Zakat on Investment Accounts

As Ramadan approaches, Muslims assess their savings to calculate zakat they have to pay the poor. General information on Fiqh issues of zakat is available across the web. This discussion is confined to the aspect of zakat on investment accounts.

There are a variety of scholarly opinions on this issue. Opinions of OIC, AAOFI, AMJA, FCNA, Sh. Yousuf Qardawi, Sh. Yasir Qadhi and others differ on calculation methodology. Zakah is an obligation in Islam. There is no tax authority audit in this case. What follows is a summary various opinions. One should choose whichever approach makes most sense. Wallahu Alam Bissawab. The discussion assumes that the payer has met the Nisab (minimum wealth required to make zakah an obligation) and Hawl (a lunar year has passed). Also it is assumed that all investments are halal as there is no zakat on haram income. Any haram portion should be given in charity without expecting any rewards from Allah SWT.

Conservative Method

A simple and conservative approach is to treat the investment portfolio as savings. In that case, 2.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} of the current market value for lunar year or 2.577{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} for non-leap solar year and 2.5775{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} for leap year would apply. Most people calculate zakat on a lunar date like first of Ramadan and calculate it at 2.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b}. For example, zakat on a portfolio of $100,000 is $2,500.

In case of retirement accounts such as 401k or IRA in US, zakat is paid on net cash value. Since retirement accounts usually are pre-tax, the taxes and any penalties, if applicable, need to be subtracted from the total balance. Taking the above example, for a retirement portfolio with current market value of $100,000, a person in highest tax bracket of 37{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} and with 10{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} withdrawal penalty, would owe

Balance ($100,000) – 37{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} Tax ($37,000) – 10{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} Penalty ($10,000)

= $53,000 x 2.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} = $1,325

Some scholars are of the opinion that zakat is not owed on retirement account until money is available penalty free. This usually happens at age 55 or 59.5. In that case, only the tax needs to be subtracted from the balance. In case of Roth accounts, zakat would apply to the entire balance since that is after tax money.

Asset Base Method

There is an alternate opinion that investments should be divided between fixed (plants, machines, etc.) and liquid assets (cash, inventory, etc.). Zakat is only due on liquid assets. Taking the above example, if the market value is $100,000 and fixed assets are 65{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b}, zakat is only owed on liquid assets which is 35{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} ($35000).

Market Value ($100,000) – 65{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} fixed Assets ($65,000)

= $35,000 x 2.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} = $875

Although the asset base method is more logical but it is very cumbersome to scan the balance sheets of all the securities in the portfolio and come up with fixed vs current asset ratio. It is even harder if the portfolio includes mutual funds and ETFs, which is the case for majority of individual assets. Some brokers and money managers provide this service and perform calculations for their paying clients.

There is an alternate opinion which sets the average current asset value at around one third of the total investment market value. So the zakat would be between 0.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} to 1.0{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b}.

Ushr Method

Sh. Qardawi and some other scholars are of the opinion that investments should be treated as irrigated plowed land. The zakat on such land is 10{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} of the produce or increase in value. Going back to a portfolio which was valued at $100,000 and has grown to $110,000 after one lunar year, the growth is $10,000. Thus, zakat will be 10{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} of $10,000 which is $1,000.

This method also requires adjustments for new deposits and disbursement. So, the formula would look like this:

Hawl Date Value – New Deposits + Disbursements – Last Year Value = Growth

Growth and Income Method

There is yet another method which is a hybrid. It depends on the intention of the investor. The portion that was for long term growth, such as mutual funds and ETFs, will incur standard 2.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} zakat on the market value. However, the portion that was for income generation such as short term stock investments, zakat is due only on the income derived from such investments. Again, taking the $100,000 portfolio which has a 80/20 ratio between growth and income, and the income received on the portfolio is $1,000, the zakat is calculated as follows:

Zakat on Growth Portfolio ($80,000) x 2.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} or $2,000.

Zakat on Income ($1,000) x 2.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} = $100

As a reminder, zakat on retirements accounts for any method, should be calculated based on their cash out value as outlined in the conservative method.

Rental Property and Business

There is no zakat on the actual real estate or business itself. Standard 2.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} zakat is levied on net income from the rental after expenses. For businesses, 2.5{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} zakat is paid on the retail value of the merchandise on hawl date.