Wednesday's vote marks a victory for President Tsai Ing-wen, whose attempts to make sweeping pension cutbacks since she came to power two years ago have faced intense opposition.
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Senior veterans will see their monthly stipend cut by more than 20 percent over the next decade, after a smaller initial drop, according to official estimates.
The government says veterans of lower ranks will see less severe cuts to their pensions.
Tsai has said pension reform is her most important task, with official reports warning that an unreformed pension system could be bankrupt by 2020.
But thousands of veterans and other civil servants have regularly gathered outside parliament to protest the cuts.
Dozens of police officers and reporters were injured in a clash in April when protesters threw smoke bombs and used chains to try to pull down a gate and storm parliament.
Tsai said that the "crises have been overcome," following the passage of the bill.
"I have faced a great deal of criticism over the past two years, and these criticisms are exactly why politicians in the past were unwilling and afraid to push for pension reform," she wrote in a post.
"But I never hesitated... reform must start from me," she said.
A former lieutenant-colonel will initially see their monthly stipend cut from Tw$70,797 ($2,340) to Tw$69,353, and eventually to Tw$56,360 after ten years, according to government estimates.
The majority of public sector retirees are supporters of the opposition Kuomintang (KMT) which relinquished its majority in Taiwan's parliament for the first time in 2016 after losing elections to Tsai's Democratic Progressive Party (DPP).
Legislators passed a separate pension reform bill last June that targeted civil servants. The government hopes both bills will come into effect on July 1.
In the past the government offered generous incentives to public sector employees to compensate for low starting salaries.
As Taiwan's economy has slowed down in recent decades government jobs have become increasingly attractive, placing additional burdens on state finances.
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