Episode 154: When NOT to Do The Smith Maneuver – A Case Study Exposing a Common Tax Trap

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Is the Smith Maneuver really the smartest move for the extra money you have sitting around? 

What about for a corporation’s retained earnings?

If you’re an incorporated business owner in Canada, you’ve likely heard the hype around using the Smith Maneuver to make your mortgage tax-deductible and accelerate your investments. But what if tapping into your corporation to do it is actually costing you more in income taxes than it’s earning in returns? This episode tackles a real-life scenario that flips the traditional advice on its head—and shows how business owners can unlock greater wealth without bleeding money to the CRA.

Here’s what you’ll discover in this episode:

• Why using corporate funds for the Smith Maneuver can backfire—and what the hidden tax drag really looks like 
• A smarter, tax-efficient alternative that turns your corporation into a wealth engine using high early cash value participating whole life insurance
• How to structure investments inside your business to grow your net worth and your estate—by hundreds of thousands over time

If you want to protect your wealth and grow it smarter, press play now to rethink how your corporation fits into your long-term financial freedom strategy.

Resources:

• Ready to take a deep dive and learn how to generate personal tax free cash flow from your corporation? Enroll in our FREE masterclass here. 
• Book a Discovery Call with Kyle to review your corporate (or personal) wealth strategy to help you overcome your current struggle and take the next step in your Canadian Wealth Building Journey!
• Discover which phase of wealth creation you are in. Take our quick assessment and you’ll receive a custom wealth-building pathway that matches your phase and learn our CRA compliant tax optimized strategies. Take that assessment here.
• Dig into our Ultimate Investment Book List
• Follow/Connect with us on social media for daily posts and conversations about business, finance, and investment on LinkedIn, Instagram, Facebook [Kyle’s Profile, Our Business Page], TikTok and TwitterX. 

Calling All Canadian Incorporated Business Owners & Investors:

Consider reaching out to Kyle if you’ve been…

• …taking a salary with a goal of stuffing RRSPs;
• …investing inside your corporation without a passive income tax minimization strategy;
• …letting a large sum of liquid assets sit in low interest earning savings accounts;
• …investing corporate dollars into GICs, dividend stocks/funds, or other investments attracting corporate passive income taxes at greater than 50%; or,
• …wondering whether your current corporate wealth management strategy is optimal for your specific situation.

In this episode of the Canadian Wealth Secrets podcast, Kyle Pearce explores why the traditional Smith Maneuver may not be the most effective strategy for certain Canadian business owners with significant retained earnings. By analyzing a real-world scenario, Kyle breaks down the tax implications of pulling funds from a corporation to implement the Smith Maneuver versus using a more strategic corporate wealth management approach. Listeners will gain valuable financial education on how to leverage permanent insurance and high early cash value policies to unlock passive income, net worth growth, and long-term wealth optimization—without sacrificing financial security or overpaying on taxes. This episode is packed with actionable investment planning tips, asset protection strategies, and insights to help accelerate your wealth building, improve your rate of return, and potentially reach early retirement and financial independence through better investment strategies aligned with your time horizon and risk profile.

Transcript:

Welcome to the Canadian wealth secrets podcast and another secret sauce episode where we’re going to take a real Canadian client scenario and use it as a model to guide you along your journey to better Canadian wealth building decisions. Today we dive into a scenario that may have crossed your mind before given all the hype and excitement around from the Canadian wealth secrets audience.

around this Smith maneuver strategy. Today’s case is going to unpack a scenario where the Smith maneuver is actually not the best way to optimize this Canadian clients tax situation and wealth building plan. I’m Kyle Pierce and today we’re to be showing you how to navigate the complex waters wealth management for eager investors who are looking to keep more of their hard earned dollars working for them in

doing so in more than one place. Now, while your scenario might not be exactly like this particular case, do know that the ideas we discuss here will help coach you to be able to better navigate your own unique wealth management plan. So stick around as we unravel the secrets to making your hard earned income work harder for you, whether you are a T for earner or an incorporated business owner.

