Smith Manouever

[Ares]

Hi Everybody; anyone ever hear of a financial strategy called the Smith Manoeuver. My financial planner is advocating it, it is a tax strategy that he says will pay off my mortgage in half the time with the same monthly payment. It involves borrowing an amount of money equal to my current mortgage, investing it and using the cash flow the investment generates to make extra mortgage payments. It also generates tax refunds from the interests cost. Ive seen his numbers, my accountant has looked at it too, but its one of those things that you have to wonder...is it too good to be true??

cheers,

 

[3Tees]

There will probably be lots of opinions on this. In mine, it is not too good to be true, but there are a lot of things to consider. First, if your mortgage does not have a home equity line of credit attached to it, you will need to break your existing mortgage to get this, and there will likely be penalties involved in the thousands of dollars range.

Second, you will be leveraged to the hilt for a while. That means you have to be very comfortable with debt, and you will likely not be able to get any more credit should you need it. That means, unlike most Canadian families, you should have a goodly chunk of cash put away for emergencies, because you will not be able to borrow any if you need it.

Third, moving or changing houses becomes somewhat difficult. If you move, the lenders may call in their debt, and if you are using Smith's Accelerated plan, where you have a lender give you 3:1 for your "Freeboard" home equity, that could be a bit of trouble.

Fourth, you need to have a high enough income to generate the most tax advantage. If you, or your spouse suddenly drops in income, you will not be getting the same tax advantage.

Fifth, you need to be very careful of the investments in which your advisor is putting your funds. They're probably secure, but if they bottom out, that is where the risk in a leveraged strategy comes in. However, if you are using competent people, this should not be an issue.

Beyond these sort of practical issues, I believe the theory to be sound and a worthwhile endeavor if it meets the practical conditions I outlined above.

 

[stang]

I've thought about it too, but every "investment" I've ever made has tanked and caused me grief.

 

[Mongrel4u]

you have to be comfortable with debt and volatility for one.

Its cleaner if you keep the leveraged investment separate from the mortgage...just use the equity in the home to QUALIFY for a leverage loan

 

[smores1]

There is also a GAAR challenge on interest deducibility, wait for the ruling before attempting to leverage. Last thing you want is a call from CRA!

 

[roxyfan]

Be careful of this. Essentially you are borrowing to finance investments - that your financial planner is making a big commission on. Ask him who benefits more - the client or the planner?

 

[red]

Hi Everybody; anyone ever hear of a financial strategy called the Smith Manoeuver. My financial planner is advocating it, it is a tax strategy that he says will pay off my mortgage in half the time with the same monthly payment. It involves borrowing an amount of money equal to my current mortgage, investing it and using the cash flow the investment generates to make extra mortgage payments. It also generates tax refunds from the interests cost. Ive seen his numbers, my accountant has looked at it too, but its one of those things that you have to wonder...is it too good to be true??

cheers,

if you use the income to make mortgage payments how are you paying the investment loan interest payments?

 

[squash500]

Fifth, you need to be very careful of the investments in which your advisor is putting your funds.

3t's brings up an excellent point. A lot of these advisors will take the $200000-300000 heloc and put all the money not only into risky mutual funds but dsc funds as well where they make 5% commission right off the top .

 

[3Tees]

3t's brings up an excellent point. A lot of these advisors will take the $200000-300000 heloc and put all the money not only into risky mutual funds but dsc funds as well where they make 5% commission right off the top .

I was very close to doing the Smith Maneuver. One of the main reasons was this fact.

 

[Primetime21]

There is also a GAAR challenge on interest deducibility, wait for the ruling before attempting to leverage. Last thing you want is a call from CRA!

Not only is there a challenge, but CRA is looking at writing in a change to the Tax Act to disallow this which would make it illegal.

 

[Mongrel4u]

3t's brings up an excellent point. A lot of these advisors will take the $200000-300000 heloc and put all the money not only into risky mutual funds but dsc funds as well where they make 5% commission right off the top .

1) If you are doing a leverage you have to be agressive in order for it to be worth while

2) The DSCs are a non issue if your time line is 7+ years

 

[3Tees]

Not only is there a challenge, but CRA is looking at writing in a change to the Tax Act to disallow this which would make it illegal.

