Financial Planning

  • Do I pay Zakat on 401k and IRA? Is it 2.5% or 10%? (updated with new info about Roth IRA)

    M Babu asks:

    As Salamualikum. Ramadan ul Mubarak. I need to understand zakat on retirement funds contributed by both employer and employee. As a teacher, I have a TIAA-CREF retirement account where I contribute and my employer contributes a matching percentage of the salary. All my investment is in stocks since other options are interest bearing.  I can not receive the cash until it vest when I reach retirement age. Do I have to pay zakat on the amount of this retirement fund that has been accumulated?

    Another Questioner asks:

    I am looking for clarification on rules for zakat on stocks and zakat on 401K.

    1) Below excerpt from _____ fund web page says zakat of 10% is due on INCREASE of asset and not on the base asset. I was under the impression zakath is due on the whole capital.  I want to do the right thing. What is the correct basis?

    2) The 401K is a fund that is joint contribution by employer and me. It is not yet tapped into as I have not retired. Although I could take withdrawal from it as I am over 59.5 yrs. Is zakth due on 401K (these are in stock fund).



    Retirement funds and similar are something many people ask about it.

    Let’s look at the issues at hand above based on the two questions presented:

    1-      How much Zakat is paid on business partnerships and investments?

    2-      Is my retirement account (such as 401k, IRA, or similar) liable for Zakat?

    If you are looking for more information on how to pay Zakat on Mutual Funds and Stocks/shares NOT part of your retirement fund, click on the previous link.

    How much Zakat is paid on business partnerships and investments?

    Business partnerships and investments are due 2.5% when paying Zakat on them. Mutual Funds, which invest in a portfolio of stocks (shares) are business partnerships and are treated as such when calculating profits and zakat. To make them analogous to agricultural projects is incorrect for several reasons most of which cannot be mentioned in a single post. Those interested can look for module five of my Zakat course entitled “Advance Topics in Zakat Law.”

    Is my retirement account (such as 401k or Traditional IRA) liable for Zakat?

    Modern scholars differed as to when to pay zakat on retirement accounts such as 401k, Traditional IRA’S,  and other similar investment vehicles wherein a person does not actively have control over and cannot access without penalty the funds therein until a threshold or time period is met.

    Perhaps the more correct of these 2 opinions is that Zakat is not due on your retirement account (401k, IRA, or similar) until it is time to cash out without penalty.

    • If the conditions of that account state that after a person reaches a certain age (say 55 or older) then he or she may withdraw without penalty then Zakat is paid on that amount when you reach that age. Each subsequent year, if Nisaab still exists in the account, you would pay on that account.
    • If you cannot access the funds in that account, or you are penalized for early withdrawal, then you are not liable to pay Zakat on that account.
      • Zakat is only due on unhindered, fully accessible wealth which is actively managed by the investor.
      • Any wealth which is lost, inaccessible, held in an illiquid state, or cannot be accessed freely without penalty is not liable for Zakat.
    • If the wealth in the retirement fund is designated for the employee then he must pay 2.5 percent of that amount only when he cashes out without penalty at the time those funds are made available to him.
    • If he or she chooses to cash out early and pay the penalty then they must still pay Zakat on the amount withdrawn immediately at the time of availability regardless of the matching funds contributed by his employer or not.
    • If he is not allowed to cash out, but instead is forced to take a loan from the 401k fund and pay it back with interest, then he or she will not pay Zakat on this amount until it remains in possession for one year after receiving it from the 401k fund.
    • You pay 2.5% on the amount available to you at the time the money is made available to you without penalty. You do not compound 2.5% for the entire tenure of the investment; you only pay 2.5% for one year on the amount made available at cashout without penalty.

    What about Roth IRAs? Do the same rules apply? (Added 7/28/2013)

    Roth IRAs function differently than 401ks and traditional IRAs. Contributions to a Roth are taxed, and thus the capital therein can be withdrawn tax-free and penalty free. Earnings however are subject to two conditions: funds must have been in the account for five years, and you must be 59 and half years old to withdraw.