All right, my friends, so we are gonna dig in here. And as mentioned here in the introduction, this was a client call that I had recently and they asked a really great question. Now, just to set the table a little bit, this individual is in their mid 40s, married with children, they have a primary residence, they also have some investments. And we’ll talk a little bit more about that as we move along here. Now, they do have

mortgage. They have a home and today I’m going to be setting the home value at 625 although it’s actually more like double that number and the mortgage value in the mortgage balance we’re going to set at $500,000 however they actually do have more equity than that here but we’re going to use it for today’s illustration purposes okay their mortgage rate right now is at prime minus 1.15 which

You know, recently, 18 months ago may not have felt very good, but ultimately now they’ve hung on for rates to fall. And as of this episode, since prime has fallen to about 4.95, they are sitting on a mortgage rate of 3.8%. They also have a flex line through one of the big banks. So they have a re-advanceable mortgage that’s set at prime plus

So that’d be sitting at about 5.2%. And here is the big question. This individual, the spouse is a T4 employee working as an educator. The husband is a business owner, incorporated business owner, and is pulling an income of about $184,000 each and every year.

and they are contemplating whether they should use retained earnings that is stuck inside the corporation in order to do the Smith maneuver. So pull money out, put it on the primary mortgage, create more line of credit room, and then borrow to invest so that the interest on that home equity line of credit is tax deductible. Now at the onset.

You’ve heard us talk about it before. We’ve talked about the Smith maneuver a lot on this show, and we’re going to continue to take scenarios that you folks want to hear. So keep them coming. Let us know through ratings and reviews what you want to hear about. So today we’re going to dig in. We’re going to talk a little bit, but about why it’s not exactly the best move for them to use the Smith maneuver in this way.

All right, so there’s a caveat here, right? Smith maneuver is still going to be very, very helpful for this family potentially, but we’ll talk about why certain moves may not be helpful and other moves will be helpful. So for those who are joining us on YouTube, first of all, thank you. Hit subscribe, hit the notification bell, leave us a comment and share away. We’re getting a lot more interest over on YouTube.

I’m gonna be sharing my screen here and you’re gonna notice that we have a little bit of information up on the screen. I’m showing kind of the personal side up here. Anyone who’s been on a discovery call knows that I love to draw things out over here. And up here we have there some equity in the home. I’m putting it at hundred thousand, but it’s actually much more in this particular case. They’re talking about this idea of borrowing to invest using the Smith maneuver. So paying down more of the home.

mortgage balance and creating more tax deductible interest while investing. Now we’re not really concerned here about what you choose to invest in. We’re talking more about the strategy. So the investment itself, we’re not going to worry too much about. And we’re going to assume that whatever I suggest here today that we’re going to make the same investment. It’s just maybe we’re going to go about it in a slightly different way. Now down here on the screen, you’ll notice I have my little corporation box.

And inside there, they have more, uh, more than $700,000 in retained earnings, and they anticipate to generate somewhere around an average of $200,000 in retained earnings each and every year. Now, as you can imagine, okay, when you have a mortgage owing of say 500,000 out here and you have more than enough inside the corporation to wipe out that mortgage, there is this incentive or

incentives, wrong word, there’s an urge, there’s a need, there’s a feel. And this is all emotional, right? Your emotions are saying, why am I letting money in here, sit here, and paying interest out here? Why would I want to do that? So their thought is, if we can take money out of the corporation, we could put it on the equity of the home, and then they’re going to borrow against that equity to invest, which

I love the idea in general, right? So it’s like, hey, we’re getting the best of both worlds. If I could do that, if I could just take this money, pull it out, put it on equity, and then invest. I love that strategy over time. But here’s the problem. If you look up in the top left of the screen here, what we have is his salary, I’m not even going to consider the spouse’s salary right now, we’re just going to look at the business owner, because that’s really all that matters at this time.

