Excellent article by Susan from the “Plunged in Debt” blog.

I help people plan for the retirement that they want. The Smith Manoeuvre can make all the difference for long-term risk-tolerant investors.

It can make the difference between having the retirement you want and not being able to get there. Or it can make your retirement far more comfortable.

This article is definitely worth reading. Read more…

 

 

Ed

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Ed Rempel has helped thousands of Canadians become financially secure. He is a fee-for-service financial planner, tax  accountant, expert in many tax & investment strategies, and a popular and passionate blogger.

Ed has a unique understanding of how to be successful financially based on extensive real-life experience, having written nearly 1,000 comprehensive personal financial plans.

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2 Comments

  1. Tom on November 14, 2017 at 1:11 PM

    Hi, Ed. Hoping can answer a question I have.

    I’ve been running the SM through my own non-reg account since October 2016. I read recently that, for taxation purposes, the lower-incomed spouse is better off owning the stocks and collecting the dividends from those stocks. The article didn’t specifically speak about SM, only that investments are better held by the lower-incomed spouse. I was considering opening a non-reg account for my wife (at the same financial institution as well) and transferring the investments to her (I already have a question to the bank whether I can transfer the investments “in-kind”).

    In your experience,

    a) is this doable (i.e. has anyone you know ever transferred investments ‘in-kind’),

    b) what will it mean to me since I’m the primary holder of these investments today (i.e. will I realize capital gains), and

    c) since this involves borrowing for investments, will there be an issue come tax time (i.e. can I claim the interest/dividends paid/obtained to date under her return or do I need to claim them)? FYI, the HELOC used for the SM is joint.

    Looking forward to your response.



  2. Ed Rempel on November 18, 2017 at 9:57 PM

    Hi Tom,

    Wow, that is a many-pronged question.

    Before I answer the questions you asked, let’s start with whether you even want to do that.

    The lower-income spouse will pay less tax on investment income, but the Smith Manoeuvre implemented effectively is the opposite. If you invest tax-efficiently, the taxable investment income should be less than the interest deduction most years, so it is usually best to have the Smith Manoeuvre taxed to the higher-income spouse, to get a larger tax refund.

    If you invest focused on dividend investing, that might be different. Dividend investing is not very tax-efficient, because you are prematurely triggering more taxable income, which means the taxable income might be more than the interest deduction. If you have a properly-diversified global equity portfolio with dividends, the dividends are fully taxed. Dividend investing can have very low tax rates only if all 3 of these apply to you:

    1. Invest only in Canadian dividend stocks (which probably means bad diversification and ignoring 98% of the world’s stocks).
    2. Have low income about $40,000 or less.
    3. Are under age 65. Seniors are generally taxed very highly on dividends, even Canadian dividends, because a few clawback programs are based on the grossed-up dividend.

    For everyone else, dividend investing is not tax-efficient.

    I think you are asking the wrong questions, Tom. You will see when I answer them. To answer your actual questions:

    1. Yes, it is mechanically doable. Your bank will say “in-kind” transfers are possible. We have done “in kind” transfers multiple times, but not with the Smith Manoeuvre because it creates tax problems.
    2. It will cause you all kinds of tax problems if you do. The attribution rules will apply, so if you transfer the investments to your wife’s name, the taxable income is still taxable to you. The exception is the income on the income, which could be taxable to your wife, but only if you track all this effectively.
    3. The interest deduction generally follows the taxable income on the investments. However, if you “gift” the investments to her (“in kind” transfer), then the interest deduction should transfer to her. The fact that the HELOC is joint is not relevant. You have taken the position up until now that you borrowed money to invest, so the interest now is deductible by you regardless of the name on the HELOC. Tax ownership and legal ownership are often different. Once you transfer the investments to her, the interest deduction transfers to her as well (even though the investment income is taxable to you based on the attribution rules). In short, your wife would claim most of the interest deduction, but most of the investment income would be taxed to you.

    See what I mean about the answers to your questions not being the real issue, Tom?

    I don’t know your full situation, so I can’t give you advice here. However, the way I would handle this is:

    1. Leave the investments taxed to you. Don’t transfer them to your wife. My clients generally have tax deductions larger than the taxable investment income most years, so the Smith Manoeuvre usually gives them a tax refunds. This usually applies even after they have been doing it for years, and even after they retire and start taking cash flow from their investments.
    2. Forget dividend investing. Focus on total long-term returns. Then try to minimize taxable income to the extent you can without affecting your returns. The lowest-taxed invesment income is deferred capital gains (https://edrempel.com/lowest-taxed-type-investment-income-6-ways-invest-deferred-capital-gains/ ).
    3. If you really want to transfer the investments to your wife, sell them all, pay off the HELOC, and then have your wife borrow from scratch to invest. Wait 30 days if some of the investments are down to avoid the superficial loss rules.

    I hope that is helpful for you, Tom.

    Ed



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