Real Estate

Smith Manoeuvre

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Jr. Member
Nov 17, 2010
155 posts
32 upvotes
whirlwinds wrote: If you fix the 300k portion you will be subject to prepayment rules and the line is not readvanceable. It boils down to whether you want to save the 1% or have flexibility in repayment and re borrowing. If you fix a larger amount you can also negotiate the rate a bit more but at this level i would say the after tax impact is bigger by going variable.
thanks for helping whirlwinds ! Can you elaborate on what you mean when you say "the after tax impact is bigger by going variable." ?

From my perspective 1% less in interest is major, is there something i am missing here ?

FYI, i dont really care about flexibility in repayment since i dont plan to repay this HELOC faster. In my specific context, borrowing against my residence is simply a way to make the interest deductibles.

thanks again !
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Jan 2, 2012
4596 posts
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Toronto
larry81 wrote: thanks for helping whirlwinds ! Can you elaborate on what you mean when you say "the after tax impact is bigger by going variable." ?

From my perspective 1% less in interest is major, is there something i am missing here ?

FYI, i dont really care about flexibility in repayment since i dont plan to repay this HELOC faster. In my specific context, borrowing against my residence is simply a way to make the interest deductibles.

thanks again !
Would the fixed rate HELOC allow you to capitalize your payments?

i.e. in a typical variable HELOC, you are paying interest only for the regularly scheduled payments from your chequing account. And as each payment is made, you can then immediately withdraw the amount back to chequing account so the interest is effectively just added to your HELOC balance.

Not sure how this works in a fixed HELOC where you would be paying interest + principal with each scheduled payment. Are you then allowed to withdraw the amount paid? Do new withdraws get added to the fixed term or do they go to a new variable portion of the HELOC?

If you aren't able to capitalize the interest payments, you would be reducing your HELOC balance and losing some of the tax benefits since the interest paid will get smaller and smaller. In a typical Smith Manoeuvre you don't want to pay down your HELOC.
Deal Addict
Dec 10, 2007
2457 posts
206 upvotes
Is anyone else concerned about the risk profile change when contemplating a SM? Generally your home as an investment profile is relatively safe (generally much less risky than stock but more risky than GIC). I see a lot of posts that people using example of buying stock which will drastically change your risk profile. Also I am interested if anyone has done analysis of using current market number to see if SM is even profitable if you use it in combination of lower risk investment (e.g. income/dividend funds).
Deal Expert
Feb 22, 2011
16504 posts
21843 upvotes
Toronto
Sepiraph wrote: Is anyone else concerned about the risk profile change when contemplating a SM? Generally your home as an investment profile is relatively safe (generally much less risky than stock but more risky than GIC). I see a lot of posts that people using example of buying stock which will drastically change your risk profile. Also I am interested if anyone has done analysis of using current market number to see if SM is even profitable if you use it in combination of lower risk investment (e.g. income/dividend funds).
At the end of the day it's just investing from a line of credit. The only advantage really is that because it's secured you can get a larger sum and the rate will be lower.

It would be more commonly used to diversify or start a business or something.
Jr. Member
Nov 17, 2010
155 posts
32 upvotes
rob444 wrote: If you aren't able to capitalize the interest payments, you would be reducing your HELOC balance and losing some of the tax benefits since the interest paid will get smaller and smaller. In a typical Smith Manoeuvre you don't want to pay down your HELOC.
make perfect sense rob444, thanks for helping !!!
Newbie
Jun 6, 2009
3 posts
Hey All,

I am just wondering how the decumulation phase works to start selling some of the SM investments to turn them into income in retirement. I expect you would need to pay down the HELOC by some amount to maintain the tax deductibility.

I would be interested in hearing how one would go about this and any aspects to watch out for.
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Jan 2, 2012
4596 posts
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Toront wrote: Hey All,

I am just wondering how the decumulation phase works to start selling some of the SM investments to turn them into income in retirement. I expect you would need to pay down the HELOC by some amount to maintain the tax deductibility.

I would be interested in hearing how one would go about this and any aspects to watch out for.
I believe (and someone can correct if I'm wrong) that you would use the ACB (adjusted cost basis) of the holding you are selling.
i.e. say you had 100 shares of Company X with ACB of $15 per share, and current market value of $30 per share. The HELOC amount linked to this holding would be 100 x $15 = $1500. So if you sold off say 10 shares at current market value of $30, you would cash out 10 x $30 = 300, then to balance you'd pay off 10 x $15 = $150 to the HELOC.

