Personal Finance

Are defined benefit pensions halal?

14 Comments

I am likely to induce a few yawns during the course of this article, as the prevalence of the word “pension” in any article is always a dangerous thing for blogs.

But bear with me, because pensions happens to be most people’s biggest pot of savings, and the money they will be relying on to live life for a good few decades after retirement – so making this pension money halal as possible is an important consideration for every Muslim who wants to be truly sharia-compliant.

Making this pension money as halal as possible is an important consideration for every Muslim who wants to be truly sharia-compliant.

First off, everyone makes an employee national insurance contribution – you have to pay this, and the state will give you a state pension at the end of your working life as a result of this. There’s nothing very controversial about this from a fiqhi  view – you have to pay this money to the government by law and then you get money back after retirement. 

Then there’s your pension contribution. There are broadly two types of pension available today:

  1. Final salary; and
  2. Money purchase

In a final salary (or sometimes called a defined benefit) pension, the individual retiring will get a sum of money equivalent to a multiple of the individual’s final salary and will often be linked to the number of years the individual has worked at the company.

In a money purchase (or sometimes called a defined contribution) pension, the individual receives a sum of money on his retirement based on the value of the underlying pot of money he (and his employer on his behalf) has been contributing into for his entire working life.

There has not been a great deal written on modern pensions from a shari’ perspective, but an important contribution to this debate is found here by Mufti Zubair Butt. His conclusions are that someone can take the money from a final salary pension, however such person is sinful because he or she entered into a defective contract from an Islamic perspective. Money purchase pensions on the other hand are generally fine, so long as they are invested in Islamic funds. However Mufti Zubair is against the purchasing of an annuity, presumably due to the standard arguments over purchasing insurance and insurance-like products and of the purchasing of a deferred payment at less/more than par value.

Let’s take a closer look at each.

Money Purchase Pension (aka Defined Contribution Pension or Workplace Pension)

“Money purchase pension” sounds complicated but really all you’re doing is contributing to a pot of money which is being invested in things as chosen by you. All you must do from a sharia-compliance perspective is make sure that where this money is being invested, is sharia-compliant. We will shortly also be running an article on all the sharia-compliant funds currently out there for you to invest in – so look out for that.

On annuities: the analysis really hinges upon whether an annuity is the same as any insurance. Arguments for this view are that annuities have the same kind of contract and have a benefit to them linked to offsetting risk on the part of beneficiaries.However, arguments against are that it is not really a pooling of risk and protection against harm in the sense of car insurance, it is the purchase of a fixed income using a pot of money. In other words, I’m kicking this one down the road to another article.

Final Salary Pension (aka Defined Benefit Pension)

A final salary pension is an interesting beast that has an interesting story behind it. They are generally being wound down and wrapped up these days, and most new pensions are now money purchase pensions. But they have historically been the main kind of pension offered by public sector employers and large companies until the early noughties. The key characteristic they have is that they are a pot of money set aside for the employee, and invested on its behalf by a board of trustees, and in the case of under performance, the employer has legal duties to meet this shortfall to ensure that the pot is capable of meeting all the pension payments that the pot will be relied upon to make.

Legally, this kind of pension is understood as a deferred salary. Accordingly, Mufti Zubair outlines the Hanafi position that where an employment contract has gross uncertainty inherent within it, it is defective and, rather than going by the letter of the contract, one must come to a judgement on what is a fair amount and pay that instead. He outlines a few examples where there is minor uncertainty (e.g. a wet nurse for whom you also pay for food, clothing and board etc. – so the precise remuneration is unknown) but explains that these are tolerated as they do not generally give rise to disputes. So under this analysis the key question is whether a final salary pension does give rise to such disputes generally, and Mufti Zubair’s view (implied in his article) is that it does give rise to disputes and as such amounts to gross uncertainty.

My Thoughts

Now I am not entirely convinced that final salary pensions do amount to such uncertainty as to amount to gross uncertainty. Using the key criterion of whether such uncertainty causes dispute, we do know that there have certainty been disputes over defined benefit/final salary pensions in the recent past, in cases such as the BHS/Philip Green case.

I also know that pension schemes do often go to court on the interpretation of certain rules within their scheme rulebook and that disputes arise out of that. However, in the Philip Green case (and in many other cases where there is a deficit in the pension) the issue is not that the amount is under dispute from pure calculation perspective, but rather that the company has not and does not want to make the necessary contributions in order to make the pension pot sustainable. So that is not a dispute about the contract, it is a dispute about a company’s behavior as to meeting its obligations.

