Advisers must test the tax case for endowment switches
The impact of capital gains tax (CGT) on long-term investment outcomes is one of the biggest reasons advisers hesitate before shifting discretionary investments into endowment wrappers. Even where the long-term case for an endowment looks compelling, the immediate tax consequences can make the switch difficult to justify without careful analysis.
Assessing tax efficiency
The considerations and implications when transferring a client’s discretionary funds into an endowment were discussed during a presentation to The Allan Gray Edge 2026 webinar. “Many investors, and especially those in high income tax brackets, assume that an endowment is automatically more tax efficient,” said Guané Coetzer, Manager in Adviser Proposition at the asset manager. “The real question is at what level of capital gain switching makes financial sense.”
Some theory is indicated to facilitate today’s complex investment product comparison. To begin, Coetzer explained the key differences between the firm’s offshore investment platform (discretionary structure) and its offshore endowment. Investments in the former are taxed in the hands of investors at their marginal tax rates, which can be as high as 45% on income or 18% on capital gains.
According to Coetzer, South Africa assesses the discretionary structure as a deemed disposal upon death, meaning that CGT is triggered in the estate. Since the investment forms part of the deceased estate, an executor is required, and executor fees apply. “Another important point is that there is no beneficiary nomination, and distribution happens according to the will; Allan Gray will take instruction from your South African executor,” she said.
Beneficiary nomination benefits
An offshore endowment is treated differently, in that tax is deducted and paid within the product. “Income is taxed at a flat rate of 30% and capital gains at a flat rate of 12%,” Coetzer said. The investment also forms part of the estate for estate duty purposes, but as long as beneficiaries are nominated, there is no executor involvement in distributing the policy benefits. “Beneficiaries can either receive ownership of the policy or a cash pay-out,” she said. If ownership transfers upon death, there is no deemed disposal, allowing the CGT to be deferred.
The key differences between the discretionary structure and offshore endowment revolve around the timing of taxation events, executor involvement and CGT treatment at death. According to Coetzer, outcomes diverge meaningfully, making the outcome worthy of further investigation. “In a discretionary structure, Allan Gray acts on the instruction of the executor, according to their will,” she said. “The beneficiary can either take a cash lump sum, transfer the investment or a combination of the two.” Executor involvement is unavoidable.
In an offshore endowment, the policyholder nominates beneficiaries directly, and upon death, the policy can either transfer ownership or pay cash proceeds. “A key distinction is that the transfer or payment of benefits happens outside of the estate administration process,” Coetzer explained.
Considering different scenarios
There are a range of considerations that derive from who the beneficiary is. A common scenario involves a surviving spouse as beneficiary. Assuming the spouse takes cash in the discretionary structure, CGT will be triggered at the deceased’s rate. If the spouse elects to take a unit transfer instead, spousal rollover relief applies, so no CGT is triggered at death. In either case, estate duty does not apply due to that spousal exemption. “Even though you may avoid CGT via the rollover, you cannot avoid executor fees,” Coetzer added.
In the case of an offshore endowment where the surviving spouse is a nominated beneficiary, there is no executor involvement, so no executor fees. If ownership transfers, no CGT is triggered at death, though it is deferred. And if cash is paid out, CGT will be triggered, but at a flat rate of 12% within the product. Again, no estate duty applies due to that spousal exemption. “The key distinction here is that the offshore endowment removes the executor involvement and allows for that deferral of CGT where ownership is transferred,” Coetzer said.
The scenario shifts if a natural person other than a spouse is nominated to receive the death benefit, with the caveat that the example only considered major children. In the discretionary structure, death is treated as a deemed disposal, with CGT triggered at the deceased’s marginal rate, but in this case, the spousal rollover falls away, estate duty becomes payable, and executor fees apply.
In an offshore endowment there is no CGT at death; this tax will be deferred regardless of who the beneficiary is. “Estate duty will still apply, but there are no executor fees because the policy pays those cash proceeds directly to the nominated beneficiary,” Coetzer explained. “One important implication or benefit of transferring ownership in an endowment is that capital gains tax may effectively be deferred until the beneficiary eventually disposes of the policy; the tax event is not eliminated, but postponed.”
Tax consequences of discretionary exit
At first glance, transferring to an offshore endowment seems a better ‘bet’ than remaining in the discretionary structure. However, many advisers and investors forget about the tax consequences of exiting the discretionary structure.
Coetzer explained that transferring from a discretionary investment into an offshore endowment triggers a real, immediate cost in the form of CGT on the disposal. “On the other hand, we have potential tax and estate savings in the future,” she said. Decision-makers must weigh up the tax advantages in the offshore endowment with the immediate CGT implications of the switch.
To explore outcomes, the presentation offered practical examples of an investor with USD100 000 in an offshore discretionary portfolio, with around 97% of that amount being an accumulated capital gain. The investor has a maximum marginal tax rate of 45% on income, which translates into an effective capital gains tax rate of 18%. The CGT in this case will deplete the capital available for transfer to the offshore endowment, leaving USD82 622 to invest. After 20 years this client passes, and the surviving spouse opts to take the benefit in cash.
Other assumptions are that the investor’s marginal tax rate remains at 45% until death; a 2% per annum depreciation in the rand-dollar exchange rate; and a 7% annual return in US dollars. Executor’s fees are charged at the maximum rate of 3.5% plus VAT.
Crunching the numbers
Allan Gray crunched the numbers to reveal that the 97% capital gain and 20-year time horizon represented the break-even threshold for the switch. “Below this level of embedded capital gain, transferring to an endowment creates value, and above this level, the upfront CGT becomes too expensive,” Coetzer said. The caveat here is that the analysis holds under the very specific assumptions that the asset manager chose.
“Two clients with identical portfolios could reach completely different conclusions purely based on their tax profiles,” said Coetzer. Advisers will have to do what they do best: run the necessary modelling to illustrate the benefits (or not) at each decision point. Allan Gray shared tables showing how different marginal tax rates, return assumptions and time horizons affect the break-even threshold, all other factors being equal.
Although too detailed to explain here, the threshold falls in line with changes in marginal tax rates. For an investor with a starting marginal tax rate of 45%, slipping to 39% at death, the break-even capital gain in the discretionary structure falls to 75%, and 50% if the future marginal rate is 31%. If the starting marginal tax rate is 39%, dropping to 18% on retirement, the break-even capital gain in the discretionary structure falls to just 16%.
If one shortens the time horizon to 10 years, with all other variables unchanged, the break-even threshold increases. And in the higher return scenario of 15% per annum, the break-even point decreases. “The higher the return, the more expensive it becomes to pay capital gains tax upfront; you lose more compounding over time,” Coetzer said. She noted that some of the outcomes in the table were implausible because future capital gains could push investors into a higher marginal income tax bracket.
Getting to grips with the variables
The conclusion: advisers must understand how key variables such as the size of the embedded capital gain, the investor’s marginal tax rate, the time horizon, return expectations and executor’s fees affect switch outcomes when moving from a discretionary offshore platform to an offshore endowment. Another important factor to consider is whether the benefits are taken as ownership or as cash, and by whom, suggesting that advisers should carefully assess client circumstances to recommend the optimal path.
Writer’s thoughts:
Shifting clients’ funds from an offshore discretionary structure into an offshore endowment demands serious modelling. Did this explainer change how you think about the switching decision, and are you comfortable factoring in future unknowns such as marginal tax rates and annual portfolio returns? Please comment below, interact with us on X at @fanews_online or email us your thoughts [email protected].