He’s pulling $184,000 through salary and dividends. And in general, based on his province, his average tax rate is about 28.8%. So around 29%, we could round up to 30 if you’d like. That means on that $184,000, he’s actually paying $53,000 in taxes already. All right, now he could get some of that back if he was to put it into the RRSP and he’d get the tax back, but now the money’s stuck in there. But at this time,

really this money is being taken out mostly for lifestyle. It’s for lifestyle needs. I’m not going to comment whether that’s good or bad, right? But ultimately at the end of the day, they need this money in order to live the lifestyle that they’ve chosen to live. So the question then becomes, okay, I have $131,000 of after-tax income that’s really already accounted for in my budget.

my car loans, my mortgage, my property tax, you know, the kids sports, whatever it is that they’re doing, that money’s already earmarked. So the thought was, well, why don’t we take more money out of this corporation? Now in our conversation, they were saying somewhere around a thousand to $2,000 a month. They weren’t dead set on a number. So today I’m going to just

suggest that let’s say it was 10,000 a year, okay, 10,000 a year, it’s actually a little less than $1,000 a month. But I want to keep the numbers nice and easy for us to play with. If we go to take that extra. So we go to take this extra one that or $10,000 a year. And I’m going to assume it’s probably going to come out as a dividend at the end of the day, because they do want this thing to come out and they are in a very high tax bracket, by the way,

their marginal tax rate is over 42%. And with every dollar that they take out as a salary, every additional dollar, this number is going to continue to move up, right? So it’s not the highest tax bracket. So it’s actually going to cost more. So if we take a dividend, I’m going to try to cap this somewhere around 39 %-ish. Every province is going to be a little bit different. But we’re going to cap that number.

And ultimately, at the end of the day, think I was even being a little bit more favorable in our calculations or a little more conservative. I said, let’s say you could do it for 35 % based on where he’s living. But again, I think it’s going to be a little bit north of that. The problem is this extra $10,000, we’re going to be losing about three and a half thousand off of that. And that is obviously problematic.

because now the additional money that they have to actually perform the Smith maneuver is now only 6.5 thousand. So what they took out, so they’re losing $10,000 down here from the corporation and they’re only gaining six and a half thousand or $6,500 that they can then put into the property, borrow and reinvest.

So right away, the math on that is really tricky because if I look at this and I go, okay, if I’m at 6,500, just to make the $10,000 whole again, I’m gonna have to have quite a return here in order for that to happen. And it’s not gonna be 35 % either, right? It’s gonna actually be north of 39 % because we lost 35%. We’re gonna actually have to gain more than 35 % in order to get back to square one.

So I don’t like that right away. And for some people you might say, well, okay, the, you know, the conversations over, but I think it’s really important for us to really get thinking about, so what should we do anyway? And ultimately what I would recommend instead is imagine if you were able to make the same investment, but inside the corporation. And one thing that this individual could do is they should be doing something with this money. Okay. First of all,

shouldn’t just be sitting under the corporate mattress. I think in their case, I’d have to go back and double check. But some of these funds are in investments. Now, the challenge is, though, oftentimes we don’t want to get too much of it tied up because we don’t know in case there’s a business hiccup along the way. As I record this, tariffs wars are going on and all these things. So there’s uncertainty going on. Well, in business, uncertainty can happen in many different ways. It can be political.

It could also just be economic based on, you know, the, the industry that you’re in. So while I’m not going to suggest that they take all of this money and invest all of it, what I do want to compare here is imagine this world where instead of taking the $10,000 out, they were to do something a little bit different and they were able to supercharge both their investments, but also their net worth over time and their estate over time.

