For several years, the Smith Manoeuvre has been used to convert non-deductible mortgage debt to deductible investment debt. Lots of twists on this strategy have evolved and one of the more successful ones comes from a company called TDMP.com.
We spoke with Sandy Aitken, President of TDMP, about how TDMP works and what drives his success in this market.
CMT: Sandy, until now, the best known method of converting a mortgage into tax-deductible debt has been the Smith Manoeuvre. In what specific ways does the strategy behind the Tax Deductible Mortgage Plan differ from the Smith Manoeuvre?
Sandy: The strategy behind the Tax Deductible Mortgage Plan is similar to the Smith Manoeuvre in that it forces the conversion of non-deductible mortgage debt into a tax deductible investment loan on a monthly basis. However, TDMP is up to 10 times more powerful than the traditional Smith Manoeuvre due to the fact that the forced debt conversion is vastly accelerated in all cases.
CMT: Compared to the Smith Manoeuvre, how is the debt conversion “vastly accelerated” by TDMP?
Sandy: In a nutshell, as shown in the Diagram below, the TDMP forced debt conversion is accelerated by ensuring that the TDMP Monthly Cash Flow performs the following three steps each and every month:
1. 5th Day of Month: pre-pay the mortgage from Client’s Regular Bank Account;
2. 10th Day of Month: re-advance the limit on the Investment Line of Credit (ILOC) back to original Balance; and
3. 15th Day of Month: deposit the re-advanced funds in the Client’s Tax Clearing Bank Account
The great value of our $39.95 monthly fee is understood by every homeowner who has tried to follow these steps by themselves manually. Although it may sound simple, actual execution of these instructions on an individual basis can often involve hours of time on phone to the banks. Our Service Level Agreement (“SLA”) with TDMP Approved Lenders provides that the Lender has the obligation to perform these three functions within 10 Business Days from being bulk instructed by TDMP. Therefore, on the 5th of each month, when TDMP instructs the Lender (e.g., Firstline) to pre-pay, re-advance the credit limit and then advance funds to the Tax Clearing Bank Account, the Lender has 10 Days to perform and will then provide an exception report back to TDMP of any failed transactions prior to Week Four.
The importance of timing is that all TDMP Clients need cleared funds Deposited to the Tax Clearing Bank Account on time, every month, in order to make tax-deductible Line of Credit Interest Payments, as well as other tax-deductible interest payments if applicable (e.g., investment loans or mortgage payments on rental properties) as well as pre-authorized monthly investments. Typically, these payments all come out on WEEK FOUR in the Diagram (e.g., usually between the 25th and the end of the month), so our TDMP Approved Lender SLA to make Deposits by the 15th of each month gives us lots of time…
CMT: TDMP’s press release cites financial benefits of $5,000 to $10,000 a year for the typical TDMP client. How are these figures arrived at?
Sandy: Homeowners must have a non-registered asset or business that generates predictable minimum monthly cash flow (e.g., rental property, mutual funds, unincorporated business income, etc.). In order for TDMP to make sense to a Canadian Taxpayer, they should be in a high Marginal Tax Bracket (35% and up) and be processing a high enough dollar volume of tax-deductible loan payments to achieve minimum annual tax benefits (e.g., tax refunds). As an example, if a salaried TDMP Taxpayer makes $1,200 per month in tax deductible loan payments and carrying charges, their TDMP tax refund would be approximately $6,600 in Ontario’s top tax bracket.
CMT: What assumptions does TDMP make regarding the average client’s annual return on their investments? For example, is the client assumed to purchase income funds in the ILOC that generate 8% annual returns?
Sandy: TDMP does not advise clients on the investments or recommend specific sets of assumptions. TDMP provides a Calculator to TDMP Certified Mortgage Planners who are able to plug in certain assumptions about both long term returns on investments as well as long-term cost of borrowing (e.g., interest rates) in order to determine potential financial outcomes. Where the homeowner asset-generating, TDMP cash flow is a mutual fund, the Mortgage Broker will work in partnership with a Certified Financial Planner licensed to sell and advise the homeowner on suitable investments. TDMP supports cash flows from mutual funds, and typically such assets will have monthly cash distributions that are predictable (e.g., set at a fixed rate such as 6% or 8%) and tax efficient (e.g., Return of Capital or Dividends as opposed to Interest Income)
CMT: Can TDMP clients invest in any fund they desire?
Sandy: TDMP clients can invest in any asset or fund that meets CRA’s guidelines for interest deductibility on borrowing to invest . If the homeowner’s asset for TDMP cash flow is a mutual fund, the monthly cash distributions should be fixed or at least predictable for approximately 6 months in advance). Beyond that, any limitation on investments would be imposed by the client’s financial advisor.
CMT: Do you typically suggest return of capital (ROC) funds? If so, how does this affect the tax deductibility of the investment loan over time?
