each month, borrow the equivalent of the principal (P) payment
above and invest it

investment loan @ 6.00%

month 1 (borrow $459)
month 2 (borrow $464)
month 3 (borrow $498)
... and so on

by the end of the first year, my balances look like this:

mtg balance = $194,151
investment loan = $5849

mtg payment is still $1342 per month (will remain the same until mtg is paid off)

investment loan is now costing $29.45 (will increase each month as additional funds are borrowed to invest)

My cash flow commitment will continually increase month by month, even though my debt level remains the same.

I'm still working on an enhancement suggested by FrugalTrader to allocate divdends from the investment portfolio to paying down the mortgage even faster (and then of course reborrowing to reinvest) but if you can tell me your marginal tax rate (and your expected investment return in percentage terms), I can run the numbers for you and send them privately in an HTML file. You will be able to see, month by month, how your mortgage declines, your LOC grows, your investment portfolio grows but your cash flow stays the same.

It was for this very reason (how can I do this without any additional cash flow) that led me to create my own calculator. I wanted to see "under the covers". That and I am too cheap to buy SM's calculator.;)

[pitz]

Can anyone co