When examining whether The Smith Manoeuvre is worth implementing for yourself, there are a number of things to consider:
- Do you have enough equity? In order for one to be able to implement The Smith Manoeuvre, the homeowner must have at least 20% equity in the home. This is because no mortgage lenders will allow the principal reduction to readvance to the Home Equity Line of Credit (HELOC) from where it can be borrowed to invest. That being said, it is possible to acquire the right type of mortgage for The Smith Manoeuvre with less than 20% equity, but the readvancing component will not be functional until there is the required amount of equity in the home.
- How do you feel about debt? The Smith Manoeuvre relies on keeping one’s debt more or less constant. But there is a crucial difference between the types of debt. Your mortgage debt is expensive because it is not tax-deductible; investment debt is cheap because it is tax-deductible. This is a fundamental concept of debt that the wealthy understand very, very well. They understand that debt can actually be good, and they use this knowledge to their advantage. That is one of the main reasons they are wealthy in the first place; the average Canadian hears the word ‘debt’ and they get a sense of foreboding – one big, dark cloud above their head, and it makes them uncomfortable. The wealthy understand debt and they embrace it. If you can’t get past the feeling that debt is that one big, dark cloud, maybe it isn’t for you, and that’s okay – we all need to sleep at night.
- What is your marginal tax rate? An understanding of how debt can work to your advantage falls down to understanding your marginal tax rate which depends on your level of income. The more money you make, the higher your marginal tax rate. And the higher your tax rate, the bigger your tax deductions. A common belief is that if you have a lower marginal tax rate (have a smaller income) then The Smith Manoeuvre isn’t worth it. While it is true that the more money you make, the bigger the advantage with the strategy, even if you are at a lower marginal tax rate, you will still benefit from tax deductions – and some is better than none. And even a relatively smaller tax benefit will still see you reducing your tax bill, getting rid of your expensive mortgage faster and building an investment portfolio that otherwise would not exist had you not started The Smith Manoeuvre. That being said, there are many things to consider when looking at implementing The Smith Manoeuvre and it may be that a lower marginal tax rate combined with a shorter timeline and your thoughts on what ‘debt’ means to you, may lead you to not start the strategy.
- What is your timeline? If you are planning to move within the next couple of years or if breaking your non-functional mortgage in order to get the necessary type of mortgage for The Smith Manoeuvre would see you incur a penalty, it may be worthwhile to postpone implementing The Smith Manoeuvre, but there are some things to look at, nonetheless. As regards a potential move in the future, it is possible to transfer any tax-deductible debt you generate over the couple of years prior to the move (but it is important you do it correctly). And while your penalty for breaking your non-functional mortgage a couple/few years early may be high, your Smith Manoeuvre Certified Professional (SMCP) can do the math to see if it makes sense or not. There is more to consider than just your new rate and any potential amortization extension – your SMCP can also factor in the 24-36 months of tax deductions and investment that you won’t enjoy if you don’t break the mortgage to implement The Smith Manoeuvre. Also, a timeline factor is whether you are very close to retirement when you are considering the strategy. The Smith Manoeuvre takes time, so that’s what you need. All that being said, there have been people in their 60’s and 70’s who have implemented The Smith Manoeuvre, but you specifically? Maybe it’s best to wait, maybe it’s not – have an SMCP review your situation.
- How do you feel about investing? We want to be sure that we are comfortable with the investing component of The Smith Manoeuvre. In order to generate the tax relief which enables us pay out our non-deductible mortgage sooner, we must invest. Are you comfortable with investing? While there is a wide universe of investments which qualify for deductibility of interest when the money is borrowed, some people just aren’t able to get comfortable with having money in the markets – any market. When it comes to investing, one of the risks is behavioural risk. If you don’t think you will be able to stomach the ups and downs of your investment portfolio – whether securities, real estate or other – then have a deep think whether the strategy is for you. Again, sleep-at-night factor is important.
In the end, like anything, there are things to consider which will make this strategy worth it for you or not. Dig in and consult with Smith Manoeuvre Certified Professionals about your particular situation and allow yourself time to get comfortable with the aspects of the strategy; if for some reason you can’t move on to something else, if you can, your SMCPs are there to guide you.