What I'm not certain of is if you've been capitalizing the interest, if the interest added to HELOC on top of the original ACB of $1500 would also need to be factored in. Over many years, constant purchases and varying interest rates, this seems like it would be a nightmare to attempt to calculate for every withdraw.

Alternatively some employ a strategy of buying just dividend yielding stocks. So when the time comes you would just be using the regular dividend payments for cashflow and wouldn't need to sell any shares or pay off any HELOC amount.
Jr. Member
Oct 28, 2012
117 posts
37 upvotes
Toronto
Sepiraph wrote: Is anyone else concerned about the risk profile change when contemplating a SM? Generally your home as an investment profile is relatively safe (generally much less risky than stock but more risky than GIC). I see a lot of posts that people using example of buying stock which will drastically change your risk profile. Also I am interested if anyone has done analysis of using current market number to see if SM is even profitable if you use it in combination of lower risk investment (e.g. income/dividend funds).
Depends on how you are defining risk. If you define risk solely based on volatility, then SM is probably not for you. If you consider other risks (sector risk, longevity risk), the SM begins to look more appealing. Holding a house, you lock your money in a single asset. With SM you can diversify into many different holdings. Have a look at this chart: http://www.vestcap.com/2016/03/31/by-th ... ck-market/

What do you think? Is holding all your net worth in home equity "more" or "less" risky?
Jr. Member
Oct 28, 2012
117 posts
37 upvotes
Toronto
larry81 wrote: thanks for helping whirlwinds ! Can you elaborate on what you mean when you say "the after tax impact is bigger by going variable." ?

From my perspective 1% less in interest is major, is there something i am missing here ?

FYI, i dont really care about flexibility in repayment since i dont plan to repay this HELOC faster. In my specific context, borrowing against my residence is simply a way to make the interest deductibles.

thanks again !
If you mix your mortgage portion (fixed) and your heloc portion (variable) into a single fixed portion, the record keeping for the deduction of interest becomes questionable and you may lose the deduction.

If you keep separate fixed and variable portions for mortgage and smith maneuver respectively, then you can deduct the entire variable portion of interest. In addition, you can capitalize the interest and therefore deduct the interest on the interest.

Your fixed (mortgage portion) is always going to be paid in after tax dollars. So let's assume a 43.41% marginal tax rate. to pay a 3% fixed mortgage you will need to earn 4.29% pre-tax. if you pay 4.15% variable on the SM, then since that is deductible you need only earn 4.15%.

So you have to consider the effect of pre and post tax dollars and look at total cost of debt as well as your marginal tax rate.
Jr. Member
Nov 27, 2013
165 posts
194 upvotes
Winnipeg
Am I correct that if I never remove the ROC payments from my Smith Investing Account, that the entire portion of my loan will remain tax deductible? I have been reinvesting all distributions received from my investments, back into the Smith account investments and never removing them. I think in that case it keeps the deductibility of my loan at 100%.
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Jan 2, 2012
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Splashed wrote: Am I correct that if I never remove the ROC payments from my Smith Investing Account, that the entire portion of my loan will remain tax deductible? I have been reinvesting all distributions received from my investments, back into the Smith account investments and never removing them. I think in that case it keeps the deductibility of my loan at 100%.
ROC payments yes.
But are dividends included in those distributions? If so, it's a very bad idea to keep dividends in your SM account since it's a non-registered accounts. You are supposed to move any dividends you receive to registered accounts (like RRSP, RESP, TFSA, etc) to grow them tax free or deferred, or use them to pay off your mortgage.

Paid dividends have zero effect on tax deductibility of the SM account. Only keep the minimum amount required in SM account to keep it entirely tax deductible.
Jr. Member
Nov 27, 2013
165 posts
194 upvotes
Winnipeg
Thats a great point that I never considered. Im going to start moving my dividends out of my Smith Account each year and into my TFSA. Ill just be sure to leave the ROC portion within the Smith investing account.
Member
User avatar
Jan 11, 2007
431 posts
142 upvotes
Toronto
Toront wrote: Hey All,

I am just wondering how the decumulation phase works to start selling some of the SM investments to turn them into income in retirement. I expect you would need to pay down the HELOC by some amount to maintain the tax deductibility.

I would be interested in hearing how one would go about this and any aspects to watch out for.
Hey Toront,

I have lot of experience with decumulation - retired clients still doing the Smith Manoeuvre.

The most tax-efficient withdrawal method is a systematic withdrawal (SWP). I call this a "self-made dividend" because you decide what amount you want. Your tax is only on the capital gain triggered and then only 50% of it is taxable. This is usually a lot less than tax on dividends, unless you are both low income and don't qualify for any government income-tested benefits.

