Many millions of people have accounts under the Employee Retirement Income Security Act (ERISA), particularly the 401(k) or similar programs, such as the Individual Retirement Account (IRA). For American Muslims, there are concerns about how to handle these assets when it comes to planning their estates.
From the perspective of Islamic Inheritance Law, there are only two different kinds of retirement plans. The first is a financial account. You or your beneficiaries can pull money from these accounts. Now there may be some taxation involved, maybe even some penalties. However, this is your money. After you pass away, it belongs to your heirs.
The second type of retirement asset is not a financial asset in the traditional sense. It is a promise. Say, for example, Mohammed works as an engineer for 35 years. Upon turning the age of 65, he has promised half of his salary for the rest of his life and the rest of his wife’s life as well. This arrangement is known as a pension plan that includes a joint and survivor annuity.
For the most part, I am going to be dealing with the first asset. While there may be some nuance to this, we generally do not consider the second type of asset to be something that you can inherit, so we do not apply the Islamic rules of inheritance to it.
401(K) Nest Egg
Retirement assets are often thought of as a nest egg, not just for the person who earned the income, but for the couple. So, for example, Hamza is an engineer, his wife of 40 years, Hafsa is a housewife. He also has a son, Ishaq, and a daughter, Kulsum. Hamza has a 401 (k). If he were to pass away, he would like for his wife to be able to “rollover” this 401(k) into her plan so that she can use this for her retirement. Under rules governing these plans, the surviving spouse typically has a favored position relative to other beneficiaries. While other beneficiaries may inherit these plans, the government will usually look to taxing them more quickly. A 401(k) is favored in this way primarily because of the purpose of it, which is retirement.
However, for purposes of the Islamic rules of inheritance, it is viewed as an asset that can be inherited. So in the example above, Ishaq and Kulsum also have inheritance rights. This would mean what is counted as Hamza’s estate, 1/8th would go to his wife Hafsa, 7/24 would go to Kulsum and 7/12 would go to Ishaq.
So How does Hafsa Retire?
The question of what does the surviving widow get is often an issue when we plan based on the Islamic rules of inheritance. In American culture, it is typical that the surviving spouse will get everything while in Islam, we recognize the inheritance rights of others. Furthermore, in Islam, inheritance rights of the surviving spouse is often quite small relative to everybody else, Including parents and children. However, there are some significant caveats here. The first is that the surviving spouse may have contractual rights upon the death of her husband, the mahar mu’akhar. This is the amount of mahar that is paid out in the event of the marriage’s end, which may be either death or divorce. This can be virtually any amount. The other thing to consider is what property is already owned by the surviving spouse. Now I just told you, in this particular example, the 401(k) belongs to Hamza, he was the engineer who worked for 35 years. His wife did not. That means Hafsa only gets ⅛ of the 401(k) right? Not necessarily.
For example, if Hafsa lives in California and she and her husband agreed, either by default or in a written agreement, that own everything as community property, then 50% of everything that he earned while they were married is already Hafa’s. It is not Hafsa’s after her husband dies, but it belongs to her regardless. The fact that the account is only in Hamza’s name does not change this fact. Of course, if Hafsa and Hamza divorced, she would get 50% of everything, including the 401(k).
Look for flexibility
A plan should allow the person who administers it after death some level of flexibility concerning what to do with individual assets. When you are doing your estate planning, you’re planning for a time where you will not know the circumstances of the people who survive you. Hamza can create beneficiary designations for his retirement plan that would allow for the spousal rollover but also include a property agreement with his wife so that she can compensate the other beneficiaries. Most Muslim spouses have two major goals. Spouses want to take care of each other, while not be unjust while doing so, particularly their children or parents when it comes to the Islamic Rules of Inheritance.
Often, people like to include a wasiyyah with a charitable purpose. They can give up to one-third of their estate for this. Since retirement assets like the 401(k) and IRA are subject to income tax at the rate of whoever is the recipient, it is often the preferred “basket” from which to give to charity after death. Normally, inheritance does not have an income tax associated with it. The government taxes previously untaxed income though. So an estate plan that includes both charitable giving and retirement plans should take this into consideration to avoid paying more than necessary.
There is a lot more to Islamic Inheritance and Estate Planning. For my free resource guide, click here.