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Smith Manoeuver Seminar
- 7. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 8. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 10. History of THE SMITH MANOEUVRE
- 11. What is THE SMITH MANOEUVRE
- 13. A picture is worth a thousand words…
- 14. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 15. THE SMITH MANOEUVRE Is your mortgage tax deductible? GOOD DEBT BAD DEBT
- 17. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 18. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 19. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 20. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 21. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 22. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 23. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 24. tidbit How much do you have to earn to pay off a $200,000 loan?
- 25. Read it and weep… • You need to earn this much: $700,402 • You pay this much income tax: $280,161 • You have this much left: $420,241 • You pay this much bank interest: $220,241 • Pay back the original loan: $200,000
- 27. Is this legal?
- 30. case history: Quantify the value of THE SMITH MANOEUVRE for the Blacks.
- 32. Future value for the Black’s current investment program?
- 34. $1,205,152
- 35. What if they did THE SMITH MANOEUVRE?
- 37. $1,962,770
- 39. For the Black’s, this is a decision worth 3/4 of a million dollars!
- 40. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 41. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 42. THE SMITH MANOEUVRE Is your mortgage tax deductible?
- 44. Lets summarize…
- 45. “ Procrastination is the enemy of your financial success” F. Smith
Editor's Notes
- The generic graph in the logo is a convenient way to explain to others how The Smith Manoeuvre works, which will become vividly clear by the time you go through this PowerPoint presentation.
- Point one – there is an important difference in Canada between deductible interest and non-deductible interest. If you borrow to invest with the intent of earning income, the interest expense on that loan is deductible from your income. Other loans for personal use, for consumption and for your personal mortgage do not yield deductible interest. The problem most people have is that they already have a huge non-deductible debt in the form of their mortgage, and have it in their mind that they should get rid of the mortgage first, and then they can start thinking about building an unregistered investment portfolio. And that is what will doom thousands of Canadians to the serial approach to debt and to investing which then leads them to needing a reverse mortgage in their retirement. To get tax deductible interest happening, so that we can generate tax refunds which will in turn allow us to reduce the mortgage faster, we need to convert the bad-interest mortgage to a good-interest investment loan. Bad interest is non-deductible (car loans and house loans), and good interest from investment debt is deductible. A $200,000 house mortgage needs to be turned into a $200,000 investment loan as fast as possible, using The Smith Manoeuvre. Point two - when the free money comes from the tax department in the form of tax refund cheques, we must be wise enough to apply this found money against the first mortgage to drive it down even faster. The tax refunds are generated by the deduction from our total income of the interest expense on the investment loan. Point three - As we re-borrow, we are able to buy more investments. Not only does this process generate the tax refunds, it also builds an investment portfolio which compounds in value over the years, and it is this portfolio which becomes our personal un-registered pension plan. The investments are free and clear as well, so they are available to sell in times of trouble, such as job loss. The process is reversible. No need for that emergency fund “six months of income” in the bank – if you have such funds sitting awaiting an emergency, consider using this money instead to reduce the first mortgage and immediately re-borrow it and get it invested. Your own personal un-registered investment portfolio is a far better pension plan than the ones so many are depending on from their company or the government. That’s a bad risk to take, and an un-necessary one.
- Stats Can advises us that 53% of the wealth of all of Canada is owned by 10% of the population. For purposes of this presentation, we arbitrarily will choose to call that 10% group the wealthy folks, and the rest we will refer to as the not-wealthy folks. If you have a mortgage, you likely assume you are in the not-wealthy group – surely wealthy people use some of their wealth to pay off their mortgage. What are the reasons that so many hard working, honest, dedicated, intelligent and talented Canadian families are finding it so difficult to move to the pointy end of the wealth pyramid?
- One obvious problem is that our living standard has been dropping for several years. This is a function of incomes not keeping up with the increase in the cost of living. For people on fixed incomes, low interest rates play havoc. Retirees can be in real trouble if they have no investment portfolio generating income to supplement inadequate pensions. Many older citizens have tiny (and taxable) interest income from money-market instruments which they purchase because they are “safe”. After tax, and after inflation, most of these instruments produce little or no real income. Taxes are rising in all areas. A Google search for Tax Freedom Day will support what every Canadian knows all too well - taxes are too high. Tax Freedom Day now arrives in Canada half the way through the year which is another way of saying that all taxes of all kinds take up about half of our gross family income each year. There has been a simultaneous increase in the cost of housing which now runs over 40% of income in BC, with a Canadian average of about 30%. The average Canadian is therefore spending as much as 80% of his income on taxes and housing. He has not yet funded clothing, food, transportation, education, retirement, medical, charity, insurances, savings, children and recreation. No wonder it feels tight for not-wealthy Canadians. Another problem is that our general education on things financial is abysmal. Most do not understand investing, compounding, interest or mortgaging, to name a few topics. Most Canadians are paying full income taxes. They have not managed to set up their financial life to take advantage of government incentives that produce tax deductions such as those routinely taken by wealthy people. Most Canadians do not have anywhere near enough put away for their retirement, and the problems enumerated here will prevent them from changing a bleak future if they don’t take action now. Government pensions are systematically being clawed back, and if they are under funded the government simply increases payroll taxes to put the burden onto those who work and their employers. Many company pension plans are dramatically under funded as is evident in recent media stories on the tragedy. The shortfall estimated by the Certified General Accounts of Canada (CGA) is over 160 billion dollars! The CGA estimates that 59% of Canadian companies are running pension deficits. But there is a much more serious systemic problem that pervades Canada which militates against financial success for not-wealthy Canadians. It is not some great conspiracy of government and business. It is a result of the human propensity to resist change, of the triumph of tradition over common sense, a bit of the boiling frog effect plus a dose of the lemming effect. This murky cloud is shrouding the lower 90% of the people in the Wealth Pyramid, but most just live with it, and most don’t even know it is there. But it is there, which will be shown, and the good news is that it is quite easy to fix once the problem is understood and acknowledged. The problem is demonstrated in the next slide, The Canadian Dream.