And what I would recommend is they do one of two things. Now, the easy thought is you just take this money and you invest it inside the corporation. Okay. When we do this. All right. First and foremost, that’s the easy move. That’s what most people would do, right? They’d put it into some type of investment. Assuming you’re investing in the same asset as outside here, as long as it’s a capital gain and not

passive income right passive income is tax less favorably inside of here however passive income is also going to be tax less favorably from them if it’s not any tax incentive or a tax deferred account because they’re in such a high tax bracket here as well however I’m going to recommend that both of these investments were in capital gains like investments why well because as of today

These are going to be treated the same way from a tax perspective. So if this grows a capital gain, I have to pay tax on half of the capital gain when I realize that gain, when I sell the asset. The same is true in here as of today. OK, we know that the government last year tried to change that and make it a little bit more painful for corporations. However, as of today, they’re exactly the same. And I could take this 10,000 and the full 10,000 can go into the investment.

and then I’m dealing with the same tax issue after. Something a lot of incorporated business owners don’t recognize is that there is also the capital dividend account, which allows you to take out, I’m gonna write it over here, the CDA allows you to take out the tax free portion or the tax sheltered portion of your capital gain when you sell.

So it’s not like it’s just the corporation that’s not going to be taxed on that portion. We actually get to take that out as a shareholder as a tax-free dividend, which is really, really helpful. So the investment being inside or outside is not really the main concern here. Of course, I would love to have the investment outside the corporation, but not at a 35 % tax in order to do so.

Now, in order to run this even more optimally, where we can solve some of the problem that he is going to have, because let’s be honest, a lot of this retained earnings that are inside this corporation, at some point in the future, when we do take it out as a salary or dividend, we are going to be dealing with the fate of this high taxation, 35%, 40%, depending on where you are. That’s going to be a big slap in the face.

So what I’d like to do is actually do two things at once. I want to make this investment. And actually what we’re going to do is we’re going to recreate the Smith maneuver inside the corporation here. What we’re going to do in this case, and by the way, this particular individual probably should be doing something with a much higher amount than this. However, we’ll use the $10,000 example for today’s episode. I’m going to take instead of the $10,000 going directly into an investment over here, which is fine.

I’m gonna first take that 10,000 and we’re going to put it into a high early cash value policy. And that policy is going to act like my home out here for the Smith maneuver. All right. Now, like a home, it’s gonna grow conservatively. Like a primary residence, it’s gonna grow tax free. Like a home, it’s going to also be

saleable down the road. In our case here, when we pass on and it turns into a death benefit tax free. The difference here is that this thing, this home, this invisible home inside of the corporation is going to be worth a lot more when I pass on than when I was alive. And the net death benefit will be able to come out through the capital dividend account, just like our investment, the tax free portion of the capital gain on the investment that we will make.

So what we’re gonna do is we’re gonna fund this policy and then we’re going to take what is available to us each year in cash value in order to invest in the same investment. And we’re gonna compare this to show you how much better this individual will be by doing this move rather than trying to do the Smith maneuver on their primary residence. Now.

noting here, one thing I will say, they do have a line of credit at 5.2 % and therefore when they’re borrowing, they’re going to borrow at 5.2 % and they’re going to get a write off on that portion. It’s kind of like having a 3 % mortgage after writing it off at a personal level. Well, the same is true in here. When we borrow against our policy here for investment purposes, we can write off the interest on that investment loan.

inside the corporation. So we’re going to have that same advantage. So we’re actually not going to look at the actual tax savings scenario here. And instead, we’re going to look at the actual result that we get from a net income perspective or not a net income, but a net worth perspective. So on my screen here, we’re going to look at this home value, home mortgage. And what you’re going to see is exactly what’s going to happen if they were to take the money out.

lose about $3,500 on the $10,000 and invest it at a personal level while doing the Smith maneuver. The advantage that they’re gonna get with the Smith maneuver is they’re going to be paying down the traditional mortgage at a faster rate than they would have if they just paid it off with the regular monthly payments. However, they are going to have a

balance on their home equity line of credit, but the difference will be is that that balance will have an interest rate that can be written off. And what you’re gonna see as they do this over time is that their net worth is gonna continue to grow as you can imagine. So if we look at the actual total net worth here, you’ll notice that each and every year, their net worth is going to be much better by using the Smith maneuver than if they didn’t.

