Question:
Permissibility of and Zakat on 401k plan
& other securities
Answer:
In the name of Allah, the Inspirer of truth
Permissibility of and Zakat on 401k plan
& other securities
The 401K Plan
401k refers to an IRS Code that allows employers to set up retirement
plans fortheir employees. This company-sponsored benefit allows
employees to invest money from theirpaychecks into an investment
vehicle on a pre-tax basis, meaning no taxes will be charged for
investing until the employee decides to makea withdrawal from his or
her plan at the age of 59 1/2. The employer can encourage the employee
by also contributing to theplan by matching or partially matching the
investment of each employee. All of money invested (up to a certain
predefined limit), along with any investment or matching from the
employer, is put into an account that is invested into funds (i.e.
money market, fixed income, or equity), as chosen by the employee from
a list of funds offered by the company.
To understand the Islamic ruling regarding of permissibility or
impermissibility of a 401K plan, we first need to understand the
different rulings regarding the various types of investment
instruments that may be associated with a 401K Plan.
Individual Retirement Account (IRA)
An Individual Retirement Account is traditionally a retirement plan
where individuals can deposit funds into an account that will earn
interest with the goal of augmenting an individual�s retirement
savings. An IRA is different than a 401k because an IRA earns a
fixed-rate of interest. It is not an investment so it does not have
the ability to earn a higher rate of return in a lucrative market.
Conversely, it is safe during periods of market correction.
It is very clear that investing in such an IRA is impermissible since
it is not considered an investment (hence no chance of loss on
invested capital). It is similar to an interest bearing deposit such
as a saving account.
Note: However, an IRA in many cases (of recent) can also be set up
with an institution like a broker (called brokerage IRAs) to invest in
lawful stocks at one�s own discretion. This could be a good lawful
investment option if the stocks one invests in meet the criteria
highlighted below.
Mutual Funds
A Mutual Fund is an investment entity, usually a corporation that
sells shares to investors, usuallyindividuals, in exchange for a
portion of the Fund�sinvestment portfolio. Different funds are
designed to meet the requirements of various types of investors. For
example, fixed income / bond funds are available for investors seeking
moderate returns and low risk and equity / stock funds are accessible
for those who are willing to accept more risk exchangefor potentially
higher returns.
Investing in Mutual Funds is permissible if one restricts his or
herself to investing only in equity / stock funds whose portfolios
consist of lawfulcompanies. Investing into fixed income / bond funds
is impermissible since the returns are derived from interest-bearing
securities.
Money Market Fund
A Money Market Fund is a mutual fund that invests in short-term
interest bearing securities and sometimes allows its investors to have
a debit card associated with it andwrite checks against their
accounts. Since the investments are made intoshort-term securities
(which typically mature within one year), these funds are very
low-risk. Investing in Money Market Funds is impermissible since the
pool of investments consists of interest-bearing assets.
Bonds, Bills and Notes
These are debt obligationsunder which the borrower,typically a
corporation of governmental entity, agrees to make specified payments
of interest for the money it borrows (the �face value� or principal).
For example, a corporationmay issue a bond which will mature in 5
years witha face value of $1,000 and promise to make annual interest
payments of 10% per year. In this case, the bondholder will earn $100a
year for five years and after the fifth year will be given back his or
her initialinvestment of $1,000 as long as the corporation does not
default. The interest / expected return of each of a bond depends on
the degree of risk, which determined by independent ratings agencies.
Bonds issued by governmental entities typically have a lower expected
return than those issued by corporations since the chances of
governmental entities defaulting are smaller.
Investing in Bonds is also impermissible since they are essentially
loans that promise to pay back the face value plus interest.
Certificate of Deposit (CD)
A Certificate of Deposit is a savings certificate at various
denominations issued primarily by commercial banks where the holder
receives interest at a specified rate upon maturity. :->
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