How Do I Pay Zakat on a Defined Contribution Scheme?

Answered by Shaykh Muhammad Carr

Question 

For a defined contribution pension scheme, where both the employee and the employer contribute a set amount, I understand that zakat becomes due only once you gain access to the lump sum. Based on this understanding, there are two possible approaches:

A. Each year, separately from your other cash and assets, you could calculate 2.5% of the current value of the pension, but delay actual payment until you have access to the funds later in life.

OR

B. Alternatively, you could add the current value of the pension to your other zakatable assets each year and pay zakat on it annually as you go along.

Are both approaches valid?

Additionally, in either case, is zakat due only on your own contributions or on both your contributions and your employer’s?

ِAnswer

Thank you for your question.

May Allah reward you abundantly for your commitment to fulfilling this sacred obligation. Zakat is one of the fundamental pillars of Islam, emphasizing both spiritual growth and social responsibility. Allah says, “Take from their wealth ˹O Prophet˺ charity to purify and bless them,” [Quran, 9:103].

Pension funds are contemporaneous and, as a result, often contentious. There are numerous scholarly differences in this regard. According to the first view, employee contributions are subject to zakat but are only payable on receipt. If you opt for this view, you would add the current value of the pension to your other zakatable assets and either pay annually or retrospectively at maturity.

The second view holds that defined benefit schemes are zakat-exempt. I espouse the latter view.

Proof that Defined Contribution Schemes are Subject to Zakat  

1. The proceeds of funds such as the above are typically made up of two portions: (a) a portion that came from the deductions from the employees salary; and (b) the portion that would have been contributed by the employer.
2. The portion of the fund that is subject to zakat is only that which represents deductions from the employee’s salary and growth thereupon, since his claim to ownership thereof is rooted in remuneration for labour.
3. The independence and separateness of the legal structure used to house the fund (eg. trust) amounts to a legal fiction which, in a manner strongly reminiscent of the company, is resorted to for expedience, but does not alter the underlying reality of ownership.

Thus:

1. Zakat applies only to employee contributions; employer contributions are considered yours upon receipt only.
2. Zakat is calculated based on the sum of all employee contributions. Although zakat is obligatory on the cumulative amount of employee contributions annually, it must only be disbursed upon receipt, i.e., upon maturity when paid out. However, an individual may distribute zakat annually to avoid paying retrospectively.
3. There is no zakat on employer contributions. When you receive the employer contributions and retain the money for a year going forward, zakat would be due, just like any other form of wealth. [See MJC Position on Succession Law and Related Matters]

Proof that Defined Contribution Schemes are Not Subject to Zakat

1. Defined contribution schemes are juristic entities similar to a waqf (endowment)
2. They are managed separately from the employer’s assets, often in a trust-like arrangement.
3. Contributions cannot be considered forced, as they do not meet the criteria for coercion.
4. At most, the employee is compelled to act in a way that ultimately serves their best interest.
5. Once contributions are made, the employee relinquishes ownership, and the fund assumes full ownership.
6. The benefits provided by the scheme cannot be reduced, transferred, or subjected to legal execution.
7. For the above reasons, defined contribution funds are not subject to zakat.

I pray this is of benefit, and Allah guides us all.

[Shaykh] Muhammad Carr
Checked and Approved by Shaykh Faraz Rabbani

Shaykh Muhammad Carr has dedicated his life to studying and transmitting our beautiful deen. His studies have taken him around the globe, where he has benefitted from many luminaries. Under the guidance of his teachers – Shaykh Taha Karan, Shaykh Yaseen Abbas, Shaykh Muadh Ali, and many others – Shaykh Muhammad has grown to appreciate the beauty and benefits of diverse scholarship. He completed his memorization of the Qur’an at Dar al-Ulum Zakariyyah in September 1997 and received an Alimiyya Degree in 2006 from DUAI (Darul Ulum al-Arabiyyah al-Islamiyyah). He is also affiliated with Masjid Auwal in Bo Kaap, Cape Town (the oldest mosque in South Africa), where he serves as a co-imam, and Dar Al-Safa, where he has taught since 2018. As a teacher, he imparts the wisdom of our heritage and tradition by opening the door for students. As an imam, he has the unique opportunity to serve his community in daily life.

In addition to his roles as a teacher and imam, Shaykh Muhammad Carr has contributed significantly to the administrative and advisory aspects of Islamic institutions. Since 2023, he has served as the Administrative Director at The Imam Kurani Institute, contributing to the institution’s growth and development. He continues to pursue traditional Islamic Sciences, possessing a keen interest in Islamic Contract Law and Finance. Shaykh Muhammad has been a Shari’ah Board Member for Islamic Asset Management & Insurance Companies since 2001, aligning financial practices with Islamic principles.