Sandy: ROC funds are a very popular choice among TDMP advisors and clients. ROC funds are highly tax efficient up front, but erode the deductibility of investment loans over time. This is fully calculated and factored into the TDMP Calculator. The erosion of tax-deductible investment loans must be properly calculated and reported on the Taxpayer’s Annual Return. TDMP provides a Tax Preparation Service through a network of accountants who are familiar with the intricacies of these tax rules and calculate benefits properly. TDMP provides a 100% Guarantee of tax benefits to clients who subscribe to this service and use the TDMP Approved Accountants.
CMT: Which readvanceable mortgages does TDMP prefer to use for its strategy, and why?
Sandy: TDMP currently has approved the Firstline Matrix and National Bank All-In-One products for use with TDMP and is currently in discussions with Scotiabank and Merix Financial. These products are approved because TDMP has a “Service Level Agreement” in place with these lenders that allows TDMP to prepay and readvance mortgages on behalf of TDMP clients with their prior written approval. The great advantage of TDMP is that homeowners don’t have to manually move funds around every month.
CMT: What are the risks of the TDMP?
Sandy: TDMP guarantees tax benefits so there is no risk there. However, in all cases, a TDMP client will own an asset/investment that generates the cash flow required to make the TDMP strategy work. Whether this asset is a mutual fund, an investment property or a home-based business, the standard risks involved with leveraged investments apply.
CMT: If someone is starting the strategy on Jan. 1, has a $200,000 mortgage and a 35% tax rate, can you provide an example of the approximate tax refund the 1st year?
Sandy: It is not the size of the non-deductible mortgage that determines the tax refund. It is the size of the Taxpayer’s deductible investment loan debt (secured as part of the mortgage) that will. In your example, if there is a $400K Firstline Matrix mortgage with a $200K amortizing component (non-deductible) and another $200K LOC at Prime Plus 1% which was 100% used for qualifying investment purposes, the first year tax refund would be approximately $2,300 at a 35% Marginal Tax Rate.
CMT: OK, but I assume most people starting out wouldn’t have a large LOC right off the bat. In any case, what initial and ongoing services do TDMP clients get in return for TDMP’s $2750 set-up fee and $39.95 monthly fee? Why would someone be better off paying those costs instead of self-managing the strategy?
Sandy: The initial setup of a TDMP file is complex and time-consuming. The TDMP Setup Fee is priced at the low end of the equivalent fee range (e.g. $3K – $5K) charged for similar services offered by competitors and is 100% tax deductible. The TDMP Setup process can take up to 60 days to ensure all cash flows are working properly and one full monthly cycle is completed successfully. The TDMP base monthly service fee of $39.95 per month (also tax deductible) represents excellent value for the basic service of making the monthly mortgage pre-payment and LOC re-advance and adjustments throughout the year as required by the strategy. The TDMP philosophy is to work with clients who appreciate the value of their own time and are willing to pay a nominal, tax-deductible monthly fee to a professional service provider who is accountable back to them. Homeowners who wish to self-manage the strategy will spend significant time each month to save a few dollars. TDMP has achieved economies of scale and the ability to bulk instruct lenders, which allows the efficient delivery of a cash management service at a low cost. TDMP clients view this service as good value, and any time they have a question on any of their statements – they can call!
CMT: One of the requirements for implementing a strategy like this is 20% home equity, correct? If someone doesn’t have 20% equity but is interested in the strategy, what do you recommend he or she does? For example, can one get a mortgage that can be easily converted into a readvanceable mortgage once one amasses 20% equity?
Sandy: This is a tough question. If homeowners do not have 20% equity, they don’t qualify for TDMP. Even if they do just have 20% equity, they still might not qualify for TDMP. Therefore, we recommend that all homeowners interested in the TDMP strategy meet with a TDMP Certified Mortgage Planner who will advise them at what point they might qualify in the future, and provide them with the appropriate, professional mortgage advice required to keep the TDMP option open and available in the future.
CMT: There was an article a while back about the TDMP that suggested 35% minimum equity before starting the strategy. Is that still applicable?
Sandy: The 35% equity threshold referred to in the article is still recommended for “very well qualified deals,” which is a good guideline for inexperienced mortgage brokers new to advising homeowners on TDMP. However, the real minimum threshold is 20%. TDMP deals that fall in the 20% to 35% bracket may or may not qualify depending on the rest of the homeowner’s personal Balance Sheet and other issues. An experienced TDMP Certified Mortgage Planner will assess those deals for suitability on an individual basis.
Please note: Leveraging your home for investment purposes involves risk. Consult a licensed tax and financial advisor before embarking on any such strategies. CMT is not affiliated with the interviewee and the above should not be construed as a recommendation, endorsement, or an assurance of future results.
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