    That said, because contributions to the Roth fund are liquid and penalty free, you must pay Zakat on the total amount of contributions. Add your total Roth amount minus earnings lesser than 5 years as a line item to your Zakat calculation and pay 2.5% on that amount. Easier still would be to add the entire value of the Roth as a line item, and consider the extra paid on earnings as a pre-payment of Zakat on those funds.

    Which ever you choose, remember that regulations and tax implications for IRA accounts are detailed. My advice is that you talk to a an advisor versed in tax law as well as Islamic financial ethics before making a decision to make a withdrawal. If you need confidential advice on how to calculate and pay your Zakat, please contact me through this site.

    What about ESA (Education Savings Accounts) and similar?

    Look forward to a new article on the topic of educational savings funds coming soon.

    Don’t see what you’re looking for here? Try our Zakat page for more information.

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  • Deconstructing Islamic Law – Focus on Fiqh texts (2)

    28 Oct 2010

    Last time we looked at Fiqh texts we mentioned:

    If we look at them substantially, they consist of:

    1. textually gleaned understandings (i.e. from Quran and Hadith)
    2. issues of consensus
    3. opinions of the companions an/or their students
    4. opinions of the “Imam” of that particular school
    5. and at times opinions of the leaders of that Imam’s school after him

    This time I’d like to discuss each of these in brief:

    1. Textually gleaned understandings

    This first category is made up of understandings taken from the texts of the Quran and Sunnah. Both of these contain texts which can generally be divided up into three categories:

    A. Texts which are explicit and unequivocal in nature, i.e. they will not and cannot hold more than one meaning without deviating from their true linguistic meanings and invoking some type of heterodox interpretation. This category is know as a “Nass” (نصّ).

    And example of this would be the verse (وَآتُواْ حَقَّهُ يَوْمَ حَصَادِهِ ) “And give its right the day of Harvest…” 6:141. The meaning taken from this verse is that zakat is due on crops the day they are harvested. No one can rightfully construe this verse to mean something other than that apparent without invoking an interpretation that would not only be foreign to the corpus of Islamic legal understanding but to the Arabic Language as well.

    An example of deviant misinterpretation of the Quran would be construing this verse (إِنَّ اللّهَ يَأْمُرُكُمْ أَنْ تَذْبَحُواْ بَقَرَةً ) “…God orders you to slaughter a cow…” 2:67, which was directed to the Children of Israel at the time of Moses to mean that God has ordered the slaughter of Aisha, the wife of the Prophet Muhammad. Such an interpretation is neither logical nor in accordance with sane readings of the texts legally or linguistically.

    B. Texts which contain more than one meaning, yet one of these is presumed stronger than the other. This is called a “Zahir” text (ظاهر).

    An example of this would be the hadith narrated by Muslim:

    “For every forty sheep, a sheep.” (في أربعين شاة شاة)

    The apparent meaning of this hadith is that a Shepard who owns forty sheep must pay one sheep as Zakat. Other scholars said that the meaning of this hadith is that he must pay the price of one sheep as zakat, not that he is obligated to pay the actual sheep. Regardless of Juristic polemics surrounding the issue at hand, when analyzed singularly the strength of first meaning is more presumptuous than that of the second.

    C. Texts which contain multiple meanings, it being impossible to designate one of these meanings without an external texts or meaning to help determine it. This type is called “Mujmal” (مجمل). The process by which it is clarified is called “Bayan” (بيان). It is then known as a “Mubayyan” (مبين) text.

    For example the 3rd verse of Surah al- Mujadilah

    (وَالَّذِينَ يُظَاهِرُونَ مِن نِّسَائِهِمْ ثُمَّ يَعُودُونَ لِمَا قَالُوا فَتَحْرِيرُ رَقَبَةٍ مِّن قَبْلِ أَن يَتَمَاسَّا)
    “Those that commit Zihar from their wives then return to that which they said must free a slave before they reunite…”

    The description of the slave here is an unknown, is it a believing slave as mentioned in other verse (4:92) or not? Does a slave who is impaired count? and so on and so forth. Some would say that in this instance we must look at similar instances in the texts, and judge the ambiguity of this text by the explicitly of the others. Other disagreed.

    The point in all of this is that the multiplicity of opinion based on B & C is found in works of Fiqh, and fiqh texts become the junction of linguistic, inductive, and logical arguments; these all leading to the categories following this first one.

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