How to get the most out of the Smith Manoeuvre
Before we get started – Please make sure you get professional guidance from an accountant, financial planner and have a mortgage broker who understands the strategy set up everything correctly.
Choosing the right readvancable mortgage product
Make sure you consider the product and lender you are choosing. We can help you with refinancing your home and setting up the correct mortgage. If you are planning on working with your own bank I strongly recommend you consider other lenders as wel. Many lenders offer a readvancable product but some have a few drawbacks such as the lack of an amortized variable mortgage product. (0.15%-0.65% more expensive on the line of credit and monthly account fees also do not help). You will want a collateral charge product that is readvancing. Learn more here.
How to pace your investments
Once you are implementing the strategy there are a few ways to approach it, please make sure you get professional advice from a certified financial planner (not me). Some will dollar cost average a monthly amount into their investments, generally this is the amount they pay down on their mortgage each month. Variable may be a better option as the interest cost is lower intitially https://www.kbmortgages.ca/article/fixed-vs-variable/ I can help you narrow this down with projections if that helps in any way.
Others will build up available credit and invest periodicaly (real estate investing, buying businesses or other investment strategies).
How to reduce the cost of your tax deductible debt
When you build up a moderate level of tax deductible home equity line of credit debt (HELOC) – you can convert your interest only HELOC debt (rate averages around Prime+0.5%) into an ammortized variable mortgage (rate averages around P-0.75%). This leads to a net savings of roughly 1.25% or $1250 per $100,000 per year.
Amortizing the debt results in triggering a penalty if you pay of the mortgage early (before the term ends, typically five years). The interest saved by locking in typically covers the breakage penalty in 6-10 months. I can run a calcuation if you need help here.
When you amortize the interest only heloc debt into a closed variable mortgage you increase your monthly payments by roughly 26% but reduce your interest cost around 34%.
The principle (debt) you pay down on this monthly payment will move over to a HELOC to be reinvested or kept as a safety net if setup correctly.
Make sure you understand your net cost of borrowing
Its important to note that tax deductible or not your net cost is an important factor to look at. Some scenarios result in a higher net cost even after the tax deductibility is factored in. There are instances where this means its best to freeze the strategy and sometimes a specific plan is needed to be beneficial. This particularly applies to aspects of the strategy that are focused on debt conversion rather than reinvesting.
Ways you can consider implementing the Smith Manoeuvre without investing
The main components of the strategy that are focused on debt conversion are debt swaps, cash daming and dividend diversion.
Implementing a debt swap
If you have non registered investments you can consider liquidating them, paying down your non deductible mortgage and reborrowing in a tax deductible way. You should speak with a qualified investment advisor and tax expert as there are tax implications here (taxes triggered by sale of your investments) and rules around the reinvestment of funds if you are realizing a loss. This strategy can create long term tax deductions with minimal additional risk being created as you are not taking on new debt but rather transforming non deductible debt into tax deductible debt. Situationaly this can also create additional write offs due to harvesting tax losses with the non registered funds (there are rules and you must get professional advice).
Setting up cash daming for the Smith Manoeuvre
If you own rental properties or have a sole proprietorship you can take the gross revenues from your business (generally equal to your business expenses) and pay down your non deductible mortgage debt. You then reborrow the business expenses. This eliminates non deductible debt and creates tax deductible debt without taking on additional investment risk.
Diverting non registered dividends to pay off your mortgage faster
For non registered assets generating cash returns (generaly dividends but can work for interest income as well). Before reinvesting the cashflow you pay down the non deductible debt, reborrow and then invest. This also creates negligible new investment or debt risk (assuming you were going to reinvest anyhow).
All three of these strategies do best when combined with the locking in method to further reduce total cost.
What does Kirkwood & Brennan do for you?
Our focus is on helping clients flow their funds the most efficient way possible and we have clients who implement the Smith Manoeuvre while minimizing any additional investment risk (they are not increasing their debt levels or borrowing to invest additional funds. They are simply taking funds they are planning on reinvesting and diverting them to reduce the non tax deductible debt and replace it with tax deductible debt. They do not reinvest their monthly principle (debt) paydown. Others are just diverting cashflows and running them through their residence to reduce the non tax deductible debt and replace it with tax deductible debt. The goal is still eliminating all of their debt as fast as possible (non tax deductible first, then tax deductible).
I started the article with this and I will end it this was as well. Please seek tax and investment advice from the correct experts. If you need a good accountant or financial planner send me a message and I will help you find someone.
Hopefully this helps! Let me know if you have questions.
