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004: Using the Smith Manoeuvre to Achieve FI | Megan

In today’s episode, we chat with Megan from Victoria, BC. She and her husband use a strategy called the Smith Manoeuvre to help them reach FI.

About Megan

Megan lives in Victoria, BC with her husband and four kids (aged 12, 8, 5, and 2). She homeschools her kids while managing three rental units and works one day a week at her government job.The first personal finance book Megan read was The Smith Manoeuvre: Is Your Mortgage Tax Deductible? by Fraser Smith. (She read it in high school.) It showed her how it was possible to get much further ahead by implementing the strategy.

As a teenager, she started putting money away to invest in real estate. After a few years of working hard and saving, she received a little bit of family help and was able to put a down payment on her first home. She slowly built up her equity until she had enough to implement the Smith Manoeuvre.

Smith Manoeuvre basics

For detailed information and to order the updated book, please visit the official website at https://smithman.net/

Converting your mortgage to a tax-deductible HELOC

  • When you have a home with a mortgage, you can set up a home equity line of credit (HELOC) on that mortgage.
  • When you make a mortgage payment, it’s split between paying the principal of the loan and the interest.
  • Whatever you pay down on the principal portion of the mortgage becomes available to borrow from the HELOC.
  • For example, if $200 of your mortgage payment goes towards the principal, then $200 will become available for you to borrow from the HELOC .
  • You can take that $200 and purchase any investment: stocks, bonds, real estate, a business, etc. You can buy anything as long as it has the potential to create income.

Paying the interest

  • Throughout the year, you pay interest on the HELOC.
  • You can then do something called ‘capitalising the interest’ which means you use the HELOC to pay for its own interest.
  • For example, let’s say you owe $30 in interest on the $200 you borrowed from the HELOC. Instead of taking out the full $200 to invest with, you only borrow $170—so you leave $30 to pay the interest.
  • Basically, each month the HELOC pays for itself and doesn’t require any extra money out of your pocket.

Tax benefits

  • When you file your taxes, you’re able to write off all the HELOC interest that you paid for the year as a deduction.
  • This lowers your taxable income, so you generally will get larger tax refunds. You’ll also receive increased government benefits such as the CCB, OAS, or GIS.
  • Using the Smith Manoeuvre means you end up with more money in your pocket.

What happens at the end?

  • Over time you:
    • Pay more and more equity towards your house.
    • Borrow more and more from the HELOC.
    • Invest more.
    • Deduct more and more interest from your taxes.
    • Pay down your mortgage.
  • You’ll eventually pay off the mortgage and have the entire mortgage amount, say $500,000, converted into borrowing room in the HELOC. At this point, you can:
    1. Pay the HELOC interest and let your investments continue to grow indefinitely, or
    2. Sell off your investments to pay off the HELOC, be done with the Smith Manoeuvre and still end up a lot further ahead than you were.
  • The beneficiaries of your estate can also choose either option 1 or 2.

Smith Manoeuvre investments

  • The majority of people use their HELOC to invest in the stock market.
  • Again, you can buy anything as long as it has the potential to create income. Even a stock that doesn’t pay dividends qualifies—as long as there’s the potential that it could in the future. (Basically, as long as it’s not stated that the stock will never pay dividends, it’ll be okay.)
  • If you’re earning an average 8% return on your stock market investments and paying 3% in HELOC interest, you’re banking the 5% difference each year throughout this 20-year (or longer) process.
  • That 5%, after 20 years, ends up being a whole lot of money.

The Smith Manoeuvre seems complicated, but in practice it takes very little time to manage. (Megan estimates it takes her three hours per year.)

FI in Victoria

  • Megan was born and raised in Victoria and her entire social network lives there.
  • She loves the outdoorsy lifestyle and the climate in Victoria. (Sure it rains a lot, but you don’t have to shovel rain!)
  • It’s big-city enough to have all the amenities, but not so big that they’re sitting in smog.
  • Victoria is hard to cut costs in, but Megan and her husband do what they can to save (credit card rewards, shopping at discount grocers, etc.)
  • She doesn’t have a ton of time to penny pinch, so she tries to focus on the big expenses to save a lot of money over the long run.
  • Megan tries to connect with local FI-minded individuals to learn from them.
  • Megan also discusses:
    • Her family’s annual spending.
    • How she manages their rental units.
    • Her job and how she balances her one day of work with raising and homeschooling four kids.

Resources

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21 Replies to “004: Using the Smith Manoeuvre to Achieve FI | Megan”

  1. Great podcast. I’ve been researching the Smith Manoeuver for a while and looking to use it in the next couple of years. Nicely done guys. Very informative.

    Reply

    1. Hi Ricky, we used our HELOC to purchase one of our rentals (the most recent one) and then the rest of the HELOC was used to purchase stocks and ETFs. We generally leave a buffer in the HELOC in case any buying opportunities come our way, but the majority of it is in use right now.

      The first 2 rentals were purchased with our savings, and then we used the Smith Maneuver HELOC on them to purchase the 3rd rental.

      Reply

  4. Hey all, great podcast. Keep up the good work.

    I’m still finding the Smith Manoeuvre a bit confusing. Perhaps, a diagram explaining how 100% of the mortgage interest gets tax deductible through the heloc might help?

