Zakat

Article bySusmita Pathak
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Zakat Meaning

Zakat refers to a mandatory charitable act in Islamic finance under which Muslims donate a fixed percentage of their income and wealth annually for social welfare. In Islamic law, the contribution applies to 2.5% of total earnings made by an individual for a lunar year.

Considered among the five pillars of Islam, it is a religious obligation for the Muslims possessing wealth above the threshold amount, known as nisab. There are expert charities that accept Zakat fund from wealthier individuals of the Islamic community and donate it to the less fortunate. Givers connect with such organizations to accomplish their objective behind this obligatory practice. Whether charitable contributions will be voluntary or mandatory varies with Muslim countries.

Key Takeaways

How Does Zakat Work?

The religion of Islam has its own set of rules when it comes to financing. While some of them are at the individual’s discretion, a few are obligatory, and zakat is one of them. Its purpose is to contribute to social welfare and distribute the wealth fairly between the rich and poor. It is also among the five pillars of Islam. Its literal meaning in Arabic is “that which purifies or cleanses.”

The followers of Islam use it as a way of worship. They believe that donating a part of their income and wealth to the needy cleanses their yearly possessions and earnings from the desire for more or greed. Their faith is to be bestowed upon by their almighty and that it will increase their wealth and bless them with prosperity.

Zakat Working

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It is a fixed proportion of assets, including property, possessions, and disposable incomeDisposable IncomeDisposable income is an important mechanism to measure household incomes, and includes all sorts of income such as wages and salaries, retirement income, investment gains. In other words, it is the amount of money left after paying off all the direct taxes.read more that goes toward charitable causes once a year. When net earnings, savings, and wealth made by a Muslim individual for a lunar year exceed the minimum amount (or nisab), it is eligible for a Zakat percent of 2.5, which varies with the source of income. Nisab is the threshold amount decided based on the specific value of gold and silver. However, not all Muslim countries have made this practice compulsory for their citizens.

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Zakat Facts

  • It is a religious obligation meant for Muslims, of which trusted charitable organizations are aware.
  • Not all Muslims are liable to pay this compulsory donation to charities.
  • If the giver acquires wealth above the nisab threshold for a lunar year, it will be obligatory for them to perform this religious duty.
  • An individual need not make charitable contributions if their income and wealth remain below the nisab threshold.
  • The gold threshold as of April 2021 is £3,400 ($4,804.56), and the silver threshold is £360 ($508.72).
  • This threshold consideration lets more and more people get involved in donating to charities. It ensures that they could help the needy community in some way.
  • It is not necessary to make contributions at once. The Islamic followers can fix an amount to be credited to the charitable organizations in a lunar year.
  • The wealth considered eligible for the donation includes cash and foreign currencies, gold and silver used as assets, stocks and shares, personal savings, farm produce, livestock animals, investment properties, business activities, money lent to others, etc.

Zakat-Able Properties

Let us have a look at Zakat rules for different types of properties:

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Businesses

The givers calculating alms on their business should know that the amount would not apply to their fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more. The deduction of 2.5% of the wealth would mean a portion of the cash, receivables, and work in progress. People with 50-50 partnerships in a business will be liable to donate alms on only their 50% ownership.

Stocks

If traders buy stocks to trade, they will require considering the total amount to calculate the alms. On the other hand, if they purchase equities to hold, they have to consider the assets held by those stocks.

Mutual Funds/Pension Funds

It is not easy to calculate alms on each share when givers acquire funds. But they can consider an approximate amount to find out the donation to make to the charity.

Real Property

As an owner of real property, an individual would need to consider the total amount to calculate the alms. However, if a person is staying in a rented property, alms remains inapplicable.

Money Lent/Debts

When lenders lend money, they are likely to get back their loan amount in some time. Hence, the amount that borrowers would repay should go into calculating alms. Those who are in debt may or may not be eligible for a charitable donation.

Cryptocurrencies

Though cryptocurrencyCryptocurrencyCryptocurrency refers to a technology that acts as a medium for facilitating the conduct of different financial transactions which are safe and secure. It is one of the tradable digital forms of money, allowing the person to send or receive the money from the other party without any help of the third party service.read more is a digital asset, Muslims have to consider their total holding while calculating alms.

Moreover, givers are free to deduct the amount they are liable to pay out monthly or at regular intervals from alms. For example, utility bills, rent, etc., get excluded from the alms-eligible assets, which will lessen the amount that will go into the donation.

Examples

Here are some examples to understand the concept and the calculation for Zakat in Ramadan:

Example 1

Zeenat bought stocks worth $200, which held only 40% of the assets applicable for the charitable contribution. Thus, she had to donate alms for $80 only. Hence, she calculated the contribution amount as:

2.5% of $80 = $2

Thus, Zeenat will have to donate $2 as alms for stocks.

Example 2

Ali acquires wealth worth a certain amount, including his residence, stocks, debts, and other commercial possessions. However, he also has some liabilities for which he had to spend every month. Let us calculate the alms he is liable to pay:

  • Property value = $5,000
  • Stock value = $1,500
  • Repayments scheduled = $1,000
  • Gold = $3,500
  • Silver = $1,200 

Total wealth = ($5,000+$1,500+$1,000+$3,500+$1,200) = $12,200

Total liabilities (utility bills + debts) = $500

Zakat-able amount = (Total wealth – Total liabilities)

  • = ($12,200-$500)
  • =$11,700

Zakat = 2.5% * 11,700 = $292.5

Therefore, Ali decided to donate $292.5 for alms based on his wealth.

Who Is Eligible For Zakat?

Anyone possessing wealth above the nisab threshold for a lunar year is eligible for the act. This threshold amount is determined based on a specific value of gold and silver. The gold threshold as of April 2021 is £3,400 ($4,804.56), while the silver threshold is £360 ($508.72).

Those, who have wealth more than the threshold among the two, are considered liable to donate alms mandatorily to the expert charitable organizations. However, an Islamist without a consistent earning beyond the threshold amount would remain exempted from charitable contribution obligation.

Frequently Asked Questions (FAQs)

What is Zakat?

It is a religious, financial obligation for Islamists to donate a fixed percentage of their income and wealth to the poor and needy annually. Only those with earnings above the nisab threshold for a lunar year are considered eligible for the donation. The nisab threshold gets determined by the specific value of gold and silver.

How much do you pay for zakat?

The givers possessing assets and properties above the nisab threshold have to pay 2.5% of their total income, earnings, and wealth they have maintained in a lunar year as alms.

When should I pay zakat?

You must donate alms once your wealth exceeds the nisab threshold in a lunar year. Also, people prefer paying Zakat in Ramadan with the belief of receiving multiple blessings from the almighty. However, it is not mandatory to pay during that time. One can donate alms throughout the year but necessarily within that lunar year and not after that.

This has been a guide to Zakat and its meaning. Here we discuss how does it work in Ramadan and who is eligible for it with examples and rules. You can learn more about finance from the following articles –

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