A 4% withdrawal rate (growing by inflation) has been sustainable for life 97% of the time in history if you are invested 100% in equities. Withdrawing 4%/year is reasonable, if you are a long-term investor and comfortable with equities.

It is most effective to invest in equities all over the world diversified by sector. With a self-made dividend (SWP), you have no restrictions and can invest globally based on proper investment methods. With dividends, you are limited to Canadian companies with higher dividends - less than 3% of global equities.

A self-made dividend means you decide exactly how much you want to withdraw each month. With dividends, the company determines how much you get.

If you are NOT capitalizing the credit line interest and the book value (ACB) of the amount you withdraw is not more than the interest (plus any tax-deductible investment management fees), then your credit line remains 100% tax deductible.

If you ARE capitalizing the credit line interest, then the ACB of your withdrawals (less any tax-deductible investment management fees) reduces the amount of the credit line that is still tax deductible.

If you withdraw more, than you need to calculate how much of your credit line remains tax deductible.

A simplified example: You borrowed $500,000 years ago and your investments are now worth $2 million. The ACB and your credit line are still $500,000. You withdraw $80,000/year based on the 4% Rule. The book value of the $80,000 is $20,000. Your credit line interest cost at 4% is $20,000/year. Your credit line remains 100% tax-deductible, because the book value of your withdrawal is not more than your interest deduction.

Your income tax: The $80,000 withdrawal is a $60,000 capital gain x 50% = $30,000 taxable capital gain. You deduct the $20,000 interest deduction. Your taxable income is $10,000/year. You pay zero tax, because this is below the personal exemption (assuming you have no other income).

Note this important detail: Your cash income is $80,000/year and your taxable income is $10,000/year.

If you are a senior, you can qualify for the Guaranteed Income Supplement (GIS) for low-income seniors. If you took $80,000 in Canadian dividends, your taxable income is grossed-up by 38% is $110,400. Less the $20,000 interest deduction is taxable income of $90,400. Not only do you lose the GIS, you also lose most of the OAS (Old Age Security) with the OAS clawback.

This simple example shows the power of a self-made dividend over an ordinary dividend, especially when combined with the Smith Manoeuvre. An $80,000 self-made dividend is taxable income of $10,000. An $80,000 ordinary dividend is taxable income of $90,400.

If you withdraw $100,000/year, then your book value is $25,000. Your interest cost is $20,000. Therefore, $5,000 of your $250,000 credit line becomes non-deductible. The following year, only 98% of your credit line interest is tax-deductible.

I hope that is helpful for you, Toront.



Ed
Ed Rempel
FEE-FOR SERVICE FINANCIAL PLANNER & TAX ACCOUNTANT
Email: ed@edrempel.com
Unconventional Wisdom blog: www.edrempel.com
To have unconventional success, you can’t be guided by conventional wisdom.” -David Swenson
Member
Jul 25, 2008
400 posts
274 upvotes
ottawa
edrempel wrote:

If you are NOT capitalizing the credit line interest and the book value (ACB) of the amount you withdraw is not more than the interest (plus any tax-deductible investment management fees), then your credit line remains 100% tax deductible.

If you ARE capitalizing the credit line interest, then the ACB of your withdrawals (less any tax-deductible investment management fees) reduces the amount of the credit line that is still tax deductible.

If you withdraw more, than you need to calculate how much of your credit line remains tax deductible.
Ed, can you expand on this or link to the related CRA tax folio?

If I'm reading what you said correctly, I think you're saying if I borrow 500k against my house today and stick it in non-registered investments, I can maintain the tax deductiblity of the entire the loan while withdrawing "dividends" to use for personal consumption.

I don't get it... The use has changed from investment to consumption, shouldn't the tax deductiblity change accordingly?
Deal Addict
Aug 26, 2004
3723 posts
869 upvotes
Toronto
I've been applying the Smith Maneuver since 2006. I've reached a point that the HELOC is a sizable amount. However, HELOC rates are higher than mortgage rates.

Question
1. Rather than using a HELOC to borrow to invest has anyone on renewal switched from HELOC to a mortgage for the HELOC amount?
2. Can mortgages be broken down?
3. Was it feasible to pay the principal plus interest on the mortgage covering funds borrowed to invest while using funds accessed through a new HELOC as you make payments for the second mortgage that funds the current and previous fund borrowed for investments?
Member
User avatar
Jan 11, 2007
431 posts
142 upvotes
Toronto
danishh wrote: Ed, can you expand on this or link to the related CRA tax folio?

