My question is regarding Zakat on 401K plans. I work for a company where each pay period certain percentage of my pay goes to 401K plan and my company also contributes a certain percentage to my 401K plan. I will not be entitled to the money until I retire. Although I can take money out with penlties. I can also take out a loan from my 401K plan and pay myself back with interest.
So, given the type of 401K plan I have. How should I pay Zakat on my 401K plan? Should I include the money I and my company contirubte each year in my yearly Zakat calculation or should I wait until I retire.
In the Name of Allah, the Most Gracious, the Most Merciful.
As-salāmu ‘alaykum wa-rahmatullāhi wa-barakātuh.
Before discussing the ruling on how to pay Zakat on 401(k) plans, the reader should note that there is a difference of opinion regarding the permissibility of investing in stocks.
The scholars that permit investing in stocks do so under the following specific conditions [i]:
1. The main business of the company is lawful.
2. The company has some illiquid assets such as buildings, machinery, inventory of goods, etc. If a company only has liquid assets then its shares may only be sold and purchased at face value.
3. The shareholder should voice his disapproval of the company’s dealings in interest which is ideally done at the annual general meeting (AGM). This is because many companies in spite of their main business being lawful usually take out interest based loans or keep a portion of their funds in interest bearing accounts.
4. The proportion of the stock dividend (if any) that represents the company’s earnings from interest should be given in sadaqah without any intention of reward.
The employee should carefully study which funds meet the above criteria before investing any money in his 401(k) plan.
401(k) is part of one’s assets and Zakat will be calculated on it annually:
The 401(k) plan is a voluntary retirement savings plan.
The employee can opt out of making contributions to the 401(k) plan or even withdraw his money before retirement age subject to taxes and penalties. [ii] [iii] [iv]
As a result, contemporary scholars have stated that plans like the 401(k) will be considered as part of one’s assets and Zakat will be calculated on them annually. [v]
Calculating Zakat by adding the employee’s contribution and the company match:
The 401(k) plan is made of two parts:
1. Employee’s Contribution (the money contributed by the employee): The employee owns 100% of this amount even if he has to pay penalties and taxes for withdrawing the money before retirement age.
2. Company Match: (the money contributed by the company on behalf of the employee): The Company matches the employee’s contribution up to a certain percentage. Ownership of the company’s contribution is usually transferred to the employee over a period of time as determined by the company known as “vesting”. This schedule usually depends on length of employment and varies from company to company.
Zakat will be due on the sum of the employee’s own contribution and the portion of the company match that is “vested” (i.e. the amount of the company’s contribution that the employee has acquired an ownership of and can withdraw along with his own money).
Zaid contributed $10,000 (adjusted for any investment gain or loss) to his 401(k) plan.
Zaid’s employer contributed $5,000 (adjusted for any investment gain or loss) to Zaid’s plan.
Total amount in Zaid’s 401(k) plan = $15,000 (adjusted for any investment gain or loss).
However, of the $5,000 invested by Zaid’s company, only 50% ($2500) is vested (the other $2500 is still owned by the company and has not yet passed into Zaid’s ownership).
Zaid essentially owns $12,500 of the $15,000 in his 401(k) plan. As a result, Zaid will give Zakat on $12,500.
Zakat on 401(k) may be given annually or when one he withdraws the funds:
The employee can either give Zakat annually by calculating the value of his 401(k) or give Zakat for all the previous years when he withdraws his funds (upon reaching retirement age or earlier than that by paying the relevant penalties and taxes).
Practically, it would be easier to discharge the Zakat due on an annual basis. However, if one wants to give Zakat when he withdraws the funds from his 401(k) he should keep accurate records so he can properly discharge the Zakat for all the previous years.
Sohail ibn Arif,
Student Darul Iftaa
Checked and Approved by,
Mufti Ebrahim Desai.
إسلام أور جديد معيشت وتجارت – مفتي محمد تقي عثماني ص. ٨٦ – ٨٩ مكتبة معارف القران [i]
[ii] Skousen, Mark. Economic Logic Fourth Edition. Pg. 403. Capital Press, 2014. Print.
[iii] Oglesby, Darren W. Concise Encyclopedia of Investing. Pg. 21. Hawthorne Press, 2007. Print.
[iv] Social Security Bulletin, Vol. 64. No. 3 http://www.ssa.gov/policy/docs/ssb/v64n3/v64n3p64.html
فتاوى عثماني ٢/ ٥٦ مكتبة معارف القران كراتشي [v]