- This graph illustrates The Canadian Dream for many Canadians. For purposes of this example, we have gone to the Wealth Pyramid, and right out of the middle, we have picked Bill and Doris and their family to be our example. They are 40, they have a home with a $200,000 mortgage on it. They got their first house when they were married at age 25 for $150,000 of borrowed money. As things got better on the job they had kids and changed to bigger houses a couple of times. We will make the assumption that they earn just enough to manage their mortgage payments and pay their bills. They have no other debt. They have never made enough to be able to gather any other assets except their house, which is why their investment portfolio, the red graph line, runs along the zero line. They would like to have an investment portfolio, but the money runs out before the month runs out. The Canadian Dream for many average not-wealthy Canadians is to retire at age 65 and pay off the mortgage on the same day. Hopefully the government pensions plus the freed up cash from no more mortgage payments will let them manage a decent retirement. The equity in their paid off house gives comfort, and they feel good that they can leave the gift of equity to their children when they pass on. They retire and pay off their mortgage on their 65 th birthday. They have a big mortgage burning party and a simultaneous retirement party. Then Bill gets sick. There is not enough income. Bill has seen the TV ads with Gordon Pape talking about the Canadian Home Income Plan (CHIP) Reverse Mortgage. They will allow him to sign up. Bill is grateful that the program is there to supply him cash flow via his home equity, but the price is steep. The Canadian Dream has turned into the Canadian Nightmare, and it looks like this:
- The Canadian Home Income Plan is a very welcome program for those jammed financially as are Bill and Doris in our example. We are thankful that there is a program and institutions in the form of the banks, willing to lend money to people who don’t work anymore, are down on their luck, but do have equity in their home. It was the same at age 25 when we got that first home with 100% financing from the bank – we were grateful they were there with the cash so we could get a home. In the end, we can’t begrudge the banks the interest they require on the capital they lend – their job is to make money for the shareholders, and do they ever. We should not get angry at the banks – we should buy their shares. Still, it is startling to look at this chart to realize that at his age 25, the bank owned 100% of Bill’s house and that he worked the next 40 years of his life to pay the debt off, just like grandpa said he should do. Then, because he is short of cash in his retirement, the bank ends up owning his house again by the time he reaches 80 years of age. Bill got cash flow at age 65 which he required, but as each month passed, more and more of his house, and his legacy for his children, reverted to the bank – again. Bill and Doris worked the whole of their life from age 25 until they died, for the bank. There is a much better way. You may say that this is a sad example, but that you are doing better than Bill and Doris, so comparison is irrelevant. But if I show you that Bill and Doris can fix their problem from their poor vantage point, then hopefully it will be self evident that you could improve your position, as good as it may be, with next to no cost of any kind, by following the same suggestions about to be given to Bill and Doris. They are going to be much better off, and so will you, and so will anybody and everybody who has a non-deductible house mortgage. The minimalist condition that Bill and Doris are in, is avoidable, at no cost except reorganizing their financial set-up. You too can improve your condition dramatically. That’s what The Smith Manoeuvre does – any Canadian with a loan that is not generating tax deductible interest can convert that bad loan into a good loan – from non deductible to deductible. This is a debt conversion program that works very well, regardless of where you are located in the Wealth Pyramid. Bill followed the admonition of his fore bearers and the financial gurus over the ages – all telling him he best get rid of his mortgage, and then, when he did, he could divert unused cash flow to building up an investment portfolio. Everyone told him he needed to gather other assets for his retirement, but only after he first got rid of his mortgage debt. His neighbours on all sides, his friends and relatives and his co-workers were all trying to get rid of their mortgages too, so Bill and Doris just did what was expected, and their Dream ended up a Nightmare.