If I'm reading what you said correctly, I think you're saying if I borrow 500k against my house today and stick it in non-registered investments, I can maintain the tax deductiblity of the entire the loan while withdrawing "dividends" to use for personal consumption.

I don't get it... The use has changed from investment to consumption, shouldn't the tax deductiblity change accordingly?
Hi Danishh,

The key things you need to know are:

- If you withdraw just enough from your investments to pay the interest on the loan, then the loan generally remains fully tax-deductible.
- This is based on the book value of the investments you withdraw, not the market value. This is because the book value represent the amount you borrowed to invest (plus reinvested taxable investment income).

For example, you borrow $100,000 and it grows to $200,000 over a period of years. Your interest is $4,500/year. Then:

- You withdraw $9,000/year from your investments, with a book value of $4,500.
- You trigger a capital gain of $4,500 and a taxable capital gain of $2,250.
- Your credit line remains fully tax-deductible. All the cash is used for investment purposes or is taxable investment income. You use $4,500 of your $9,000 to pay the interest on the credit line and the other $4,500 is taxable income.
- You get $4,500 that you can spend and a net tax deduction of $2,250 ($4,500 interest deduction less $2,250 taxable capital gain).

Does this answer your question, Danishh?



Ed
Ed Rempel
FEE-FOR SERVICE FINANCIAL PLANNER & TAX ACCOUNTANT
Email: ed@edrempel.com
Unconventional Wisdom blog: www.edrempel.com
To have unconventional success, you can’t be guided by conventional wisdom.” -David Swenson
Newbie
Apr 3, 2008
24 posts
7 upvotes
Toronto
Big thank you to Ed and all the bloggers who have taken the time to offer SM advice and examples. Really appreciate the knowledge & experience.

I am learning about tax implications of different investments in a non-sheltered account, and hope to get some fee for service advice before I start investing.
But in the meantime I need to take out a mortgage and would like to get things set up with a HELOC for a Smith Manoeuvre. Want to make sure I organize the accounts properly.

accounts:
I’m an existing TD customer: personal chequing, self-directed RRSP & TFSA accounts
- where my paycheques go, bills are paid, registered savings, etc. Don’t like their mortgage record though.
new mortgage will be a Scotia STEP mortgage & readvancing HELOC. Meeting with them shortly to finalize.
- anyone know if Scotia will require that I open a bank account there?
- if so, is Scotia One appropriate? ($300. promo now, high min. balance is fine for a few months)
I will open a Tangerine free chequing to actually make & track my SM payments
- Scotia subsidiary, should hopefully make transfers easy, same ATMs, etc.
- also has a $200 new account promo now
will open a Questrade account for the future SM investments

Here is how I imagine the payments, assuming no Scotia chequing account is needed:
- Regular mortgage payments: TD to Tangerine to Scotia STEP
- what is the most efficient way to arrange these transfers?
- Can I automate this monthly mortgage payment?
- Borrow to invest: HELOC transfer to Questrade SM account
- HELOC interest: Tangerine to Scotia HELOC
- Capitalized HELOC interest: same $, Scotia HELOC back to Tangerine
- any ’gravy‘ payments on mortgage principal like dividends, extra payments or tax refunds: Tangerine to Scotia STEP mortgage

Money flow questions:
- Is it better to run the regular monthly mortgage payments from the TD to the Scotia STEP by way of the tangerine account?
I see this is how therichmoose.com suggests the mortgage payments should be channeled.
- Is this just to track all the SM payments in one place, without referring to TD records?
Anyone know if the STEP product can automatically withdraw the HELOC interest monthly from a Scotia or Tangerine chequing account?

Thanks for reading.
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User avatar
Jan 2, 2012
4596 posts
3098 upvotes
Toronto
Cleanhead wrote: Big thank you to Ed and all the bloggers who have taken the time to offer SM advice and examples. Really appreciate the knowledge & experience.

I am learning about tax implications of different investments in a non-sheltered account, and hope to get some fee for service advice before I start investing.
But in the meantime I need to take out a mortgage and would like to get things set up with a HELOC for a Smith Manoeuvre. Want to make sure I organize the accounts properly.

accounts:
I’m an existing TD customer: personal chequing, self-directed RRSP & TFSA accounts
- where my paycheques go, bills are paid, registered savings, etc. Don’t like their mortgage record though.
new mortgage will be a Scotia STEP mortgage & readvancing HELOC. Meeting with them shortly to finalize.
- anyone know if Scotia will require that I open a bank account there?
- if so, is Scotia One appropriate? ($300. promo now, high min. balance is fine for a few months)
I will open a Tangerine free chequing to actually make & track my SM payments
- Scotia subsidiary, should hopefully make transfers easy, same ATMs, etc.
- also has a $200 new account promo now
will open a Questrade account for the future SM investments

