Why Putrajaya has no choice but to shake up public pension, say economists

Malay Mail
Malay Mail

KUALA LUMPUR, Feb 5 — Economists greeted Prime Minister Datuk Seri Anwar Ibrahim’s plan to discontinue the pension scheme for civil servants hired this year onwards with cautious optimism, calling it the first step towards fixing a pension system that has become a huge financial strain.

The plan, while yet to be formalised, comes after years of warning from economists that a ballooning pension could threaten development goals and pile up more debt, prompting calls for reform.

“The current pensions for existing retirees is RM32 billion for 2024 but this does not include the payments for current working civil servants which is RM16.7 billion so this is close to RM50 billion which must be paid from taxes and other revenue,” said Geoffrey Williams, a professor at Malaysia University of Science and Technology.

“So Malaysians without pensions are paying for the pensions of civil servants and do not have enough to save for themselves.”

The Bill for public pensions is projected to rise to RM46 billion by 2030, as a sizeable number of civil servants are set to reach retirement age. There are currently 900,000 civil service retirees receiving retirement benefits, official figures show.

A big chunk of the payouts is funded by tax money because investment yields from public pension managers, like the Retirement Fund Incorporated (KWAP), have not kept up with the growing bill, forcing public and private sector workers, many already grappling with little retirement savings, to subsidise the pension for retired civil servants.

The government offers what is known as a defined-benefit pension plan. Unlike the define-contribution programme in which workers rely on their own built-up retirement savings, the former guarantees annuity; the government is obligated to pay out retirement benefits regardless of its financial condition.

The security that comes with the system is widely seen as a key factor that attracts talents into the civil service, and also as a way to court political support. There are about 1.7 million government workers.

Pull factor

Since Malaya’s independence, lawmakers have voted several times to expand retirement benefits, including raising the minimum pension payout rate and reducing the minimum service tenure for eligibility.

Today, a civil servant qualifies for various retirement benefits after just three years of service.

All this has driven pension spending up. Retirement benefits expenditure under the current scheme is estimated to increase four times to RM120 billion by 2040.

Muhammad Irfan Abdul Rahman and Wee-Yeap Lau, researchers behind a paper that studied the public pension system, said a defined-benefit plan comes with financial risks because the system relies on the annuity provider’s ability to fulfil the short- and long-term commitments in paying pensions.

“Despite rising pension costs, the Federal Constitution of Malaysia safeguards the pension system and guarantees solvency,” they said.

“When the pension deficit becomes too large and persists, the pension scheme becomes unsustainable, requiring the reviewing and changing of pension parameters to ensure sustainability.”

Ageing population

Deputy Prime Minister Datuk Seri Ahmad Zahid Hamidi said the proposal to discontinue the pension scheme for new civil service recruits is part of a revamped policy on hiring, likely part of the broader drive to rein in spending. Government debt stood at RM1.21 trillion as of June 2023.

Anwar, who vowed fiscal discipline upon taking office, said public employees and political appointees hired after February 1 will instead contribute to the Employees Provident Fund, which manages mostly private sector retirement savings.

Economists have long shared Anwar’s concerns. They said keeping the current public retirement scheme could weigh on public savings or prevent funds from being used on more urgent programmes with more workers set to reach retirement age in just seven years.

By 2030, a seventh of the population would be 60 and above.

“The aim is to gradually reduce the government’s accrued pension liabilities that will continue to rise with more employees added,” said Yeah Kim Leng, a professor of economics at Sunway University.

“Together with other pension reform measures on the assets side, the new measure will prevent the pension liabilities from ballooning and jeopardising the country’s public finance in the long term.”

With the country’s birth rate also declining, analysts have raised concerns about a shrinking labour force. A smaller ratio of working population to retirees, combined with longer life expectancy, could widen the pension deficit, a situation when there is less retirement contribution and tax collection to sustain pension payouts.

“A pension deficit means the contribution collection and returns do not match the payments to pensions. When a pension deficit occurs, the pension scheme becomes financially unsustainable,” Muhammad Irfan and Wee also said in their report.

“It thus creates a pension debt that the government needs to finance through its revenue or by raising taxes.”

Tough fix

The Anwar administration has so far ignored calls to introduce a broad-based consumption tax but extended levies on cheap imports and luxury goods as a way to widen its tax revenue. The prime minister said the country is not ready for higher taxes and that the government can still afford to fund programmes if it’s careful with its spending.

But shifting to a contribution-based retirement plan is still unlikely to reduce the government’s pension liabilities in the short to medium term since the existing scheme still applies to all working civil servants.

“Moving to EPF will not help the government in the short-term. First the current pensioners will still be on the old scheme so the cost will not fall. Payments into the current scheme for existing civil servants will continue,” Williams said.

Williams suggested consolidating the various public pension funds like KWAP and the Armed Forces Fund Board into a “superfund”.

The superfund, he estimated, would have combined assets of RM309.4 billion, enough to provide low-income earners around RM2,000 a month even with just a 5 per cent yield annually.