- There are multiple solutions to the multiple problems created by the inertia of tradition we live with as not-wealthy Canadians in this country. The first is to get educated in things financial so that you can feel somewhat comfortable about pulling the trigger on the sacred cow that debt is bad and you must get rid of it before you start to invest. You are off to a good start if you have read this far. The Smith Manoeuvre is remarkably simple, and some elements of the strategy will be familiar, but by the time you finish this presentation you will hopefully have a new appreciation for the opportunity that is in store for you. A part of the solution to the problem is to get financially independent sooner. Free money from the tax department would help you meet that objective. Compounding growth of assets that you purchase as you reduce your mortgage would also help you meet that objective. The risks for your retirement will be rather modest if you start now to generate free money for your family via tax refund cheques from the government. The point is, you are paying huge interest payments as part of your mortgage payment every month to the bank in any event. The Smith Manoeuvre allows you to change the character of that interest expense from the bad kind to the good kind by converting interest expense to tax deductions. You do not need to increase your debt to do this. This is not a leveraging strategy – it is a debt conversion strategy. You do not need to spend more of your own money to make this happen – you are already spending the money on your mortgage payment. It is a relatively simple rearrangement of your financial affairs that effects these dramatic improvements to your financial well being. Any planner will tell you that reducing income tax is one of the most efficient ways that exist in order to improve your personal net worth. That’s because you have to earn $1,000 in order to have $600 to spend if you are at the 40% tax bracket. The interest in the first year on your $200,000 mortgage at 7% is about $14,000, non-deductible. If you had implemented The Smith Manoeuvre, you would have a $14,000 tax deduction to claim. Furthermore, you could have this $14,000 tax deduction every year for the rest of your life . My objective for all Canadian mortgage holders is that they die at age 130 still owing the bank $200,000, still claiming $14,000 per year every year in tax deductions, and living off of the income of a huge portfolio of several million dollars that represents the compounding of $200,000 for all those years. What a wonderful personal pension plan. That’s what wealthy people do. So can you. The solution is to make 75% of the equity in your home work for you now – don’t wait until you are 65 and short of cash flow. The solution is to get rid of your bad mortgage, build an investment portfolio and get free tax refund cheques, all at the same time. It’s called The Smith Manoeuvre, and it’s easy to do. Stop doing things in serial fashion, and start doing them parallel. It’s profitable. The solution will be optimized if you are wise enough to make your plans with a financial planner who has the education and the experience to ensure that you capitalize on all of the benefits of The Smith Manoeuvre that are there for your family. He/she will have banking alternatives for you, mortgage and loan advice, investment alternatives for you to consider and tax analysis to apply. For most families this is the biggest debt they will ever deal with, and it deserves to be touched by your planner who has a lot to add to your considerations. You can do it on your own, but will you optimize your opportunity?
- As a financial planner in Vancouver in the early 80’s, I was fascinated by the fact that Americans could deduct their mortgage interest expense and Canadians could not. Over a couple of years I developed a strategy that needed the help of a friendly banker to make it work. If I could find one, I suspected I had a program that could effectively convert Canadian non-deductible interest into deductible interest. I was initially turned down my several large banks because my request was “irregular”, which was true. I finally realized I needed to deal with the president of a bank, and the closest one was Larry Bell, then president of Vancity and now Chairman of BC Hydro. Larry liked the idea which would bring new business to Vancity at the expense of the banks who had most of the mortgages, and within two months we were off and running. For 20 years I profited from this special arrangement as did my clients and several financial planners that I licensed and franchised to use The Smith Manoeuvre. Right from the beginning I planned to write a book and give away my idea to the people of Canada and I did just that. I retired in 2002 and wrote my book which is now a Canadian Best Seller. My mechanism in the beginning was the 75% collateral mortgage which evolved to Vancity’s Readvanceable Mortgage, and which is now offered by almost all banks across Canada with the Royal and BMO being the latest to offer the product. The BMO product called ReadiLine looks particularly adapted to handle The Smith Manoeuvre. ManulifeOne offers a unique style of first mortgage which will operate with The Smith Manoeuvre as well. TD Canada Trust has a very flexible readvanceable mortgage, and Scotia has the STEP program. As of the end of 2004, none of the banks have quite managed to match the maximum flexibility offered by the BC Credit Unions, but that is changing rapidly. Financial professionals have been attracted to the power of The Smith Manoeuvre, including financial planners, accountants, bankers, mortgage brokers and realtors. There are now over 150 financial planners listed at their request on my website as being interested in supplying assistance to you in implementing The Smith Manoeuvre in your community. See them at www.smithman.net under the “Find a Planner” tab. Planners interested in doing the same will find a registration form at the same tab. Several planning firms and planners have been bringing me in to their communities to conduct public seminars on the topic. Financial professionals considering seminars in their towns and cities may contact us at [email_address] The book and the CD called The Smithman Calculator can be ordered on the website. I will always remember that first meeting with Larry Bell when I had the chance to show him my stuff. As I finished explaining my strategy, he pushed his chair back and asked me, “Why isn’t every Canadian doing this?” What a great question.
- Next slide.
- This slide states the facts, but….
- Next slide.
- The Smith Manoeuvre can be used to convert any non-deductible debt to good debt, but in the case of house mortgages, I have always recommended that the client operate the Manoeuvre from the 75% or less mortgage level. Don’t start it up until you have at least 25% equity. It will be difficult though not impossible to start with less than 25% equity. Most banks want at least 25% equity, otherwise you are into expensive high-ratio mortgages with huge extra expense. 25% equity gives the bank comfort and you a safety margin. Many Canadians have more than 25% equity in their home. When the readvanceable mortgage is put in place, you and your planner will want to discuss whether or not you should consider putting the excess equity to work to increase your investment portfolio. If such a strategy is suitable for you, access to the capital will be require no additional banking exercises – your capital will be available by virtue of having structured your finances to facilitate the The Smith Manoeuvre. Consider using this excess equity to finance investments that yield income which you will then be able to divert as extra payments against your first mortgage. You could invest in dividend paying stocks or mutual funds, or investment real estate as an example.
- As the bad debt (red) is reduced either because of regular monthly payments or over-payments from time to time, the money is re-borrowed (yellow) and invested. If the average reduction of the mortgage by regular payments for the next 12 months is say $500 per month, then it would seem safe to set up a $500 per month PAC (Pre-Authorized Chequing) to purchase investments without undue management required.
