Smith Maneuver Blueprint: Top Tips for Success in 2024
Disclaimer: Past performance does not guarantee future results. The information on this website is for education and illustrative purposes only, and is not intended to be used as, or construed as investment advice. Seek the advice of a licensed investment processional before investing.
Pay off your mortgage years faster. Send kids to school. Retire years sooner, with more. No matter why the Smith Maneuver tax deductible mortgage strategy has caught your eye, you’ll likely have a few questions about what’s involved with setting it up and managing it successfully. While this is not a difficult strategy to master, there are a few important points to understand.
By reviewing our Smith Maneuver Blueprint, you’ll get our 10 best tips for implementation, while learning how to help improve performance and minimize risk. At the end we’ll look at an Smith Maneuver example, and what the results could look like. Altrua Financial Mortgage Brokers and Financial Planners can work with you at each step to help ensure an easy process and your best result.
Let’s jump right in.
Understanding and Strengthening Tolerance for Risk
Because the Smith Maneuver involves borrowing from a HELOC to invest, the first thing to understand is your tolerance for risk.
Risk tolerance boils down to your ability to hold on to your investment/ not sell your investment, when the market drops.
When the market drops, will it come back up? At every point in the history of the modern financial markets/stock markets, going back over 150 years, markets have always gone on to increase after a drop. But the key has been holding during the dips. Those who try to avoid the dips or time the dips by selling, usually get caught holding losses and missing out on market rebounds.
There will continue to be market dips and corrections in the future, but markets will continue to rebound and increase as well.
Tolerating risk is a high level understanding that there will be fluctuations, and with this understanding, building confidence in your ability to withstand acting on emotion during these fluctuations.
Holding the course even when things look terrible is the single biggest key to success.
Holding the Course to Mitigate Risk
Going hand in hand with understanding the inevitability of market fluctuations and your risk tolerance, is holding for the long term. We’ve studied the numbers going back 50 years and have seen that for periods of 20+ years, there hasn’t been any point where you would have lost with the Smith Maneuver, using a simple S&P 500 index investing strategy. In all 20 year periods there have been strong gains. However there were shorter term, 5 year periods where you would have lost money with the Smith Maneuver using the same S&P 500 index investment strategy.
So the message is not to pull out funds in the short term. The Smith Maneuver is designed for, and rewards those who take a long term approach of 15 – 20+ years.
Given this, it’s a best practice to think of the Smith Maneuver as a tool to help you reach your longer term goals, such as paying down the mortgage faster or retiring sooner, with more. The strategy should not be aligned with shorter term goals that require funds within the next 5 years.
Picking the Right Mortgage for Savings and Simplicity
Picking the right mortgage is essential for a well operating Smith Maneuver. At Altrua Financial, we go through a vetting process to select the right mortgage. Typically the mortgage is sourced through a Big Bank, and we ensure the lowest most competitive interest rate with that lender. In addition we ensure these features:
- Readvanceable HELOC: The credit limit grows as the main mortgage is paid down.
- Flexible pre payment/ extra payment privilege: Extra allowable mortgage payments that do not trigger penalty and are not limited to ‘annually’ or ‘semi-anually’.
- Allows readvancing of the HELOC at 80% loan to value/ 20% down payment: Every dollar of mortgage repayment increases the HELOC limit from the beginning.
- Multiple mortgage components: Allows the mortgage to be separated into several distinct parts, with each part serving a specific purpose and organized for clean record keeping. For example, there could be a HELOC component for personal use, and a HELOC component for the Smith Maneuver, in addition to the main mortgage component.
- Deduct HELOC interest payments from the HELOC itself: As the borrowings from the credit line charge interest, we seek the option to charge this interest back onto the HELOC itself. This option means no additional out of pocket payments for you and higher income tax deductions.
- Automatic investment: The HELOC can contribute directly to your investment without account transfers or additional work.
The right mortgage will make all the difference with efficient, time saving operation and income tax accuracy. But not all mortgages are created equal and the big differences are in the details. Connect with Altrua to get our recommendation for today’s best Smith Maneuver mortgages and how they meet these criteria.
