Todd Stanislawski is a 65-year-old retired math teacher living in Kamloops, B.C. He just inherited $250,000 and isn’t sure if he should invest it, or repay the $200,000 he owes on a home equity line of credit (HELOC).

The problem

Todd taught for 35 years, retiring at age 60. His monthly pension is $3,500; CPP is about $900 a month, which he didn’t start taking until this year because his pension plan paid him a $1,000 monthly bridge benefit between 60 and 65.

OAS is just under the maximum $546 a month. He also works 10 hours a week as a part-time tutor. At $40 an hour over 36 weeks per year, that’s an extra $14,400. Todd’s total annual income is $73,752 before tax. His marginal rate is 29.7%.

The expert

Markus Muhs

Markus Muhs

Investment advisor at Canaccord Genuity Wealth Management in Edmonton

Ten years ago, he and his wife divorced. His wife earned roughly the same as he did, so there are no support payments. But Todd’s attached to the matrimonial home: an avid guitarist, he converted his basement into an elaborate home studio. Relocating would be a major hassle.

That meant buying his ex-wife’s share of the home. Instead of a mortgage, Todd took out a HELOC at 3.5%.

“If he were my client when I was a bank rep,” Muhs says, he would have suggested Todd use the same strategy. “It’s a lot easier to plop the money down on a line of credit and pay it off, instead of having a closed mortgage, which has a prepayment penalty.”

Read: When bad trusts happen to good people


Degree of difficulty

8 out of 10 “The biggest issue is the decision to pay back the debt or [invest] the inheritance,” says advisor Markus Muhs. “You have to know the client well, and have a clear risk assessment.”

On the investment side, Todd has $150,000 in RRSPs. He’s invested in a balanced growth mix (60% equities, 40% fixed income) for the last 10 years. In 2008, his portfolio lost 25%, but it’s recovered since.

He also keeps $1,000 in chequing and $5,000 in savings as a rainy day fund. Otherwise, most of his savings have gone toward paying off the HELOC.

The $250,000 inheritance gives him an opportunity to be debt-free, but Muhs says investing it using what’s called the Smith Manoeuvre is another option. That’s because his non-tax-deductible HELOC interest payments would become tax-deductible.

The issue

The Smith Manoeuvre involves borrowing to invest, so Muhs focuses first on Todd’s risk profile.

For this option to make sense, Todd’s returns would have to exceed 3.5% (interest on the HELOC) net of fees and taxes. Muhs calculates Todd would need at least 5% annual returns to accomplish this. That would mean an equity allocation of about 60%. Muhs says Todd can handle that level of risk for three reasons:

  • he’s used a 60%/40% mix for a decade;
  • he didn’t panic and run in 2008 because he understood the need to stay invested, and he would likely do the same in future; and
  • he can cover his expenses with his pension and other non-investment income.

Muhs says he wouldn’t recommend the Smith Manoeuvre if Todd didn’t meet those conditions. Instead, he would urge Todd to put the inheritance towards the HELOC.

The solution

For most people, the Smith Manoeuvre works like this: as they make mortgage (or HELOC) payments, they reborrow equivalent amounts against the mortgage and invest it.

Interest on that reborrowed money is tax-deductible, provided the client invests the loan in income- or dividend-generating vehicles, or in investments that may generate income or dividends in the future. The money can’t be invested within an RRSP. Thanks to his $250,000 windfall, Todd can do the Smith Manoeuvre all at once, instead of gradually. The inheritance exceeds his HELOC debt by $50,000, but the excess still factors into his strategy.

Read: RRSP, TFSA or both?

Below, Muhs reveals how he’d structure Todd’s portfolio. Todd’s borrowing $200,000 at 3.5%, so it’s costing him $7,000 a year.

“He’s deducting that against his income at a rate of 29.7%, which yields a $2,079 tax savings,” explains Muhs. “So, his after-tax cost of borrowing is $4,921, rather than $7,000.” Muhs notes dividends from Todd’s basket of 10 stocks should cover that interest. As for the overall portfolio, here’s how the numbers shake out.

  • Using the inheritance to pay debt: Todd has $150,000 in his RRSP, uses $200,000 of the inheritance to pay off his HELOC, and invests the remaining $50,000. “After 10 years, assuming investments grow at 6%, he goes from $200,000 to $297,000 and is debt-free.”
  • Using the Smith Manoeuvre: Todd has $400,000 invested ($150,000 in the RRSP and $250,000 in non-registered accounts and TFSA). “And, say he makes 5% after tax. After 10 years, he has $597,000. Subtract the $200,000 owed, and the $70,000 in interest, and he still comes out ahead: $327,000, versus $297,000.”

Muhs notes it’s crucial to keep a clear paper trail for paying back the HELOC, and for reborrowing under the Smith Manoeuvre. It’s also important to understand how to repay funds borrowed under the Smith Manoeuvre.

Say Todd decides to sell one of the 10 stocks he bought with borrowed money. If:

  • he sells when it’s worth $30,000, $20,000 goes to repaying the loan, and the extra $10,000 is taxed as capital gains;
  • the stock’s value reaches $30,000 but he only sells $15,000, Todd has to repay half the original loan amount, which in this instance is $10,000 (the repayment amount in such cases is based on the percentage of the holding sold); and
  • he sells after the stocks’ value drops from $20,000 to $10,000, Todd has to repay the full $20,000 right away.

Muhs notes straying from CRA’s rules will mean losing the interest deductibility the Smith Manoeuvre is designed to provide.

Read: Middle class needs the most pension help


Prior to the inheritance, Todd’s RRSP had a 60% equity 40% fixed-income mix Now that he has an additional $250,000 to invest , his advisor should reorganize the assets. The first step is to put the entire RRSP in fixed income. “He’s not going to be well-served having [a lot of] further growth in [the RRSP] because he’s at an income level (about $74,000) that’s not too far below the next tax bracket, which is around $80,000,” Muhs says. “To minimize his taxes in the future, it’s better to have less growth in the RRSP and more outside it.”


Muhs suggests a core/explore approach. The core will take up $120,000 and he recommends a fund with 40% government bonds and 60% investment-grade corporates.

The other $30,000 makes up the explore portion, and Muhs suggests one or more low-to-medium risk global bond funds that include high-yield.

The Smith Manoeuvre loan is invested entirely in Canadian dividend-paying stocks. This overweights Todd’s Canadian equity allocation, but Muhs offsets this by choosing names that do a lot of business in the U.S. or globally. He suggests 10 stocks at $20,000 each . “You can’t just chase the highest dividends. I want companies with the potential for growing them. Ideally, the payout ratio will be under 50%, and I’m aiming for 2.75% dividend yield.”

Todd’s never contributed to a TFSA because he’s been paying the HELOC, so he has $31,000 in room. Muhs says he should top up the account with funds from the inheritance . That leaves $19,000 from the inheritance, which gets invested within a non-registered account . But it’s a placeholder: Muhs says Todd should move $5,500 a year to his TFSA. (This can mean capital gains tax, but the benefits of migrating the funds will likely outweigh the costs.) For both the TFSA and the non-registered account, Muhs suggests a medium-risk global equity fund that has 5% to 15% in emerging markets. The MER should be 1.25% or lower (Muhs, who’s fee-based, uses F-Class).

Client acceptance


Todd doesn’t need the extra money the Smith Manoeuvre would deliver, but he goes ahead with it because it can mean leaving more to his children and his favourite charities. Having weathered 2008, he understands the risks and is comfortable with the asset mix necessary to give the strategy the best chance of succeeding.

Dean DiSpalatro is a Toronto-based financial writer.