- Next slide.
- This is a standard example of a Canadian mortgage for $200,000 at 7% for 25 years. It barely recedes in the early years as the payment is composed mostly of interest expense to the bank. As the loan gets smaller each month, the amount of the interest expense obviously goes down, which means that next month’s payment will have a little more pay down, and a correspondingly less amount of interest to the bank. It will take 25 years to pay the loan off, which is called the amortization of the loan. Any dollar extra that you can pay against the mortgage will reduce the principal owing by the whole dollar, which is why extra payments are very effective in reducing the length of time it takes to amortize the loan, which cuts down dramatically on the total amount of interest eventually paid by the time the loan is paid off.
- Here we see what happens if we ask the bank to reorganize the structure of our loan with them. The first thing to realize is that the bank gains something at this point in The Smith Manoeuvre which is why Vancity was willing to provide this special banking service, and it is why the banks are breaking with tradition after all these years, and are now starting to offer similar programs. This graph illustrates the device called The Readvanceable Mortgage. My request of Vancity was that they allow my client to borrow back and invest any dollar that the client first used to reduce his first mortgage. The blue line shows the mortgage dropping over the years, and the purple line shows us borrowing back and investing the same amount of money each month as payments are made. If we pay a dollar down on blue, and borrow it back on purple, then our total debt will stay at the same level which is what the yellow line is indicating. Purple is a mirror image of blue. Yellow is the addition of the purple value plus the blue value. Debt does not rise. We are converting the debt, not increasing it. That is why this is a debt conversion strategy, not a leveraging strategy. If you could handle the cost of $200,000 of debt at the beginning of the mortgage, the assumption is that you should be able to handle the same amount of debt next year, and every year after that. To make The Smith Manoeuvre work, all we have to do is make a decision to hold up on our urge to try to reduce our debt to zero. Instead, we have to get our head around the fact that it will be good for you to hold your debt constant, at least for the length of time it takes to make the conversion complete. As you can see in this example, the mortgage conversion completed in just over 22 years instead of the original 25 years we had contracted for in the original mortgage. How did the amortization period get reduced? By free tax deductions from the government. The tax refund cheques arrive each year and you use them to reduce your mortgage faster. As soon as you reduce your mortgage with these free cheques, you immediately borrow the same amount back from the bank and get it invested. The reason that the tax department will send you refund cheques is that the interest on the purple line is tax deductible because you ensure that when the money gets borrowed back, the re-borrowed money is used to buy investments. If it is, then the interest expense is classified as tax deductible from your other income. The interest expense you have been paying on the blue line, your original house mortgage, was never deductible, and probably never will be. Accordingly, the right thing to do is to convert the blue interest (bad interest), into purple interest (good interest). When the conversion is complete at just over 22 years in this example, you will still be paying interest on a $200,000 loan, but it will be 100% deductible from your other income. The effect on your income tax will be identical to the effect of you buying an rrsp for the same amount. To get that rrsp you had to buy it with your after tax disposable income. If you have done The Smith Manoeuvre, the equivalent tax deduction is free for the sake of having reorganized your financing. You could decide to start paying off your newly converted loan, using the cash that you used to pay for your mortgage payment. Wealthy people would not do that. They would likely pay interest-only on the $200,000 loan, and use the residue to increase their investment portfolio because if they reduce the newly deductible loan, they will not only start getting smaller tax deductions as the loan goes down, they will also have ceased to be adding investments into their portfolio because cash is being used to reduce the investment loan. Wealthy people have no aversion to dying at age 130 still owing Vancity $200,000 if it means they will have had over a 100 years of free and large tax deductions every year they are alive. In addition, $200,000 is a modest number compared to what they expect their investment portfolio to have grown to prior to their demise. The way wealthy people keep score is to subtract what they owe from what they own. The difference is net worth. Modest debt can provide compounding assets. You recognized that when you took on modest debt to buy your house, and your leveraging of your borrowing power has paid off as your house is likely increasing in value. The fly in the ointment is that all that interest on your mortgage loan is the bad kind. You need to convert it to the good kind which is what The Smith Manoeuvre will do for you. Simultaneously you gather free and clear investments to produce retirement income when the time comes. The cherry on the top is that free refund cheque from the tax department every year for the rest of your life. Just like the wealthy get. What would Bill and Doris own if they had employed The Smith Manoeuvre as recommended here?
