Many Canadians, although it hasn’t been easy, have managed to put aside a few dollars for retirement. Maybe you own a few thousand dollars worth of mutual funds; maybe you own some stocks or bonds in your investment portfolio…. And that is great – you are ahead of the game compared to many of your compatriots. But these assets can increase your net worth more than just the growth you are seeing over time.
If you are implementing The Smith Manoeuvre already, you have the appropriate type of mortgage – a readvanceable mortgage – and you can execute a Debt Swap. Basically, you swap non-deductible debt for deductible debt, and this does great things to your tax bill in April.
How Does it Work?
Let’s say you have $10,000 in mutual funds in an open, or non-registered account. You have been adding to this investment over the years or maybe you just invested a lump sum a while back. Regardless, all you need to do is liquidate your investment and get hold of that $10,000 in cash. What happens next is that you make a prepayment against your mortgage of this $10,000 and then, via the readvanceable nature of the mortgage, reborrow it from the line of credit portion of your mortgage and either buy the exact same investment back again or invest in something new.
What’s the Result?
All of this can be accomplished in one week or so, and what you have done is replaced $10,000 of non-deductible mortgage debt with $10,000 of tax-deductible debt. This may not seem like a big deal, but the longer you carry non-deductible mortgage debt, the more you pay for it. And by prepaying $10,000 against your mortgage you will significantly reduce the amount of time it takes to pay that expensive mortgage debt off, and that means you will be paying less to the bank in the form of non-deductible interest. PLUS, you still own the investments you did prior to the Debt Swap.
So now you still have the same amount of debt, but a big chunk of it is tax-deductible debt – the type of debt that the wealthy have learned to embrace; the type of debt that allows your net worth to increase rather than decrease; the type of debt that works FOR you, not AGAINST you.
What Do I Watch Out For?
Firstly, mortgages typically have annual prepayment limits, meaning if you prepay more than what they allow, they will charge you a penalty. But don’t let the word, ‘penalty’ set your hair on fire – you’ll very likely find that the penalty you are charged – if charged at all – is well-worth the long-term financial benefit you will see from the Debt Swap. Am I willing to pay a hundred bucks or so for a transaction that will increase my wealth by thousands? You bet I am.
Secondly, when you redeem the assets for cash, if your investment has made money, you may be subject to capital gains tax – your Smith Manoeuvre Certified Professional (SMCP) investment advisor can let you know your situation. Again, though, it is very likely that it is well worth it.
Finally, there are rules surrounding the sale and repurchase of identical assets. That being said, there are times where this may not apply, or if they do, there are likely almost identical assets you can repurchase so you don’t run into this. Your SMCP-accredited advisor can guide you here as well.
As Canadians, we want to eliminate the most expensive payments in our lives, and we want to save as much as we can for our future. The Smith Manoeuvre is a very effective strategy that allows us to do both at the same time. And the Debt Swap can increase the pace at which we accomplish these two goals.