And in the case of the court claims on pensions – I have not done a detailed analysis of how many pension schemes are disputed, but I am comfortable in saying it is not the vast majority. So to my mind, a final salary pension does not amount to a grossly uncertain element of an employment contract. Indeed, one could argue that as final salary pensions use quite precise numbers (x number of years in employment etc) one can calculate these with more certainty than a money purchase pension which relies on the performance of the underlying investments in the stock market.

So simply put, my conclusion is the same as Mufti Zubair’s in that I am of the view that you can take such final salary pensions, but I don’t entirely agree that taking such a payment is sinful as the uncertainty of such a remuneration does not strike me as grossly uncertain. Nor do I necessarily agree (though I am not sure I disagree strongly) that one should change from their final salary pension and instead go for a money purchase pension where one has that choice.


I am of the view that you can take such final salary pensions

Additional thoughts

An additional contour to this debate is that while having a pension is not yet compulsory, it is certainly heading in that direction. I mean, when an employer is literally going to give you free money and match your pension contribution up to a certain threshold, it would be silly to turn it down. And on the employers’ side, they are legally bound to match pensions up to a certain threshold, and to automatically enroll all employees into a pension scheme from the start of their employment. So if you do want to opt out, you would actually have to put in a bit of effort and research and liaise with HR departments to do that.

In other words, it is possible for a Muslim to turn down a significant chunk of their salary in order to avoid uncertainty (that is in the context of final salary schemes) but it isn’t particularly realistic or advisable.  

And given that most public sector employers and large corporates have historically offered such pensions, from a macro perspective if you say that Muslims are not allowed to take their pensions when they work for such employers, the Muslim community would lost out to the tune of billions over the course of their working lives, and would be left with a defective pension (if they have one at all). Alternatively, Muslims simply choose not to work for such employers – but again, that is unrealistic and counterproductive (the NHS is a huge employer of Muslims, and it has a defined benefit pension scheme for example).

A point to note: as you do not control where a final salary pension is invested, and rather you are simply in a contractual agreement with the employer to be remunerated a fixed amount based upon the rules of your pension scheme, you are not in control of where the pension scheme invests the money and as such your returns are not directly linked to the underlying investment and consequently you would not be required to purify your income for any investments made by the pension scheme in impermissible avenues. However, to the extent you can push your pension scheme to invest in halal avenues, you should try to push for that as much as you can.

Finally, from a macro perspective, final salary pension schemes are excellent from an employee perspective as they guarantee in a much more definitive way, a certain basic level of pension for an employee post-retirement. It puts the onus on large corporates and public sector employers to ensure their employees are properly looked after, after their years of service have ended – rather than expose them to the vagaries of the stock market as to their ultimate pension.

As we have been hearing these last few years, pensioners in the UK are often quite poor, because their pensions turn out to be inadequate to live upon. So,while I am still reflecting on this point (and interested in your thoughts too), prima facie, I am not at all convinced that what Islam wants from us is a money purchase pension plan where the employee takes all the risk, and the rich corporates/shareholders get richer as a result of not having to guarantee certain pension payments.

As ever, please feel free to post any comments/queries in the comment section below, or drop us a line via our contact us page.

We have also written a bunch of related content on investing, saving and pensions too – so make sure you check those out.

Useful reading resources:

  1. http://theconversation.com/britains-great-pension-robbery-why-the-defined-benefits-gold-standard-is-a-luxury-of-the-past-100844
  2. https://www.ppf.co.uk/sites/default/files/file-2018-10/annual_report_2017-2018.pdf
  3. https://publications.parliament.uk/pa/cm201617/cmselect/cmworpen/54/5405.htm
  4. https://www.thepensionsregulator.gov.uk/en/document-library/codes-of-practice/code-3-funding-defined-benefits-
  5. http://alqalam.org.uk/wp-content/uploads/2017/07/pensions-and-gross-uncertainty-revised-V1aa.pdf
  6. https://islamqa.org/hanafi/daruliftaa/8491
  7. https://islamqa.org/hanafi/askimam/82707
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14 Comments. Leave new

  • Looking forward to the article on sharia compliant funds!