Here is how I imagine the payments, assuming no Scotia chequing account is needed:
- Regular mortgage payments: TD to Tangerine to Scotia STEP
- what is the most efficient way to arrange these transfers?
- Can I automate this monthly mortgage payment?
- Borrow to invest: HELOC transfer to Questrade SM account
- HELOC interest: Tangerine to Scotia HELOC
- Capitalized HELOC interest: same $, Scotia HELOC back to Tangerine
- any ’gravy‘ payments on mortgage principal like dividends, extra payments or tax refunds: Tangerine to Scotia STEP mortgage

Money flow questions:
- Is it better to run the regular monthly mortgage payments from the TD to the Scotia STEP by way of the tangerine account?
I see this is how therichmoose.com suggests the mortgage payments should be channeled.
- Is this just to track all the SM payments in one place, without referring to TD records?
Anyone know if the STEP product can automatically withdraw the HELOC interest monthly from a Scotia or Tangerine chequing account?

Thanks for reading.
You are way over-complicating everything. Assuming your HELOC will ONLY be used to purchase qualifying investments to do SM and for no other purpose, there is no need to use multiple bank accounts.

First off, Scotia will NOT require you open a banking acct with them. They will certainly try to up-sell you on their bank account and other products I'm sure, but it's perfectly fine to keep your own TD bank account to do everything. Both the mortgage and HELOC interest payments will simply be pre-authorized debits from TD chequing account. There is essentially no benefit to switching all this to Scotia.

When you use the HELOC to purchase investments, you will simply make a bill payment directly from Scotia HELOC to Questrade. Or if that's not possible (some HELOCs may only allow withdraws to the chequing account it's linked to), then you simply make the withdraw to TD, and then immediately transfer from TD to Questrade.

When the monthly HELOC pre-authorized interest payment happens from TD account, you can then immediately capitalize the interest by simply borrowing the identical amount right back to your TD account.

At the end of the day, your entire HELOC will remain qualified for SM and you can simply use the entire interest amount come tax time. Scotia should send you an annual statement each year on how much interest you paid, or you can easily track just 12 payments made during the year.
Newbie
Apr 3, 2008
24 posts
7 upvotes
Toronto
Thanks for replying. Glad to know I won’t be required to open a Scotia account.
Yes, I plan to keep the HELOC and Questrade accounts only for the SM.
However my personal chequing account at TD is already pretty busy. I would think, and people have recommended, that one would want to have a dedicated SM account to track at least the in & out HELOC payments at Scotia and perhaps any dividends coming out of the Questrade investments. Proposed Tangerine to keep the fees low and separate it from my TD registered accounts.

Non-sheltered SM investment questions to follow…
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User avatar
Jan 2, 2012
4596 posts
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Toronto
Cleanhead wrote:
However my personal chequing account at TD is already pretty busy. I would think, and people have recommended, that one would want to have a dedicated SM account to track at least the in & out HELOC payments at Scotia and perhaps any dividends coming out of the Questrade investments. Proposed Tangerine to keep the fees low and separate it from my TD registered accounts.
I really don't understand how tracking HELOC payments is confusing. There are literally 12 payments per year you have to track, and it doesn't get any more complicated than this. Once a month you can take just a minute or two to record the interest payment on an excel file or something. Also your Scotia account should have a yearly summary for you to show exactly how much interest you paid on the HELOC in a given tax year, and will have online access you can log into anytime to see a history of transactions and show you the interest payments in and payments out.

For the life of me I can't even begin to understand why one would want to go trough hassle of setting up a 2nd bank account for this. To me would be extremely annoying to have to continually fund some 2nd bank account every few weeks to ensure mortgage and HELOC amounts are in there so there isn't an accidental NSF.

Dividends coming out your Questrade account are irrelevant to the SM. They will be taxed under dividend rules. As dividends are paid you have a few options:
- Set up a registered account in QT (TFSA, RESP, RRSP, etc). Transfer the dividends from the unregistered QT account used for SM, to your registered account to continue them growing tax-free or tax-deferred.
- transfer dividends to your TD chequing account and use the extra cash to pay down mortgage/increase HELOC availability
- or just use the dividends as extra taxable income, paying bills, etc

Just make sure when purchasing investments for SM, do not get any funds that pay out Return of Capital (ROC) as this will cause extra headaches to keep the SM account fully eligible. Stick to funds that pay out nothing, or are dividend payments only.

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