To address your question about whether you should convert your discretionary investments such as your unit trust into a retirement annuity before retirement, the overall recommendation is that doing so is not advisable.
While retirement annuities play a valuable role in long-term planning, transferring discretionary investments into an RA at this stage would create unnecessary tax costs, reduce liquidity, and introduce regulatory constraints that offer little benefit in return.
Converting discretionary investments into a retirement annuity requires you to sell the underlying assets in full, and this disposal immediately triggers capital gains tax (CGT).
Any capital gain above the annual exclusion of R40 000 is taxable, with 40% of the gain included in your personal taxable income. For example, if the sale generates a capital gain of R4 000 000, only the first R40 000 is excluded.
The remaining R3 960 000 is subject to CGT, and 40% of this amount – R1 584 000 – would be added to your taxable income and taxed at your applicable marginal income tax rate.
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Although contributions to a retirement annuity are tax-deductible, the deduction is limited to the lesser of R350 000 per year or 27.5% of taxable income or remuneration. This means that even if you invest a large lump sum into your RA after selling your discretionary portfolio, only a portion up to R350 000 would qualify as an immediate tax deduction.
Any amount above this limit becomes an over-contribution, which can only be recovered later under Section 10C of the Income Tax Act when you begin drawing income from your living annuity. This delayed relief does not offset the significant upfront CGT cost created by selling the discretionary investment in the first place.
Liquidity is another central consideration.
When you finally retire and convert your retirement annuities to a living annuity, these structures do not allow ad hoc withdrawals, and any changes to your income level can only be made once per year on the anniversary.
Even then, you are restricted to drawing between 2.5% and 17.5% of the capital value per year.
For more flexibility …
Discretionary investments, by contrast, allow full access to your funds at any time.
This flexibility becomes especially important in retirement, where unexpected expenses or lifestyle changes may require additional capital.
If your living annuity income is not sufficient to meet your needs, supplementing it with withdrawals from a discretionary unit trust is generally more efficient and avoids the limitations imposed by retirement products.
Regulatory framework
It is also important to consider the regulatory framework governing retirement annuities.
RA investments are subject to Regulation 28 of the Pension Funds Act, which places limits on exposure to certain asset classes, including offshore assets. While Regulation 28 is designed to promote diversification, it may restrict your preferred investment strategy.
Read: Retirement annuities: From tax deductions to the two-pot retirement system
Additionally, retirement fund benefits fall outside the estate and are therefore exempt from estate duty and executor’s fees. However, these benefits are allocated at the discretion of the fund trustees, which means the distribution may not perfectly align with the wishes expressed in your will.
Although keeping your discretionary investment increases the value of your dutiable estate, it is important to recognise that an over-contribution to a retirement annuity can, in certain circumstances, create an estate-planning benefit.
Read: What many investors don’t know about their retirement funds – but should
Since retirement fund assets fall outside your estate, using Section 10C to recover previously disallowed contributions may offer a degree of tax efficiency over time. However, this benefit must be weighed against the practical realities of moving discretionary capital into a retirement structure.
The impact of Regulation 28, the upfront capital gains tax triggered on disposal, and the loss of liquidity and withdrawal flexibility all introduce meaningful constraints.
For these reasons, it requires a very specific set of circumstances for the estate-planning advantage of an over-contribution to outweigh the tax, liquidity, and regulatory drawbacks discussed above.
As the optimal strategy depends heavily on your broader financial position and long-term objectives, it is advisable to consult with a Certified Financial Planner® who can evaluate your full financial landscape and ensure that your retirement and estate plans are aligned in the most effective way.