PESHAWAR: The Khyber Pakhtunkhwa government will transition from the unfunded pension scheme to a funded one by 2045 after all employees hired under the former are expected to retire, show official documents.

The unfunded pension scheme for government employees was replaced by a contributory pension system in 2022.

While unveiling the next budget a few days ago, the provincial government announced a 10pc pay raise for its current employees and seven per cent pension hike for former employees in 2025-26.

In monetary terms, the increase will take the province’s pay and pension bill to a whopping Rs875 billion-Rs680.39 for salary and Rs194.97 billion for pension-which makes up 41pc of the total budget outlay of Rs2.12 trillion.

The document states that the pay and pensions constituted the largest part of the government’s expenditure.

Pay, pensions dominate govt expenditure

“The rising cost of pensions and salaries has limited fiscal space for other priorities particularly the development budget and non-salary spending. As a result, important areas such as infrastructure upgrades, provision of school textbooks, and supply of essential medicines to healthcare facilities face funding constraints,” it said.

The document noted that in the incoming financial year, pension increase had been set at 7pc compared to 17.5pc in the current fiscal.

This, according to it, shows the KP government’s effort to create fiscal space for development spending and adopt a more cautious and responsible approach to managing recurring expenditure.

The documents show that pension obligations have become a major fiscal challenge across the globe. The situation in the country is particularly critical as the pension system is entirely unfunded.

“Many public sector institutions across the country are struggling, with some even unable to pay commutation due to severe financial constraints,” a document said.

The figures illustrate the enormity of the strain, pension liability alone were putting on the province’s finances. The actuarial valuation projected KP’s accrued pension liability at Rs3 trillion as of June 2020, with 540,000 serving employees and 170,000 pensioners.

“As of today, active employees have increased to over 600,000, and the number of pensioners has risen to 228,000, showing that the current accrued liability may now exceed Rs3.5 trillion,” a document read.

On the other hand, the pension expenditure for the current financial year is Rs160 billion, which is expected to rise to Rs193 billion in the upcoming fiscal year—posing a significant and unsustainable burden on the provincial budget, according to documents.

Regarding the mitigation strategy, the document noted that the KP was the first province in the country to transition from an unfunded to a funded pension system, introducing a Defined Contribution (DC) scheme exclusively for new entrants into government service.

Since the launch of the DC scheme, the province has enrolled 59,433 employees under the funded scheme.

“In the current financial year, the government has contributed Rs1.5 billion as the employer’s share for these employees [and] next year the same employer share will be Rs2.4 billion,” the document noted.

It added that during the transition period (until 2045), the government must finance both the old Defined Benefit (DB) pension scheme and the new Defined Contribution (DC) pension scheme, effectively bearing a dual pension burden.

However, the budget document pointed out that despite short- and medium-term strains, the dual pension system was a necessary step toward sustainability.

“By 2045, the DB pension scheme is expected to be phased out, and the DC scheme will fully take over, thereby containing long-term pension liabilities and easing the burden on the provincial exchequer,” it said.

The document also noted that in view of the looming pension crisis, the government was actively considering parametric pension reforms.

“These reforms aim to adjust key features of the existing Defined Benefit pension scheme, such as retirement age, commutation formula and pension indexation, with the objective of reducing fiscal pressure and potentially shortening the transition period to a fully-funded Defined Contribution system well before 2045,” it said.

Published in Dawn, June 20th, 2025