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Friday, August 24, 2012

Islamic Banking and Saving for College

Graphic from thomaswhite.com
 There are special requirements in Islamic Law when it comes to finance. I find it very intriguing. Maybe our country would not have gotten into such a financial mess if we took advice from our ancestors and global neighbors!
 I met a woman this weekend who would like to start saving for college for her 1 year old. The problem is, she cannot have an account that accrues interest because of her religion, Islam. We were talking about two different 529 plans (a prepaid trust and a college investment plan). She was asking if either of these accounts accrue interest, because if they did, she could not take advantage of them.

To take a step back, a lot of folks intertwine the meaning of income (interest) that you earn on a savings account at your local bank/ credit union and income (interest) that you earn on an investment. The primary difference is the risk you are taking and the potential reward/ loss that you may receive.

The income that you earn on your savings account is determined by a set rate and is insured by either the FDIC (banks) or NCUA (credit unions). The income you earn on an investment is determined by how the company's stock or your portfolio fares in the market. It is not insured, so you can potentially lose your investment, however the reward can also be significantly higher.

So I had to determine if this woman was talking about any form of interest (including investments) or if it was just tied to one or the other. This led me to do some research on the topic of the Islamic view of money and saving to determine specifically if this woman can use a 529 plan to save for her child's education.

What I found:
First of all, Sharia is the moral code/ religious law of Islam; Islamic banking adheres to this code. Sharia prohibits the payment or acceptance of interest and/ or fees (known as riba) for monetary loans. The reasoning behind it, is that money is merely a medium of exchange, has no value in and of itself, and is purely a way to define a common value between things; therefore, 'money' should not be used to make more money on itself through interest (whether in a bank account, or lent to someone).

One can invest in a business or property however, as long as the business/ real estate venture does not provide products or services that go against Sharia.
(http://www.islamic-banking.com/prohibition_of_interest.aspx)

So, can you save for your kid's college education in a 529 plan if you are Islamic? 
Yes. However, since a person is not allowed to invest in businesses that go against Sharia, this may be a difficult thing to successfully accomplish. Technically, a person could have a prepaid trust or investment plan (as neither are providing mere interest on money) if they make sure that each investment in the portfolio complies with the Islamic law. This is one of the few if only options this person would have; they would not be able to save money in a Coverdell account or any other account tied to a traditional banking institution since that would be earning money, on just.. well, money.

If anyone runs across this post and has more information, please let us know!


An interesting find:
It appears as though the nation of Islam are not the only ones who feel this way (at least historically):

  • “Very much disliked also is the practice of charging interest: and the dislike is fully justified for interest is a yield arising out of money itself, not a product of that for which money was provided. Money was intended to be a means of exchange; interest represents an increase in the money itself. Hence of all ways of getting wealth, this is the most contrary to nature." Aristotle

  • “Do not charge your brother interest, whether on money or food or anything else that may earn interest.” (Deuteronomy 23:19)
  • “If you lend money to My people, to the poor among you, you are not to act as a creditor to him; you shall not charge him interest.” The Holy Bible (American Standard Bible)
  • [Jesus said], “If you have money, do not lend it at interest, but give [it] to one from whom you will not get it back.” Gospel St Thomas, V95

5 comments:

  1. Are there resources to find 529 plans geared towards Islamic investors? In other words, is there an easy way to find plans where each investment in the 529 complies with Sharia?

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  2. Great question, and while I can't vouch for these companies personally, there are places that specialize in banking for the Islamic community such as http://www.shariaportfolio.com/investing/education and http://www.azzad.net/OurApproach.aspx. You can also find a list of companies that abide by the Islamic Sharia principle at http://muslim-investor.com/mi/mutual.phtml. I hope this helps!

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  3. Hello Danielle,

    I was wondering if you were able to find any new info on this topic. Can you please explain how a prepaid trust or investment plan works.

    Thanks

    ReplyDelete
    Replies
    1. Yes no problem!
      Both the prepaid trust and college investment plans that I will talk about are 529s. This means that they carry federal tax benefits. The money that you place into these accounts, grows tax free, and remains tax free as long as it is used for qualified education expenses when you take it out. Depending on your state, you may be able to take a state income tax deduction as well (check here: http://www.finaid.org/savings/state529deductions.phtml)

      In a Prepaid College Trust, you lock into college tuition at today’s prices. So today it might be $5000 a semester, but in 10 years in might be $10,000 a semester. With the trust, you would lock into that $5000 rate. You can buy anything from a semester to a full 4 years. There is generally a residency requirement here: either the account holder that opens the trust or the beneficiary (the kid) must be a resident of the state that runs the trust. Also make sure to check what the states prepaid trust covers... do you have to go to a state school or can you go to any accredited higher ed institution.

      College Investment plans are generally run by an investment company (i.e. T.Rowe Price, TIAA Cref). The create portfolios that you can choose from that are set up as 529s so you gain the tax benefits. You contribute what you can per month (sometimes there is a minimum starting contribution, or just monthly requirement). States that have these plans will often open them to anyone around the country that wants to join; keep in mind that in order to receive the state income tax deduction (if applicable) you must be a resident of that state. You can also check out www.savingforcollege.com which provides information on 529s across the country.

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    2. You said the 529 accounts do grow. How do they grow? What are they being invested in? Do the companies, such as, TRowe Price list the products they are investing in? In what way does each account generate it's growth?

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