- Reborrowing and investing the $200,000 represented by the conversion of their original mortgage, plus using the tax refund cheques to pay down their mortgage even faster (and reborrowing and investing the same amount) would grow to just over $500,000 in a free and clear investment portfolio if they achieved the 54 year average of the Toronto stock market of 10% per year. If they invested in US stocks, they would expect to average over 12% every year, and if they invested in US small cap stocks they would expect over 14%. These are the historical annual averages as documented by a Canadian firm called Andex Associates in Windsor Ontario. (www.andexcharts.com) Some will say that this example is only over 25 years, the original amortization interval of the mortgage, which is true. But even if we decided to inspect intervals as short as 10 years, we will find that 10% holds up as an average. Here are the results for several decades, starting with 1950: 1950 – 1959 12.7% 1960 – 1969 10.0% 1970 – 1979 10.4% 1980 – 1989 12.2% 1990 – 1999 10.6% I feel 10% is a fine representative number, because I believe we need to look to history to see the future. It beats gut feel, and it surely beats guess work. In any event, everybody deals with these things differently, and most folks would like to look at the alternative results depending upon changing assumptions, so we developed proprietary software over the past 20 years that is consolidated into a CD called The Smithman Calculator which allows you to enter what-if assumptions until the cows come home. It is available on my website www.smithman.net. These projected investment portfolio results may have tax considerations if and when you sell them, depending upon which asset class they may be. Any tax will be at favourable rates because most gains will be capital gains or dividends. There will be no tax unless something is sold, and a good planner will show you how to pull value out in tax-advantaged ways. For instance there will be no tax if the planner is arranging your funds to be return-of-capital as opposed to earnings. Holding instead of churning leads to tax free accumulation which means you will have the same growth effect in this unregistered portfolio as you would have in your rrsp. Unfortunately the funds removed from your rrsp are taxed at 100%. It is unlikely that anything removed from this unregistered portfolio would be taxed at 100%. It is important to understand the rationale for holding investments instead of churning them. The second wealthiest man in the world is Warren Buffet. He buys blue chip investments and then sits on them to let them compound. He does not panic and sell if the share prices take a dip. Usually he just lets the magic of compounding values make him even wealthier. It is not unlike the way you treat the value of your home. Do you panic and sell when house prices take a tumble, as they have many times? You stay where you are, and wonder of wonders, a few years later the value of the house is up again. You consider your house to be a pretty good investment – it has gone up an average of about 5% a year for many years now. The equity markets have gone up about 10% over the same years, maybe 7% or 8% after expenses and taxation. 8% is 60% more than 5%. Maybe Warren is onto something. Let history be your teacher. Treat your equity investments as you do your home – get them and sit on them. To be fair to the comparison between The Smith Manoeuvre way and the usual way, the total funds of say $500,000 shown in this example would have to be offset by the $200,000 investment loan which we expect to be on the books until you die. (It is your choice whether you keep that good loan in place or pay it down) Subtracting $200,000 means the net gain is about $300,000 in this example. It is free for simply arranging your financing at the front end. No new money came from you – it came from the tax department. Let’s assemble these elements, and generate The Smith Manoeuvre logo.
- Free for the asking.
- Bill and Doris are 40, as we have been told. If they want to avoid The Canadian Nightmare, then they need to revise their plans a bit, at next to no cost or ongoing expense, to produce a Revised Canadian Dream. It is called The Smith Manoeuvre, and looks like this:
- All they have to do is make an appointment with a licensed financial planner who is an implementer of The Smith Manoeuvre, and together with you and your banker, he will organize your affairs to convert your debt from bad debt to good debt as illustrated in this slide. If you do, the red line on the graph, your investment portfolio will start to rise off of the zero line and build over the years ahead to provide you an excellent source of income when you come to retire. You won’t need to depend on iffy pension plans that may or may not be there when the time comes. You will not need a Reverse Mortgage. You will have an estate to leave your kids – if they deserve it. The banker will still be profiting from you over the rest of your life, but that is more than fair if you are profiting too – and you are. This example requires no reduction in your life style. It requires no new money from your cash flow, although the performance of The Smith Manoeuvre accelerates dramatically if you do add additional funds to the program. It does require that you learn to live with good debt, which is much more tolerable than bad debt. It requires therefore that you think like a wealthy person even if you don’t attain to be one. We can learn from them. They are happy to share their secrets. They are mystified that you do not take the steps they do to make their equity work for them. Now you can. Now you will. Need some more convincing?
- If you accept this invitation to reorganize your current financing arrangements, your red line will take off. The assumption shown in this slide is that the re-borrowed money from the purple line was invested at the 54 year Canadian TSE average of 10% (taxable) per year. If that was attained, Bill and Doris would have an investment portfolio of just over $509,000 by the time they reached 65 years of age. The old mortgage would have been retired a few years earlier (blue), and they would be paying interest-only on their $200,000 investment loan (deductible) which used to be their $200,000 house mortgage (non-deductible). We show the investment portfolio flat from age 65 to 80 because we have assumed they need some cash flow augmentation, which originally was going to be supplied by a Reverse Mortgage. This might indicate that the portfolio was converted at age 65 to produce income from an annuity or from dividends, or a systematic withdrawal plan of some sort, leaving the capital in place. This rendition obviously leaves an estate at age 80 of the house, which has been compounding at say 5% per year since age 40 and would therefore list at $1.8 million dollars. The value of the house is not shown in this illustration. But we must not forget that we still have a $200,000 mortgage against it, so it would only be worth $1.6 million net. Our estate would also have an investment portfolio of $509,000 in it, because we have shown it left constant, drawing off only the earnings it made from age 65 to 80. While it is becoming obvious that any Canadian with a house mortgage should convert it from non-deductible to deductible, even if he is debt adverse, the prior paragraph gives us a hint as to how the rich get richer and