    Here is what I have gathered so far:

    You have a home say for $500K. You put 20% down (100K) and have a mortgage of 400K. With using 3% as the bank rate and using the ratehub calculator:

    https://www.ratehub.ca/mortgage-payment-calculator

    You get $1,893/month mortgage payment. For year 1, you pay a total of $22,716 (principal: $10,939, interest: $11,777) according to the calculator.

    As you pay your principal, you can borrow that amount to invest but there isn’t enough in the heloc to tax deduct $11,777 in year 1 (assuming the same 3% for the heloc). So my question is

    How can I get $11,777 interest tax deductible in year 1 using the heloc? Or is that captured later in the years.

    Forgive me for my lack of understanding.

    Reply

    1. Hi Abid,

      It is best that you think of the equation as separate entities. Your principle payment and your mortgage interest. Which you are paying 3% interest on and
      this is not tax deductible.
      If you ‘borrow’ another $100 from the HELOC side of the mortgage, you will pay a higher interest rate. My HELOC is Prime +.5%. So the 4.5% that you are required to pay on the $100 is what you can deduct on your income taxes at the end of the year. Of course this only works if you have used that $100 to invest in a non-registered account with an eligible investment. Does that help?

      Reply

  5. Awesome podcast, I just stumbled across the site searching for more info on the Smith Manoeuvre. Super good to hear more about a young person using it for Real Estate and other asset types as well. I’m in BC as well (North Central) with a few rentals and working on learning more about index investing, etc. I was kinda wondering if there were more Canadian FI podcasts / folks around behind the scenes. Super excited to listen to the other episodes and connect with others in the community.
    Thanks again!

    Reply

    1. Hi Physio for FI,

      Welcome to our little community! We’re happy you’ve joined our listenership and look forward to connecting with you.

      Feel free to contact us anytime to share your feedback and questions. We love hearing from our listeners-positive messages like yours help keep us going! Thanks for taking the time to leave a comment.

      Reply

    1. Hi Lisa, I’m not sure which one of us this question is for, so I’ll go ahead and answer!

      Our investments are managed by an investment manager whom my financial planner works with. He invests our money using an index-like approach.

      If I were to DIY it (as I used to) I’d use index ETFs from Vanguard, iShares or BMO.

      Does that help?

      Reply

  8. Hi Megan,

    My fiance and I are looking to purchase a house shortly and will likely look to implement the smith maneuver when doing so. Our degrees are in commerce and thus far have managed our own investments (ETFs) through Questrade.

    We feel we have a pretty solid understanding of the SM, but were wondering if it makes sense to discuss with someone knowledgeable on the maneuver when first getting the mortgage/setting up our accounts to ensure everything is done properly and will be kosher during tax time. What approach did you use when beginning and what would you recommend?

    Thanks!

    -Mike

    Reply

    1. Hi Mike,

      It’s Chrissy here. Just in case Megan isn’t able to reply, I thought I’d chime in. I’m not sure if you listened to our interview with Robinson, but we discussed this very topic in the latter half of the episode: https://exploreficanada.ca/podcast/028-smith-manoeuvre-case-study-robinson-smith/

      In the interview, I said that I felt most comfortable getting professional help with implementing the Smith Manoeuvre. Like you, I wanted to make sure everything was done properly and that I’d have no issues at tax time. While the SM is simple on the surface, there are a lot of moving parts and many ways to make unintended mistakes!

      Many people, like Megan, have been able to figure it out on their own. But it comes down to your confidence in your level of knowledge of the SM and the Canadian taxation system. If you feel comfortable, there’s no reason not to do it on your own. But there’s also no shame in paying for professional help. For me, it’s been worth every penny for the peace of mind.

      Feel free to reply to this if there’s any further info you’d like from me.

      Reply

      1. Hey Chrissy,

        I appreciate the reply! I have also listened to this podcast and did recall your statement on this.

        My biggest question is in regards to what securities I am able to invest in without impacting the deductibility of my interest expenses on the HELOC come tax time. I have read that if a security provides a Return of Capital (ROC), this can impact the amount of interest expense you can claim from your HELOC. I generally invest in ETFs, but have read that these generally provide ROC in their distributions.

        Since you have utilized the SM, what type of securities do you invest in (if they are ETFs, which ones), do they provide ROC (and therefore adjustments need to be made), and is my concern about this element a legitimate one?

        Thanks again for your thoughts!

        -Mike

      2. Hi Mike—by complete coincidence, Bob Lai at Tawcan just happened to publish an interview he did with Robinson Smith today. In the interview, they discuss ROC: https://www.tawcan.com/the-smith-manoeuvre/

        Unfortunately, your worries are correct. ROC distributions do make SM accounting more complicated. You can work around it by re-investing the ROC or paying that amount back on the loan. But that does create accounting headaches. 🙁

        There are some ETFs that don’t pay ROCs, and someone on Red Flag Deals has created a list: https://forums.redflagdeals.com/etfs-no-roc-2019-2368771/

        However, reading through the comments, it sounds like there are no guarantees—a fund could pay out an ROC anytime. 🙁

        Sorry to be the bearer of bad news. In my opinion, it may be worth paying one of Robinson’s certified professionals for a few hours of their time to consult on this issue. You want to make sure you get this right!

      3. Sorry, I forgot to answer your question about what I invest in. As you know, I invest through one of Ed Rempel’s investment managers.

        They create their own funds and/or invest in funds which Ed has vetted to ensure their tax-deductibility.

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