You may not have a 401k plan or an IRA, but instead a more traditional pension. If this is the case, you are not alone, and like many other people are asking yourself:
Do I have to pay Zakat on my pension or retirement plans?
Investopedia defines a pension plan as:
A type of retirement plan, usually tax exempt, wherein an employer makes contributions toward a pool of funds set aside for an employee’s future benefit. The pool of funds is then invested on the employee’s behalf, allowing the employee to receive benefits upon retirement.
If this is the type of retirement plan you are inquiring about, then this is the appropriate post for you. If you are interested in 401k plans, then read some of other posts on Zakat on 401k.
TYPES OF PENSION PLANS
Pension Plans are two main types:
1- defined-benefit plans and
2- defined-contribution plans.
In the first type of plan, the employer guarantees that the employee will receive a definite amount of benefit upon retirement, regardless of the performance of the underlying investment. In the second, the final amount of benefit received depends on the underlying investment’s performance.
HOW YOUR PENSION IS CONTRIBUTED TO MATTERS
Different plans are contributed to in different ways. Some plans are based solely on employer contributions. Others are based solely on contributions from the employee. Some are a hybrid of the two, both employee and employer contributing.
Why the difference? Employer contributions are gifts, and as such even though they may be larger than Nisab are not considered to be in your possession until they are contributed for your benefit AND you have actual possession of them. The funds that you contribute (employee contributions) are yours from the get go. Since you own the wealth contributed, you are liable for Zakat. However, since you were not able to benefit from this wealth, the pension is basically an illiquid asset until you can receive payouts. When you do cash out, you pay Zakat for one year only at the time of payout, according to the below mentioned methods.
PENSIONS WITH EMPLOYEE CONTRIBUTIONS ONLY
If your plan is based on employee contributions only, then you will need to understand how the pay-outs are managed. There are three things to consider here:
1- Plans with life annuity options (which is mandated by law as an option) are paid out month to month (ie not lump sum).
a. Monthly pay outs are not liable for Zakat when the pension benefit is received IF the amount is less than Nisab.
b. In other words, if you receive $400.00 a month from your pension, you will not pay 2.5% on this amount. Once your aggregate liquid assets (checking, savings accounts, cash on hand, etc.) the amount is more than Nisab then and only then are you liable for Zakat.
2- Plans which offer lump-sum payouts offer a onetime payment in lieu of a life annuity. While a lump-sum payment offers you more flexibility with how you can invest this money, which may payout more monthly. If you do choose to receive a lump-sum payout, then you must pay Zakat on this amount when you receive it, if it is (and it probably will be) more than Nisab.
3- Plans that offer a hybrid of 1 and 2, in other words you can take a lump sum along with a life annuity to be paid monthly, are no different than above. If your lump sum or monthly payment is more than Nisab, then you will pay Zakat on the amount received. If it is below Nisab, you will wait for a year and pay on your aggregate surplus wealth.
PENSIONS WITH EMPLOYER CONTRIBUTIONS ONLY
If your pension plan is made up employer contributions only (regardless of whether they are government plans or private sector) then you will only pay Zakat on this amount if it is more than Nisab and has been in your possession for a year or more. In other words, youll take the payout, add it to your checking or savings, spend freely from it, and then once you reach the time of year that you regularly pay Zakat, you will pay on your aggregate liquid assets (checking, savings accounts, cash on hand, etc. ).
PENSIONS WITH BOTH EMPLOYEE/ EMPLOYER CONTRIBUTIONS
For pension plans that are a hybrid of employer and employee contributions, you will only pay on the total percentage of employee contributions. In other words, if you contribute 50%, then youll pay Zakat on 50% of your payout.
Heres an example if you contributed 20% to your pension:
If you pay 20% then youll pay 2.5% on 20%. Lets say your payout monthly is $1500.00, your contribution to that would be $300.00, which is less than Nisab. In this case the entirety of the payout can be deposited in your account, and you wont pay anything in Zakat until a year passes and youve fulfilled the other conditions for Zakat.
Lets say you contributed 50%:
If however your payout is $1500, and you paid 50% in contributions, you will then pay 2.5% on 750 dollars when you receive the payout, which is $18.75. The remainder of the payout you will deposit, and following the general conditions for Zakat.