Zakat: The Third Pillar

Nisab and Zakat

In order to distinguish the needy from the well off, a limit known as nisab was established by the Prophet (Salla Allahu Alayhi wa Sallam). According to Mahmoud Abu-Saud, the basic definition of nisab is the "amount which is sufficient to sustain the minimum average family for one year," an amount which is roughly equal to the definition of the "poverty line" in the United States. Essential needs are defined as things which one could not live without: food, clothing, shelter, transportation, health care, education, and the tools of one's profession. If your net worth surpasses the level of nisab, the excess is subject to zakat.

Who Receives Zakat?

Zakat funds should be distributed according to the categories of need outlined in the Qur'an (at-Tawba 9:60). These include:

• those who are poor
• those who are needy or destitute
• those employed to administer zakat
• those whose hearts are being reconciled
• those held captive
• those in debt
• those who are stranded
• in the cause of God (fi sabilillah)

The last category, fi sabilillah, is broad enough to allow zakat funds to be used for the general welfare of the community. Under this category, considering the fact that our mosques and community centers promote Islam and in many ways act as dawah centers, a portion of one's zakat may be paid to these centers. Zakat funds may also be used for education of the people and for promotion of Islam and the ummah.

When is Zakat to Be Paid?

Zakat is incumbent upon all Muslims and is paid according to the lunar calendar. No zakat is due on wealth before one year from the date of acquisition, the most well known hadith being: "No zakat is due on wealth till one (full) year passes." Zakat can be paid any time of the year. Many prefer to pay during the holy months of Ramadan or Rajab while others prefer Muharram, the first month of the Hijri year. Assuming nisab has been met, and the investment is held for a full lunar year, most jurists agree that zakat can be paid in advance, during the month of Ramadan, or when there is a special need because of a calamity, sickness, or fi sabilillah.

An estimated monthly payment of zakat is encouraged. This not only helps to mitigate the obligation by spreading out the payments, but it also fulfills the purpose of zakat sooner rather than later. The final calculation and reconciliation of payments, however, can be done at the end of each lunar year.

The legal provision that a complete lunar year should elapse starting from when nisab was exceeded means that a zakat year may run at different times for different investors. If an investor chooses the end of the fiscal or calendar year (to coincide with payment of other obligations like federal and state income taxes), one must keep in mind that the difference between the Gregorian and the lunar year is 11 days, the lunar year being shorter. Zakat is calculated on the basis of the lunar year not the Gregorian.

Zakat and Investments

There are different rates of zakat that apply to different types of assets. According to Imam Malik, zakat is due on three types of assets only: "the produce of plowed land, gold and silver, and livestock." Contemporary Islamic jurists have extrapolated zakat rates for nearly all types of assets.

Zakat on Stock Investments

Muslim scholars believe stocks and investments are most appropriately categorized as "the produce of plowed land," as both are "productive capital" assets which yield gains. Accordingly, zakat is due on the gains of such "productive capital," not the "productive capital" itself. As for the rate of zakat applicable to stock investments, the following hadith offers guidance: The Prophet (Salla Allahu Alayhi wa Sallam) said: "On a land irrigated by rain water or by natural water channels or if the land is wet due to a nearby water channel, ushr (i.e. one-tenth, 10%) is compulsory (as zakat); and on the land irrigated by the well, half of ushr (i.e. one twentieth, 5%) is compulsory (as zakat on the yield of the land)."

The hadith makes reference to a zakat rate of half of ushr (5%). However, according to scholars, this rate is not appropriate for investments like stocks as it is possible to clearly calculate net gains. Thus, the full (10%) rate is appropriate.

Zakat on Long-term Investments

Muslims are encouraged by their faith to invest for the long-term. Though investors may see gains in their portfolio value, the gain may not be realized for years. Islamic jurists have agreed that in order to distribute zakat sooner rather than later it is allowable to consider the difference in the market value of your portfolio from the beginning to the end of each Gregorian calendar year and pay 10.3% (or 10% calculated according to the lunar calendar) of the gain, if any, as zakat. This method of estimating your zakat is based on two assumptions:

• You have/will reach nisab within the calendar year
• You have held your investments or your resources for investment (cash, for instance) for at least one lunar year before your zakat is calculated for the calendar year

Zakat on Retirement

For the purpose of zakat, retirement accounts are considered part of net worth, as the contributor has eventual access to the funds. Thus for retirement accounts (401(k), Keogh, IRA, SEP-IRA, Roth IRA), the investor is subject to zakat on 10.3% of the increase in a Gregorian calendar year. Public trusts and charitable organizations are not subject to zakat. The same method as that illustrated above with Amana shares can be applied to zakat calculation for entire portfolios.

Zakat on Brokerage

As brokerage accounts can be any of the investment types mentioned above (stocks, long-term investments, retirement investments), accounts with Saturna Brokerage Services are automatically incorporated as part of the zakat estimation performed by Saturna Capital.