But that’s not really the discussion here. What we’re going to look at is we’re going to try to figure out where would the $10,000 from that company be best spent. And we’re going to look at the difference there. And when we look at taking the $10,000 inside the corporation and instead funding a high early cash value policy, you’re going to notice a few things. First of all, we’re going to start with a cash value that’s a little bit north.

of the $6500 that they have after tax. Now to some people, they might say, Well, isn’t that the same thing? But actually, no, because we have two assets growing, we’re gonna have cash value that’s going to grow each and every year. And we’re going to borrow and in this case, we’re going to borrow 90 % of the cash value right away to start investing in the same investment, we’re going to assume 7 % is the average rate of return of these investments.

So there’s no change there. Everything is consistent there. And what you’re going to notice is that we’re actually going to start borrowing against our cash value. And after the first couple of years, what you’ll see happening while in the other case, you’re going to each and every year lose about $3,500 of the 10,000 after about year five, when I put 10,000 in to the policy, I’m going to be able to leverage more than 10,000 out in order to make

more of an investment, a larger investment over time. So what you’re going to see is a total net worth that actually extends to be much, much larger than what you would have in the Smith maneuver case where you’re taking $10,000 out, losing 35 % on it, and then investing it in order to make a very small tax deduction. And the first year,

That tax, that interest that you’re earning on the 6,500, I shouldn’t say earning. The interest that you are spending on borrowing against $6,500 is only $330-ish, right? That’s not a lot of money, but $3,500 that you’ve lost to tax forever is a big deal, and that’s hard to make up for. So when I go to my summary sheet, what you’re gonna see here,

up on the screen as a comparison between what’s going to happen with the Smith maneuver by pulling more money out of the corporation, getting taxed at a high rate and trying to put it on the mortgage and then re-borrow into an investment versus taking that same 10,000 inside the corporation, putting it into a high early cash value permanent policy. In this case, it’s going to be a whole life policy and borrowing against the cash value to make the same investment.

you’re gonna notice that right away your total net worth is gonna be greater. And you’ll see that that net worth is going to forever increase in the corporate wealth plan that I’ve provided for you here. After 20 years, what you’re gonna notice is that your net worth in the Smith maneuver scenario is gonna be about 1.7 or sorry, 1.07 million. So $1,077,000.

Whereas the net worth, the total net worth scenario in the high early cash value permanent policy situation is going to be about 1.47 million. So you are looking at almost a $400,000 difference over a 20 year period by keeping money in the in the corporation and essentially creating your own corporate owned Smith maneuver inside the corporation. Now you’ll notice I haven’t given

any sort of ideas around what you should invest in. That’s not the point here. It’s that if you’re going to make this investment, the best move for this particular individual is not to take more money out for the Smith maneuver and to leave it in and start a corporate wealth management plan. I call it the corporate Smith maneuver plan. Now also something that you won’t get, you’re going to notice here that in the Smith maneuver column, I have an estate value column and really

It’s just exactly the same as the total net worth column because what we’re counting here is the equity in the home and the investments. All right. And we have taken away any debt off of there. All right. Whereas in the corporate wealth plan, the actual estate value is much higher. Why is that? Well, when we look over here, we actually have a death benefit that’s hidden in the background. means nothing to you while you’re living.

but it means a lot to your estate when you pass on. And you’ll notice starting in year one, the estate value is 284,000, meaning if you were to pass away, unfortunately, during year one, you’re gonna be at 284 instead of having only a total net worth of 125 if you were to try to perform this Smith maneuver. Now, as the years go on, the total estate value continues to rise.