Can you show me where this is? I'm exceptionally curious to see what the proceedings are like. Smith says, and I agree, that if they disallow his maneuver , it could also mean disallowing deducting ANY type of investment interest as an expense. If that were the case, I believe it would stop short of plunging Canada into a Civil War.

It would decimate any sort of real estate investment, including building new dwellings - developers live off of mortgages and then deducting interest. Any business that borrows money to invest, whether it be in R&D or in a security would also be wiped-off the map unless CRA is going to do this very carefully and selectively. This is why I want to see the source of the information.

----EDIT-----

OK - a previous poster mentioned a GAAR challenge - I looked it up, and apparently this is how CRA could do it without affecting other investments in Canada.

 

[3Tees]

The Department of Finance, not the CRA, write amendments to the ITA.

Anyways, I agree with 3Tees. What's the problem with interest deductibility? There is direct tracing to the use of funds, and the investment income would be taxable.

Also, what is the pending GAAR challenge?

Don't know what the exact GAAR challenge is, but it seems that they could use this to say that any home owner that uses interest deductions tied to a mortgage is "avoiding" taxes, and that particular method of avoiding taxes is not allowed.

I may be speaking out of my ass, as I know nothing of tax law, and have only spent 10 minutes researching this while my dinner heats up. However, I'd be very upset if I have interpreted this correctly and if they went ahead with it. Personally, a very sad day for Canada, IMHO.

 

[xarir]

One of the biggest challenges to making this work is that the investment income is taxable. If you assume 50% taxes, you can see how quickly something like this can unravel.

The one thing that can make this work is that money is cheap right now. i.e. The cost of borrowing (interest rates) is relatively low. As such, the investment stream required to make this work is not as high as it might otherwise be.

Clearly this is not a slam-dunk by any means. But if your outstanding mortgage is low relative to the amount you have to invest, it might work.

 

[y2kmark]

I guess so...

Hi Everybody; anyone ever hear of a financial strategy called the Smith Manoeuver. My financial planner is advocating it, it is a tax strategy that he says will pay off my mortgage in half the time with the same monthly payment. It involves borrowing an amount of money equal to my current mortgage, investing it and using the cash flow the investment generates to make extra mortgage payments. It also generates tax refunds from the interests cost. Ive seen his numbers, my accountant has looked at it too, but its one of those things that you have to wonder...is it too good to be true??

cheers,

The catch would seem to be where the money comes from to pay the original loan. Since borrowing costs exceed investment returns when risks are equal I don't see where you come out ahead unless you manage to gamble big and win.

 

[red]

The investment income is first used to pay the interest, and the residual is used to paydown the mortgage. Of course, this assumes that the investment income earned exceeds the sum of:

1. The cost of debt (interest)

2. Transaction or brokerage costs (trading and admin fees)

thanks. at least that makes more sense to me. seems risky when you figure the rate of return you need to make this work.

 

[C Dick]

The catch would seem to be where the money comes from to pay the original loan. Since borrowing costs exceed investment returns when risks are equal I don't see where you come out ahead unless you manage to gamble big and win.

It is the standard baby boomer assumption, that investments can be counted on to return whatever rate you need. Someone has a 6% mortgage, and assumes their investments will return 12%, so the Smith plan makes total sense. So then why would anyone give him a 6% mortgage? It is just another way of achieving a higher average rate of return by taking on some risk.

 

[Shades]

Bad...bad....bad investment idea. I know of several people that have done this and have lost big time. The only people that make money on this scheme are the mutual funds and of course your bank that provided the collateral loan.

 

[billybobjoesue]

We considered it at one point and discarded the idea because we thought it too risky, especially in volatile markets. Shortly after we declined our former financial advisors advice, he then quit trying to sell the Smith Manoever. I thought that kind of said it all, so we got rid of him and went to another.

 

[Mongrel4u]

Bad...bad....bad investment idea. I know of several people that have done this and have lost big time. The only people that make money on this scheme are the mutual funds and of course your bank that provided the collateral loan.

Its not a scheme... just not for everyone and you have to make sure you are properly invested