Pension breaking point

REALISATION that Malaysia’s pension liabilities have become a growing fiscal burden has forced the government to look at reforming the country’s costly and rapidly expanding pension scheme.

With pension payments projected by earlier estimates to grow to RM46.36bil by 2030 and RM120bil by 2040, it was recently reported that the government is looking at introducing a contributory scheme for newly appointed permanent civil servants to replace the current non-contributory pension system.

It basically means this would shift new recruits to an Employees Provident Fund (EPF)-style model instead of pensions fully by the government.

The move is due to the rapid growth in pension obligations.

In 2026, retirement charges are projected to reach RM42.8bil, or 12.7% of the operating expenditure (OE) budget.

Salaries and retirement charges account for about 44% of OE.

Together with debt servicing costs, they make up more than 60% of the OE budget.

Two decades ago, pension payments was just shy of RM6bil. Malaysia has toyed with the idea of moving all new civil servants to the EPF model a few years ago, but faced severe political backlash.

In the past, civil servants had the luxury to choose between the pension and EPF schemes, but for the majority, the pension scheme won out in the end.

One simple reason is that with lifespans of people increasing over time, it is easier to manage finances on a pension rather than on a EPF scheme.

There have been enough horror stories of EPF members exhausting their savings a few years after retirement, causing their kin and the government to bear the responsibility of welfare payments to keep them afloat.

In the past, families were large in the hope that one or more of the children become successful and support their parents in old age.

Today, however, with smaller families and falling birth rates, non-contributory pensions are becoming a burden on children and with an ageing society, the tax base will shrink over time, leaving the government with fewer taxpayers to support a growing number of retirees.

The government’s pension obligations are already substantial and will become even more burdensome in the years ahead.

The pension and gratuity bill has been growing by an annual rate of 7.8%, while the number of civil servants has increased by about 2.4% a year.

Civil servant salary revisions may occur less frequently, but each increase will only add to the burden of future pensions.

So what is to be done? The answer is obvious. Government pensions will have to migrate to contributory model, and this time there must be the political will to make it happen.

A contributory system would significantly reduce the government’s long-term fiscal burden.

However, any transition would need to be accompanied by other benefits, particularly as civil servants currently enjoy post-retirement healthcare and other pension-related entitlements.

The question then is whether the EPF is the best instrument to handle the pensions, and how existing civil servants should be migrated to a contributory scheme.

One possible approach would be to establish a cut-off point by calculating the pension benefits already accrued based on an employee’s years of service and salary. Future retirement benefits could then be built through EPF contributions, allowing for a gradual transition to a contributory system.

Using the EPF does seem like an obvious way out, but there could be a drag on EPF dividends for existing members if large sums are injected into the fund following a migration.

Increasing allocation to markets abroad seems like a solution, as returns from overseas markets have outstripped the returns from the domestic market.

Another alternative is figuring out how to utilise the Retirement Fund (Inc) or KWAP as a buffer.

KWAP was supposed to take over pension liabilities, and although its assets under management have grown strongly, its size is still too small to take over the full burden of pension obligations.

KWAP has, on average, delivered a compound annual growth rate of just over 9% per annum, outperforming the EPF.

However, the EPF model is generally considered less risky, and when it comes to pensions, risk minimisation is often the priority.

Increasing the retirement age could also lessen the pension burden on the government.

Many western countries have done so to alleviate fiscal pressures and reduce the duration of pension payouts.

However, such a move often faces backlash from younger workers, who argue that a higher retirement age handicaps their progress up the job ladder.

That argument is not entirely accurate, as longer working lives simply extend career trajectories; over time, it evens out.

Another pressing issue with a later retirement age is that youth unemployment is high at above 10%, as it may delay people entering the workforce.

However, job creation remains a key government responsibility and will need to be accelerated.