the poor don’t. The clue is that the wealthy do not suddenly wake up at age 80 and say “my goodness, my house is worth $1.8 million!” Truth is, the wealthy learned a long time ago that you don’t just use OPM (other people’s money) when you go to borrow that first mortgage to buy your first house – that’s just how they get things started. What the wealthy do is that if their equity subsequently rises in any meaningful way, they are back to the well to take that new equity out to make it work for them. They do not sit on their equity whether it is in their house or in their business. They do it with care, they do it with assistance from professionals, they do it often, but they do it. The not-wealthy do not. Which is probably why they are not wealthy. If Granddad is still whispering in your ear, and if you just can’t bear having any debt at all, The Smith Manoeuvre does not preclude you from getting to zero debt if that is what you must do. But first, take the time to convert your bad debt to good debt, and then, if you must, begin to pay off that investment loan. This compromise will benefit you greatly because you will not be starting to go to zero debt until you have completed the conversion, and that means you will have your $509,000 portfolio in place before you start to pay off that last loan. May I remind you that the $509,000 requires no new money from you – it builds for you because of the free tax deductions and because of the magic of compounding of your investments. All that is required is that you arrange to have your financial planner reorganize the way your mortgage operates. If the investment portfolio only managed to earn 8% instead of 10% over the 25 year interval in our example, the investment portfolio would sit at $384,000. If the portfolio was invested in the US market on the other hand, the 54 year average (taxable) of over 12.5% would yield a portfolio by age 65 of $744,000. If you only invested in US Small Cap stock, at the 54 year average annual return in this sector of 14.3%, your investment portfolio would stand at $994,000. (These US averages illustrate why it is that financial planners work hard to encourage you to build a diversified portfolio.) These numbers are still large even after you do the arithmetic to offset the fact that you still have a $200,000 investment loan (deductible). If you run The Smithman Calculator on an iterative basis you will find that you only have to get an annual average return of less than 3% in order to generate an investment portfolio of $200,000, enough to offset the investment loan so that you are indifferent. If you only get 3% in your investment portfolio over the next 25 years, then we have more serious problems in the world than mortgages and investments, in my opinion. Your real choices are to take the Reverse Mortgage route which is a disaster, or bank on the world performing as it always has, once you have a program in place to make your investment portfolio grow. The deductibility of interest rules let you invest in many different asset classes, and we recommend you do just that. Invest in stocks and bonds, investment real estate, mutual funds, your own business, somebody else's business. Investing in this fashion makes the interest on those loans tax deductible, and the mixed bag of assets reduces your investment risk.
- I expect they are not teaching your kids this Tidbit in their school today.
- Is it easier now to understand why it is so hard for the average Canadian to get ahead? Is it easier to understand that you have to defend yourself, that you have to do something to fight back?
- This figure is very precise down to the dollar level because it is a combination of mortgage arithmetic and future value arithmetic. There is no guessing at this number. The same assumptions given to any planner or accountant anywhere in the world will yield the same answer to 8 decimals if you wish. The point is that it is very simple to do something about this number – all you need to do is work with a planner and with his/her help, you can turn the immutable laws of compounding into your favour instead of to the favour of your banker.
- The Smith Manoeuvre is legal. It relies on the tax dictum that money borrowed to produce income is generally deductible. There is an exception where your investment is solely for capital gains. The money you make on a capital gain is not considered income in the normal sense, by the tax authorities. Accordingly, interest paid on loans made to purchase investments purely for capital gain will not qualify to be deductible. As an example, if you invest in bullion gold or raw land, there is no income other that capital gains, so these items would not give rise to deductible interest on the loan. Most equity mutual fund or stock investments are purchased because we hope they will increase in value, giving rise to capital gains. But because there is an expectation that at some point there will also be dividends, the tax department allows you to borrow to make investments like these and still deduct the interest expense of the loan. This policy overrides the policy in paragraph one above. A famous court case back in 1936 involving the Duke of Westminster vs Inland Revenue set a standard measure that the citizen is allowed to arrange his personal financial affairs to his best tax advantage. That’s what we are doing when we institute The Smith Manoeuvre. Revenue Canada did come to see me several years ago, examined me and my strategy, visited the credit union to compare what I represented with what was being done, and have never come back to either of us. Why would they. The Smith Manoeuvre requires Canadians to purchase investments in order to convert their mortgage to the tax deductible variety. More investment means new businesses for Revenue Canada to tax to death, and new businesses need new employees which can also be taxed to death. So it’s win-win for all concerned. Revenue Canada will be happy to send you refund cheques, but every once in a while they may ask you to prove that the money you borrowed was used to purchase investments that you expect to provide income. For that reason, always be precise about your record keeping. Do not mix deductible loans with non-deductible loans. If you sell one of your investments that you bought with borrowed money on which loan you are claiming deductible interest, be sure that you use the loan proceeds to pay down the loan from whence the funds came in the first place. You may immediately re-borrow and purchase other investments. You must never use the proceeds to pay down your mortgage, or use the proceeds for personal reasons. If there is a profit attached to the referenced sale, you may and you should separate it, and use the profit to reduce your first mortgage further, and immediately re-borrow a like amount and get it invested too. The rules are sometimes arcane, and changes occur from time to time, but don’t let that stop you from taking advantage of the rules of taxation. You will not need to be concerned about the complexity of taxation laws because you are going to be working with a great financial planner who will ensure these things are done correctly for you.
- The first two steps form the Plain Jane Smith Manoeuvre.
- You enhance the Plain Jane by adding two more steps to the extent you have assets to liquidate in Step 3., and you have cash flow available to make overpayments on your mortgage in Step 4.
