As the Muslim holy month of Ramadan reaches its halfway point, Aamina Zafar explores how Islam’s obligatory charitable contribution, known as Zakat, can affect Muslim savers’ retirement planning.
Zakat can have a significant impact on Muslim savers’ retirement wealth and must be factored into pension planning, according to a defined contribution (DC) expert.
Under Islamic principles, Muslims are required to pay Zakat, a charitable contribution of 2.5%, on their qualifying wealth held for a full year, and it is generally considered payable on DC pension savings.
Shabna Islam, head of DC provider relations at Hymans Robertson, said this means Muslims with DC pension pots must factor in an effective additional annual outflow linked to their accumulated pot – a cost non-Muslim savers do not face.
“Current member communications do not flag [Zakat] as an additional consideration. It will be a shock to some Muslims who will be unaware until they retire.”
Shabna Islam, Hymans Robertson
Over the course of a working life, even relatively small differences can compound significantly, potentially reducing projected retirement income if not planned for in advance.
Islam said: “Muslim savers need to account for this obligation on them to pay Zakat in their retirement planning. If the objective for a Muslim saver is to achieve a net income in retirement that is comparable to someone who is not required to pay Zakat, then they will need to consider paying more into their pension savings.
“This intensifies the adequacy problem in DC pensions for the Muslim community. Current member communications or savings and retirement modellers do not flag this as an additional consideration. It will be a shock to some Muslims who will be unaware until they retire.”
Awareness of Zakat ‘limited’
Hymans Robertson’s Islam added that there was limited awareness around Zakat rules in relation to pensions. She explained that, in a DC arrangement, savings are invested in funds and are legally attributable to the member.
By contrast, defined benefit (DB) pensions promise an income based on salary and service, without an individually owned investment pot.
She said: “I believe many Muslims savers are not aware that Zakat is payable on DC savings but not on defined benefit schemes. This stems from the lack of understanding of the key differences between DB and DC schemes. DC members are not always aware that their DC savings pot is attributable to them as an individual, therefore Zakat is due.
“For DC schemes or DB additional voluntary contributions, Zakat is payable in the accumulation phase, but can be deferred until income is received if you lack the funds to pay. It’s recommended that the Zakat due each year is noted and then paid once the DC pension is accessed. Note that Zakat is not payable on income as it is received, it is payable on wealth owned for a year.”
“Simple online Zakat calculators are available, but not one that provides comprehensive whole wealth calculations by specific assets held – this would be the ambition.”
Shabna Islam, Hymans Robertson
Calculating the precise amount due is complex, Islam said, as it depends on the types of assets held in DC pots, and there are several ways to calculate the Zakat amount. “It is complex and challenging to achieve an accurate calculation, therefore individuals need help to navigate this area,” she said.
Islam highlighted the importance of ensuring that Muslim savers have access to accurate information regarding their obligations, as well as the necessary guidance to calculate their Zakat liability.
She said: “Having fund values and factsheets readily available online or through digital tools at the right date to determine wealth is a key priority. The DC pension provider market serves the Muslim community well on this point.
“However, fund factsheets are not always clear on the asset class or fund ownership. Simple online Zakat calculators are available, but not one that provides comprehensive whole wealth calculations by specific assets held – this would be the ambition.”