Other Mortgage Resources:
Consolidating Debt for Hyper Growth
If you have a car loan, other loan or credit card debt, it’s usually best to consolidate this into the main mortgage at the outset of the Smith Maneuver. This is because:
(1) It can reduce the interest cost
(2) It frees up monthly cash flow that can be used for extra payments into the mortgage.
For example: Instead of making a monthly mortgage payment of $2000 and a car payment of $500, the idea is to consolidate the car loan into the mortgage and then increase the mortgage payment to $2500 per month.
This is helpful because when extra payment is made against the mortgage, it speeds up the conversion to tax deductible interest and improves long term results from the strategy.
Optimize the Investment to Maximize Returns
There are different personal takes on what investment works best, with some preferring dividend paying stocks and others real estate investments. The main rule for deducting interest for income tax purposes is that the investment is income producing, or has the potential to be an income producing investment. So no bitcoin or gold investments would qualify, because these investments can’t even possibly pay a dividend or income stream.
At Altrua, we believe stock market index Exchange Traded Funds (ETFs), such as the S&P 500 index are very well aligned with the Smith Maneuver.
One reason we like ETFs is that we can easily study past returns over long periods of time. With an ETF such as the S&P 500 index, the returns are more reliable long term – not just for 3-5 years of past performance, but for 100+ years.
Another reason is ETFs provide ‘efficient’ returns from a highly diversified index of investments/companies (ex. The S&P 500 index invests into 500 top US companies!). Returns are efficient because the management fees/costs of owning ETFs can be very low, under 0.10% in some cases. Because of the low ongoing management cost, this leaves more returns for you, the investor. Some mutual fund investments, for example, charge 2%+ in fees, and this eats into your return over time.
Finally and perhaps most important, the ETF strategy is simple. All you need is an investment account such as Questrade or through your bank, and investment purchases can be set up automatically. It is easy to set up and manage long term.
Average in to Reduce Risk
Averaging in, or buying into the markets slowly and consistently over time, is a key way to reduce risk and improve returns. Because the Smith Maneuver works over years to convert taxable mortgage interest into tax deductible interest, this also means you are spreading out your investing over the months and years.
When markets are going up, you’ll feel the confidence that comes along with the returns. When markets are falling, you’ll still be adding to your investment consistently at bargain prices.
In fact, by buying as markets are decreasing, profits can be made during longer periods of ‘flat’ markets, as markets move back up to/return to the point when they started dropping.
Record Keeping for Good Nights Sleep
Record keeping is essential for the success of the Smith Maneuver, in case the CRA wants to see how you’ve been deducting the HELOC interest. Altrua Financial assists clients in keeping proper records to help make this process simple and straightforward. Managing these records takes just a few minutes per year and is mainly done in online banking.
The main records you’ll need to have access to are:
- Annual mortgage statement (typically mailed directly from the Bank in January)
- Copy of your annual mortgage payments. (downloaded PDF file)
- Record of all HELOC transactions including interest charged back/ recapitalized onto the HELOC and of each month’s investment purchase. (downloaded PDF file)
- Copy of the years investment purchases (downloaded PDF file)
- A spreadsheet file that matches/reconciles and summarizes these different transactions for the year. (Template provided by Altrua Financial)
WARNING: For record keeping ensure your HELOC and Smith Maneuver investment account are strictly dedicated to Smith Maneuver activities. We need to be able to trace and match each transaction (there should be only 12 transactions per year) across these forms. However if there are other transactions, such as spending on personal items in the HELOC, this will throw off the accounting and could result in hours of reconciliation from a professional accountant.
As long as the mortgage components (ie, the HELOC) that are used for the Smith Maneuver are kept distinct, it will be simple and there should be no issue.
If there is other non Smith Maneuver related spending required from the mortgage, this should be done from a distinct mortgage component (ex. a different HELOC account) within the overall mortgage.
Transactions can be monitored monthly if desired, however the book keeping only needs to be done once annually, and it should just take 15 – 20 minutes to complete. Altrua Financial will help to set this up and ensure you’re on track.
We recommend the mortgage be set up for monthly payments to help reduce the number of payments to 12. Keeping in mind, monthly payments can still be accelerated by making extra pre payments, as discussed in ‘picking the right mortgage’.