- Many great ideas, strategies and schemes sound good, and indeed may be good, but unless the claims can be quantified and verified independently, they probably have no lasting future. In the case of The Smith Manoeuvre, we are fortunate to be dealing with amortization software, tax arithmetic and future value calculations, all of which are rather precise in their genesis and their use. The Smith Manoeuvre is essentially a financial strategy that is supported by a rather large piece of software that combines these three financial disciplines into one program called The Smithman Calculator. It is the amalgamation of the mathematics it takes to provide precise comparisons between net worth differences that will occur for a Canadian tax payer who has a mortgage with two options to consider in the disposition of that mortgage. Option One is to do what 90% of all Canadians have been doing and are currently doing. This option is very common because it is a sacred cow as previously discussed, but also because when others in your family, your friends, your neighbours on all sides as well as your co-workers are all doing it the same way, then it must be the right way. Even Jonathan Chevreau may be coming around, and he is one conservative guru. Inertia is a huge and difficult force to overcome. The Smith Manoeuvre fights against that inertia. The arithmetic contained in The Smithman Calculator does a super job of proving the mathematical reasons that all Canadian mortgage holders should switch to The Smith Manoeuvre as fast as they can. But inertia is a huge blunt force to overcome, and it has been a long tough slog, and progress has been slow. If we keep picking at it, one by one the conversions will continue to happen on an increasing frequency. You will need some amount of courage to strike out and be different. Most bankers and some financial planners will not even have heard of The Smith Manoeuvre, but do not be diverted. This is a new program with a long history, but a good planner will not be offended if it is you that introduces him to The Smith Manoeuvre. Some of my most avid supporting financial planners were advised about my strategy by their own clients. Option Two is to embrace The Smith Manoeuvre, shoot the sacred cow, find a trusted financial planner and make the break. Look at the difference The Smith Manoeuvre makes for the Black Family.
- This might be a standard, both-working family in Canada. After 40 years it is not unreasonable to think that this family has put away $50,000 which they build at the rate of $500 per month.
- We want to see what the difference will be for this family if they switch now to do The Smith Manoeuvre compared to what they can expect the way they are currently going which is not too bad. The Smith Manoeuvre is not going to be able to take credit for the fact that they already have put away $50,000 on their own, and that they are saving $500 per month to make that $50,000 grow. By running The Smithman Calculator, we will be able to see what $50,000 will grow to in 25 years, (the length of their mortgage), and what it means in addition to save $500 per month for 25 years. We run a build in financial calculator to get the two numbers……
- Now we add the two numbers together to know what this family was going to do without the benefit of The Smith Manoeuvre…..
- Pretty impressive. But if you have keeping in touch with the newspaper stories on pension plans and retirement problems, you will know that this is not actually likely to be a big enough number for this family to enjoy retirement. What option do they have?
- We will apply these resources against their first mortgage to calculate what incremental benefit they will enjoy if they get two uses for their money - the benefit they already have, plus the incremental benefit of running these resources through their mortgage first…..
- Each step they take adds more value to their net worth.
- Maybe this is not going to be enough either, but considering that it is a much bigger number and that it takes no new money to get to it, would we not make the switch?
- The three quarters of a million comes from the fact that these people started getting free money from the tax department, and they made a decision to re-borrow and invest the equity in their house as fast as it became available. They put no money of their own into the program. Their debt did not rise. It started at $200,000 and it is still at $200,000. They got free tax refunds and used them to reduce the first mortgage and immediately borrowed that money back to get it invested. They sold their $50,000 rainy day fund, used the money to pay their mortgage down by the same amount, then immediately re-borrowed and invested the same $50,000. (They had no tax to pay in this case because they were holding CSB’s and GIC’s. If they were selling stock or real estate for instance, they might or might not have some tax to pay.) Your financial planner will be very useful in helping you calculate the net after-tax cost of liquidating any paid up assets you may own so that you can pay down your mortgage faster. After paying down, you will be able to re-purchase replacement assets, and now the interest expense will be a tax deduction. Finally, they were buying $500 worth of investments each month, but to optimize The Smith Manoeuvre it is an easy calculation to show that they are far better off making an extra mortgage payment of $500 each month, in addition to their regular payment, after which they can immediately borrow back the $500 to purchase the intended investment. The Smithman Calculator shows the value before and after each of the four steps these people took in effecting The Smith Manoeuvre for their own account. It is an easy matter to then run the numbers again after changing the assumptions on future mortgage rates, future investment returns, lump sum payments etc. In seconds, you will be satisfied that the risk is next to zero, and the benefits are large, if you make a decision to implement The Smith Manoeuvre.
- All for the sake of rearranging their financial affairs. Let’s just see these four steps represented graphically.
- First, Steps 1. and 2. (the Plain Jane) engineered just over half a million is our investment portfolio (taxable), with the $200,000 investment loan still in place, for a net of just over $300,000, free for the re-arranging of our affairs.