    Reply
  • Robert Hannah
    December 8, 2018 1:23 pm

    I have worked in finance and pensions throughout my career, and so was quite interested in your piece (I did not yawn once!). I agree with you that defined benefit pensions and annuities are not sinful. In fact, they provide a great benefit to millions of retired wage earners who are assured of some regular income through their retirement, thus removing a great deal of uncertainty from their lives. It puzzles me greatly why Mufti Zubair does not recognize this benefit, as one reads in many places that the objectives of sharia are as follows (the following is typical):

    “The legal philosophers of Islam, such as Ghazālī, Shāţibī, and Shāh Walīullāh explain that the aim of Shariah is to promote human welfare. This is evident in the Qur’ān, and teachings of the Prophet (s).The scholars explain that the welfare of humans is based on the fulfillment of necessities, needs, and comforts.” (Islamic Supreme Council of the United States – Understanding Islam).

    I understand Mufti Zubair’s point in his fatwah that contractual uncertainty exists in individual db pension and annuity contracts. But of course, that is what risk pooling and pension risk management is all about – how to deal with pension risk systematically and scientifically, and convey the benefits to pensioners, contributors, and employers. His myopic focus on contractual risk does harm by discouraging devout Muslims from benefiting from the risk management that pension sponsors can perform. Can we send Mufti Zubair on a risk management 101 course?

    Having said that, risk management for db pensions is not trouble free. There is some discretion in the way actuaries, consultants, unions, and pension sponsors apply mortality tables and discount rates, so that db plans often deal with expensive “experience deficits” – this is the reason for the move to money purchase. I think this is the real risk issue in db plans.

    Reply
  • Awesome article. Hannah, Ibrahim – I look at this from a governmental pension (defined benefit plan) standpoint in the U.S. – Governmental pensions, whether they be local, state or federal are hands down the biggest pensions in the U.S. Every single one of these governmental pensions are investing heavily in interest based investments. I will stop there…although I understand there are islamic pension options for public or private companies, the same is not true for governmental pensions, hence I am under the thinking that governmental pensions are not permissible. In Illinois, where I live, the state has a $250 billion net pension liability i.e. a underfunded pension, and the state has no idea how to fix it. There is so much hikmat in islam, if only people understood.

    Reply
    • Jzk khayr for your contribution. Yes, this is an important point you raise and one I have been mulling over too. Given our context, the underlying assumption behind this article is that we can live with it (and on a technical level, as you’re not investing directly in DB pensions, it is acceptable from a fiqhi perspective). However, from a holistic/maqasid perspective, it does seem a rather temporary and unconvincing solution to say people can hold DB pensions (and a lot of interest-bearing investments) on a technicality and because of our times.

      Ultimately, I think it comes down to two things: (i) where your money is being pooled and invested and if you know for certain there is a great deal of interest-bearing investments in there; and (ii) how much control you have over the investment strategy. To the extent you have a choice between a DC pension and DB pension where you know the underlying pot of money is invested in haram investments, it makes sense to choose DC pensions. But where you haven’t got a choice of a DC pension, I think your only choice is to stick with a DB pension and campaign for Muslims with the pension scheme to structure things in a sharia-compliant way (which IFG can then advise on!).

      Reply
  • There is an a third solution, in-between db and annuities. We could pool our db schemes into big db schemes and collectively draw down. Which could be structured in a halal way and mitigate the huge risk within db schemes.

    Reply
  • Sorry i meant pool dc schemes not db. Makes it halal and works like an annuity.

    https://www.ftadviser.com/pensions/2018/02/14/how-collective-defined-contribution-schemes-work/

    Reply
  • مؤمن متولي
    December 9, 2018 7:43 pm

    At its most basic level, is a final salary pension not a glorified pyramid scheme? In practice, companies do not store earnings for such a long period to fulfil their anticipated expenditure, instead relying on their projected future earnings (if they even consider their responsibilities at all), so it’s uncertainty upon uncertainty. I struggle to understand how a final salary pension is sustainable on a societal level. As evidenced by the fact that it’s not, so it’s being discontinued as you mentioned. It’s ultimately a perk for the elderly at the expense of the young, and ends up collapsing sooner or later.

    Reply
    • Companies are supposed to keep a topped up pension fund that will pay the anticipated expenditure.
      Clearly, some have failed.

      Reply
  • Looking forward to an article on funds that are shariah compliant

    Reply
  • Aslaaamualaikum, do you know if the met police pension fund alpha is shariah compliant?

    Reply
  • Can anyone help me with regards to a SIPP or Pension ? Can I leave it to my spouse after my death or does it need to be distributed to all my heirs ?

    Reply
    • As part of your Islamic estate this should be distributed to all your heirs. We can assist with that at wills.islamicfinanceguru.com.

      If you would like assistance with your SIPP, we can also point you in the right direction.

      Reply

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