Income Tax Savings Secured
Because the Smith Maneuver dedicated HELOC balance is invested in to income producing (or potentially income producing) assets, the interest paid can be deducted for income tax purposes. This involves a simple ‘interest cost’ entry on Line 22100 of the income tax return.
For those comfortable with bookkeeping and income tax preparation software, the income tax can be done by themselves. However for most a human tax accountant is recommended.
Any qualified tax accountant will be able to ensure the interest is deducted correctly for tax purposes.
Altrua also works with competent tax advisors who charge less than $100 per return and understand how to report the Smith Maneuver correctly.
Income Tax Re-investment is Key
Once the interest deductions are processed and the income tax return is received, how this refund money is used can help to make the Smith Maneuver work to its fullest.
The best practice, and fundamental to optimizing the Smith maneuver strategy, is to take the income tax return and put that against your mortgage.
Paying down the main mortgage using your income tax return is nice because it’s simple and perpetuates the tax deductible mortgage conversion process.
At the End – Efficient Collapse for More Tax Savings
Years down the road when approaching retirement, you’ll likely have a large NON Registered investment (ie. NON RRSP/ TFSA) that is part of the Smith Maneuver strategy. So when selling the investment and taking the profits, it will be subject to capital gains tax.
It’s very important to consider the income tax treatment of these capital gains (profits from the Smith Maneuver), and to potentially reduce income tax.
One way to do this is to collapse the Smith Maneuver slowly over time. This means selling the investments to pay down the HELOC and take profits, perhaps over 5 years as leading up to, or as you enter retirement. If you still have a main amortizing mortgage in addition to the tax deductible HELOC, you could pay off the main mortgage at 20% per year, for example and potentially avoid pre payment penalty.
Another potential strategy is to plan some years at the beginning of retirement, with no other income. This means postponing pensions for some time, to dedicate these years to cashing out your Smith Maneuver, thereby keeping the marginal tax rates and average income tax paid, at their lowest.
Yet another strategy is to purchase RRSPs with the sale of Smith Maneuver investments. Buying the RRSPs reduces the higher taxable income in the year, that was caused by the capital gains/Smith Maneuver profits. Then once the investments are in the RRSP, the funds can be withdrawn from the RRSP slowly over your retirement, to help reduce taxes paid. Once the RRSP is converted into a RRIF (registered retirement income fund), at the age of 65 or later, there is also the option of income splitting with a spouse, and the pension income tax credit that can work to make taxation even more efficient.
Smith Maneuver Example
Here’s an example of the Smith Maneuver based on the Blueprint above. For more Smith Maneuver examples, click here.
Assuming:
Home Value $1,000,000
Starting mortgage balance, (in this example a refinance): $500,000
Amortization: 20 YRs
Interest rate: 4.5%
Mortgage Principal payment at beginning: $1,294.37 (amount invested from HELOC in month 1)
Mortgage Interest payment at beginning: $1,857.66
Total Regular mortgage payment: $3,152.03
HELOC Rate (average in this example): 5.75%
HELOC interest cost starting in month 2: $6.20 (this amount is ‘recapitalized’, or added back into the HELOC and this will continue for 20 years)
Income is $100,000 with a 31.48% Marginal Tax Rate
Income tax refund from HELOC interest paid (average tax refund over 20 years): $3,898 – used to repay the mortgage faster
Return on Investment: 7%
Results after 20 years:
Note: Mortgage payment did not increase given a consistent 4.5% (mortgage) and 5.75% (HELOC) interest rate over 20 years. Interest rates are likely to vary.
Investment portfolio value: $852,877
HELOC Balance Owing: $500,000
Net Investment gain after HELOC repayment: $352,877
Accumulated income tax savings: $99,466
In order to help reduce capital gains tax on the $352,877 of realized gains in the unregistered Smith Maneuver portfolio we apply the following strategies:
- Spread the sale over 5 years or $70,575.4/yr to keep marginal tax rate lower
- Arrange for first years of retirement to be ‘other income free’ by postponing other pensions/ cash flows to keep marginal tax rate lower on the sales.
- Place some of the funds in RRSPs (if under the age of 71 and have room left)