What if I told you there's a way to invest in the stock markets, pay down your mortgage, and save thousands of dollars each year in tax?
It's my take on the Smith Manoeuvre (SM), a strategy popularized by a former B.C.-based financial planner. I want to give full kudos to the late Fraser Smith for sharing this strategy. If you want to learn the intricacies of this strategy before implementation buy the book like I did, it's well worth the money. You can also get Fraser's book at most public libraries.
The Smith Manoeuvre Guide
The Smith Manoeuvre is an advanced strategy that takes a bit of financial knowledge to implement. Management of several accounts linked to the strategy, careful accounting, and financial discipline are key to making the Smith Manoeuvre pay off big time. Over the course of your lifetime, you can literally be hundreds of thousand dollars wealthier with no extra cost to you by using this strategy!
The Smith Manoeuvre is best used by homeowners who have at least 35% equity in their homes and are putting money away into investment accounts each month. You should have a general knowledge of methodical self-directed investing before implementing this strategy.
Here are the detailed steps to implement the Smith Manoeuvre strategy:
- Obtain a re-advanceable HELOC style mortgage. You need to have at least 35% equity in your home first! Make sure the HELOC is structured so you have two separate parts: a nondeductible portion for your house mortgage and a revolving, re-advanceable, tax deductible portion for investing;
- Start a online chequing account with Tangerine or Simplii Bank;
- Sell your current taxable (not TFSA/RRSP!) investments and pay down your house mortgage portion of the HELOC;
- Start a new Cash/Margin Account with a brokerage. Make sure it is separate from any other Cash/Margin Account you may have! You must have a clean paper trail;
- Make regular mortgage payments and put all extra savings towards the house mortgage portion of your HELOC;
- Borrow back the newly available money from the investment loan side of your HELOC by making a transfer to the Cash/Margin Account;
- Use investment loan money to purchase Canadian stocks which pay some dividends. Make sure the dividends get deposited in your separate online chequing account;
- Use the dividends and new investment money to pay down your house mortgage portion;
- Borrow back newly available money from your investment loan portion and transfer to your Cash/Margin Account;
- Borrow from investment loan portion, transfer to chequing account, and send back to investment loan portion to pay the interest expense on the investment loan portion (guerilla capitalizing);
- Claim Canadian dividend income on your income tax return to the highest income earner, or split between both spouses if in the same tax bracket. Always claim investment income and deduct interest expenses (Step 13) in the exact same proportions;
- Adjust the investment loan for any Return of Capital distributions paid by your ETF, REIT, or stocks;
- Deduct all interest paid for investment loan portion ONLY in the tax return of the highest income earner or split between both in the same proportions as the investment income (Step 11);
- Apply tax refund to house mortgage portion, borrow back under the investment loan portion, and invest in your Cash/Margin account;
- Repeat steps 5 through 14.
When you are finished paying off the mortgage (Portion 1 of the HELOC), you have several options. Here's a post to give you some ideas.
The SM Strategy Effects
In this admittedly complicated strategy you are basically shifting your debt from non-deductible mortgage interest expense to a fully deductible interest expense used for investing purposes. This allows you to invest the principal repayment and tax savings with no extra monthly cost to you.
There are numerous steps involved; to get an idea of the money flow, here is a diagram of the accounts and steps involved. There's a lot of money movement involved!
With the Smith Manoeuvre strategy, you don't become debt-free. Instead you maintain your debt level at a maximum of 65% of your stated house value, but you grow a massive investment account alongside your loan.
After the first few years, your investment account should start to increase in value and exceed your investment loan liability. Combining tax savings and compound interest from investing is a powerful force which generates substantial wealth over time.
This strategy is somewhat more risky than simply paying off your mortgage and building an investment account on the side. However, as this post shows, the risk is manageable and the rewards are potentially significant.
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