- This is Step 3, part of the Enhanced Plain Jane. We have converted their $50,000 rainy-day fund into cash and used it to pay down the first mortgage in a big lump so we could immediately turn around and borrow back $50,000 to get it invested in something else. The growth of the investment portfolio is so dramatic (rising to over 1.4 million dollars) that we have to break the graph across the middle in order to be able to see the size of the portfolio at the end of the original mortgage amortization period of 25 years. Notice the large reduction in the amount of time it takes to effect the total conversion of the mortgage from non deductible (blue) to the good kind of debt (purple). We have cut our mortgage payout time by over 12 years, simply be rotating an asset we already owned through the old mortgage in order to be able to reborrow to repurchase the asset. Our investment portfolio will now stand at about 1.4 million dollars (to be offset by the $200,000 investment loan we still have on the books)
- This is Step 4. of the Enhanced Plain Jane – we are getting excellent improvements in our circumstances by getting an extra use out of the $500 per month that this family has been using to buy investments each month. We have been saving $500 per month to increase our investments, and while that’s been a good thing, it is much more powerful to get a second use out of that monthly amount of cash by running it through the mortgage as an extra mortgage payment each month, which then allows us to pick up $500 worth of investments as we were intending to do anyway, but using borrowed money. When we add this Step 4. into the program, we find that we have only about 8 instead of 25 years left to pay off the old first mortgage to effect the conversion to good debt. In addition to that we have jumped our investment portfolio up to better than 2.1 million dollars, offset by that $200,000 investment loan which will likely be there until we die, for a net of 1.9 million dollars of investments. Pretty fine numbers for having worked with a planner and a banker to get our affairs reorganized. Almost painless. There is no new money required from this family to make these numbers appear. The increase in their wealth is a result of new, free money from the tax department, and from the natural compounding of their reorganized assets.
- Reminder that the Black’s were on their way to about 1.2 million dollars in investments before they learned about The Smith Manoeuvre, so the program can’t take credit for their efforts. The difference provided by adopting The Smith Manoeuvre for this average Canadian family if over three quarters of a million dollars.
- The Smith Manoeuvre will allow you to convert your interest expense from the bad kind to the good kind, in the same way that wealthy people have been handling their debt since time immemorial. It costs you nothing to do this, but you will start to receive free tax refund cheques from the government. This found money will allow you to speed up the pay down of your mortgage. You will they be able to build your investment portfolio faster so it can compound faster. Your house will be the security for the investment loan which will become your personal retirement pension plan. If the house is the security for the loan, you will get the lowest possible investment rates, the same as for your first mortgage. The investments will therefore be free and clear. Thus there can be no margin calls. If you lose your job you will sell back enough investments to make your mortgage payments until you are working again. Your debt can stay at the level it is now – it is not required that you increase your debt, nor is it required that you use any of your own funds to make this strategy work. It gets its power from free tax deductions as well as from the magic of compounding values in your newly acquired investment portfolio. These two phenomenons together put you thousands of dollars ahead of where you would otherwise end up if you followed your current plan. The process is legal in Canada and has been used continuously since 1984. It is financed by the largest credit unions and banks in the country who are advised by the largest and most prestigious law firms in Canada. You will get financially stronger each month as your tax refunds pile up and your investment portfolio multiplies. Your banker will be delighted with this program. First, you will be getting stronger each month as you add investments to your portfolio on a free and clear basis. The banker likes that. Your debt with the banker will now stay level each month. In the past, each time you made a payment, his asset (your liability) dropped, so he had to hustle to find new customers to sell mortgages to, people he did not know. When you ask him to do The Smith Manoeuvre for you, he smiles, because you have solved his problem of monthly depreciating assets because you are asking to be allowed to leave your debt at a constant level. He does not need to hunt for new customers, and he gets to deal with someone he knows already, who is going to be getting stronger as each month goes by. He is indifferent on rate because he gets paid the same amount of interest whether your loan is deductible or non-deductible. The Smith Manoeuvre would not be possible if there was not something in if for the banks. If you visit the websites of the banks you will find that they are promoting their readvanceable mortgages as just what you need to buy cars, boats, vacations etc. This is an abuse of the customer as far as I am concerned as it means that if they accept these offers, they are likely to end up with debt that does not go down, but is also not deductible. Seems to me that the banks should study The Smith Manoeuvre very intently so they can see that they are hurting their customers by encouraging them to reborrow equity for consumption, and that the right thing to do is to teach and encourage their customers to only reborrow to invest, and to pay cash for their toys, just like the wealthy folks do. If the banks examine the mechanics of The Smith Manoeuvre they will also see that if they start now to encourage their customers to utilize The Smith Manoeuvre, the need for the Reverse Mortgage will drop off as citizens gradually become strong enough to take care of their own retirement. They will build their own resources now instead of relying on the bank to supply debt against equity during the client’s declining years. The client, with the bank’s assistance will build their retirement assets at the front end of their life when they can better stand the vagaries of life, and when they can avail themselves of the magic of compounding interest. The banks will be far better off if they have clients grateful for the ability to work their equity as they earn rather than banking their equity to be drawn down at the back end of their life. Grateful clients will do more business. The absolute return to the banks for assisting their clients to carry constant debt (deductible) for their whole life, far exceeds the profit to be made from a customer who is gradually reducing his debt until finally he needs a reverse mortgage, which simply puts him back into debt again.
- It’s real. It’s legal. It’s virtually free. It will bring new and permanent wealth to your family. Don’t wait. Find your planner and do it now.
- The generic graph in the logo is a convenient way to explain to others how The Smith Manoeuvre works. The grid lines on the X axis represent 5 year intervals through to 25 years, and the vertical axis is the amount of the mortgage in $100,000 increments. This is a Smith Manoeuvre conversion of a $200,000 mortgage at 7% for 25 years being converted to a $200,000 investment loan by re-using monthly equity generated each month to re-borrow and invest. The same is happening to the tax refunds that The Smith Manoeuvre provides, as well. The rate of accumulation used is 10% which is just slightly less than the 54 year average for equities on the Toronto Stock Exchange. These results may be taxable. Fraser Smith www.smithman.net