And you’ll notice that the total estate value after 20 years here of performing this particular maneuver, your net worthwhile you’re living is 1.47 million, but your actual estate value is about 1.76 million. Now, I haven’t accounted for the capital gains taxes that you will pay on the investment buckets. But keep in mind, the bigger bucket is in the corporation

anyway, and therefore that would still be a net benefit in this particular case. The actual investment bucket that you’d have personally is actually going to be smaller in the Smith maneuver case because you had less money to invest each and every year anyway. So that is actually a non factor here. It’s not going to improve that case. It’s actually going to just show essentially it’s going to be

it’s going to bring them a little closer together in terms of net benefit, but definitely not on the estate side, right? So on the estate side, have about $1.76 million that we’ve achieved here without having to give anything up during your living years, which is so critical and so important. So what’s the moral of this particular episode? Well, it’s that not

every single idea and wealth building plan will work for every situation. With this particular family, I think that the Smith maneuver is a great move for them to do with any of the money that they already have outside of the corporation. So that means the spouse’s salary, for example, if there’s extra money each year, that spouse is receiving a T four and cannot hold back on that. So if that extra money is there, put extra money on the home.

and then borrow it out so that you can go and do the Smith maneuver if that’s something that you’d like to add to your plan. However, before I did that, I would be looking at the husband’s salary here who is taking 184 and is already being taxed at a very high tax bracket. If there’s extra money laying around already, I would take less out of the corporation each year and I would be starting this plan inside of the corporation. Now,

Outside the corporation, you could do the Smith maneuver just through regular principal pay down. So what I mean by that is you have a general or a basic monthly payment that you’re making on your mortgage. Anyway, each and every month you are knocking down principal, which means you are creating additional home equity line of credit room. You can use that room in order to invest outside of the corporation. So that will give you a net win.

However, I wouldn’t advocate in this particular household to be taking more money from the corporation in order to speed up the pay down of that particular mortgage. It is being shown as we’ve seen through the numbers and through the actual calculations that that’s actually not going to be your best bet. You are actually going to hinder your wealth building journey as opposed to building a corporate wealth management plan inside of the corporation.

So hopefully today, whether this applied to your scenario specifically or not, hopefully it’s giving you ideas around what must be considered before you decide on your own wealth management journey. If you are a T4 employee, you’re not going to obviously have to think about how much to take out of the corporation each and every year. You’re going to be receiving T4 income anyway. However, you do want to be analyzing when those dollars come to you,

Where are the best places for those dollars to flow? Depending on your risk tolerance and your risk capacity. Now, if you’re an incorporated business owner, for many who have additional retained earnings each and every year, what we’ve discussed today is likely going to be a helpful tool for you, whether it’s $10,000 of premium you’re putting in each year, $500,000 of premium you’re putting in each year or any other value.

utilizing permanent insurance inside the corporation can be a wealth monster. And in a good way, it can supercharge your wealth plan. Now, if you’re interested in hopping on a call to have your situation reviewed by me and my team, feel free to reach out to us over at corporate wealth. Sorry at Canadian wealth secrets.com forward slash discovery. And you can book a discovery call today.

If you are an incorporated business owner and you like some of the ideas you heard today, you’re going to love what we have inside of our masterclass. It’s a completely free masterclass and it’s self paced for you to dig into head on over to Canadian wealth secrets.com forward slash masterclass and you can dig in today. Just as a reminder, this is not

investment advice. It is for entertainment and informational purposes only. You should not construe any such information or material as legal tax investment, financial or other advice. And to remind you that I, Kyle Pierce, am a licensed life and accident and sickness insurance agent and the VP of corporate wealth management with the pan Corp team. However, more than happy to work with you with your unincorporated wealth management plans. We’ll chat soon and we’ll see you in the next episode.

Canadian Wealth Secrets is an informative podcast that digs into the intricacies of building a robust portfolio, maximizing dividend returns, the nuances of real estate investment, and the complexities of business finance, while offering expert advice on wealth management, navigating capital gains tax, and understanding the role of financial institutions in personal finance.

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