California’s public retirement systems carry roughly $300 billion in unfunded pension liabilities, the largest such shortfall of any state in dollar terms. Two systems account for nearly all of it: CalPERS and CalSTRS. The gap exists because promised benefits have outpaced what investment returns and contributions have delivered, and because state law makes it very difficult to reduce benefits already earned.
What an Unfunded Pension Liability Is
An unfunded liability is the gap between what a retirement system has promised to pay and what it holds today (plus expected investment growth) to cover those promises. California’s public pensions are defined benefit plans: a retiree’s check is calculated from salary and years of service, not from market performance. Actuaries project those payments decades out and then estimate what pile of money, invested today, would cover them.
The most important variable in that estimate is the discount rate, or the assumed annual investment return. A higher assumed return makes the same promises look cheaper today. When actual returns fall short, or when retirees live longer than projected, the gap widens. Someone eventually closes it: employers, employees, or taxpayers.
How Big the Debt Is
Across all state and local public retirement systems in California, unfunded pension liabilities totaled approximately $300.4 billion as of 2023, with an overall funded ratio of about 79%.1Equable. Unfunded Liabilities for State Pension Plans in 2023 For every dollar of future benefits owed, California’s funds collectively hold about 79 cents.
CalPERS
The California Public Employees’ Retirement System is the largest public pension fund in the United States. In its actuarial valuation dated June 30, 2023, CalPERS reported an unfunded liability of $186.3 billion in its Public Employees’ Retirement Fund and a funded ratio of 71.4%. Its discount rate is 6.8%, reduced from 7.5% over the past decade and last adjusted in 2021 after a strong return year triggered an automatic reduction under the fund’s risk mitigation policy.2California Public Employees’ Retirement System. Annual Comprehensive Financial Report Fiscal Year Ended June 30, 2024
CalPERS covers state employees, most local government workers, and public school staff other than teachers. It serves nearly 2.4 million active members, retirees, and inactive vested members.3CalPERS. Facts at a Glance – CalPERS Organization FY 2024-25
CalSTRS
The California State Teachers’ Retirement System, which covers public school educators from kindergarten through community college, reported a net pension liability of $67.2 billion as of June 30, 2024.4CalSTRS. Financial Statements FY 2024-25 CalSTRS uses a higher assumed return than CalPERS at 7.10%.5CalSTRS. CalSTRS Earns 8.5 Percent Net Return in Fiscal Year 2024-25 The CalSTRS Funding Plan is designed to eliminate the system’s unfunded obligation by 2046 through a set schedule of employer and state contributions.6CalSTRS. Funding Plan Fact Sheet That centralized schedule was possible because the legislature sets teacher contribution rates and benefit levels by statute, rather than leaving them to individual employer contracts the way CalPERS does.
Why the Discount Rate Matters So Much
The discount rate is the most technical number in pension math and also the most consequential. When CalPERS assumes 6.8% and earns less, the shortfall compounds against a portfolio worth hundreds of billions of dollars. Actuarial sensitivity analyses show that lowering the assumed rate by a single percentage point can add billions to a system’s reported liability.7Society of Actuaries. Discount Rate Sensitivity Analysis The effect is not symmetric: lowering the rate raises liabilities more than raising it reduces them, because the discounting stretches over 30 or 40 years.
Some economists argue that public pension promises are guaranteed obligations and should be discounted using a risk-free rate closer to U.S. Treasury yields, roughly 4 to 5 percent. Under that approach, California’s reported unfunded liabilities would be dramatically larger. Pension systems counter that their long investment horizons justify a higher assumed return. Both CalPERS and CalSTRS have gradually lowered their assumptions over the past decade, and each reduction has pushed reported liabilities and employer contribution rates up.
What Drives the Gap
Investment Returns Below the Assumption
The biggest single driver is years when returns miss the assumed rate. When CalPERS assumes 6.8% and earns 5%, the shortfall on a portfolio that size is enormous, and it compounds. A single bad year lowers the base from which future returns are calculated, so the system has to earn above-average returns just to catch up to where it was projected to be. The 2008 financial crisis, which erased roughly a quarter of CalPERS’ portfolio value, is still rippling through employer contribution rates because those losses were amortized over decades.
Higher-Risk Portfolios
To chase returns, public pension funds have shifted toward riskier assets. As of June 30, 2024, CalPERS held roughly 42% of its portfolio in public equities, 15.5% in private equity, and 13.2% in real assets like real estate and infrastructure, with about 19% in traditional fixed-income securities.8CalPERS. Trust Level Review as of June 30, 2024 Nationally, public pension plans held about 77% of their assets in equities and alternative investments by fiscal year 2022, up from 74% in 2019. Higher expected returns come with wider swings, and those swings produce sudden spikes in unfunded liabilities and contribution rates.
Longer Lifespans
Retirees are living longer than actuaries originally projected, so each pension is paid out over more years than the system planned for. Meanwhile, the ratio of active workers paying in to retirees drawing benefits has been shrinking. Every mortality update pushes total projected liabilities higher. The adjustments are quieter than an investment crash, but they only move in one direction.
How the Debt Is Paid Down
The amortization schedule matters as much as the size of the debt. CalPERS uses a layered approach: investment losses recognized in a given year are amortized over 20 years, with payments ramping up over the first four years before reaching their full level. Changes in actuarial assumptions and non-investment experience are also amortized over 20 years. When the total unfunded liability is recalculated through a “fresh start,” CalPERS typically uses 25 years or less with level dollar payments, though in extreme cases the chief actuary can extend that to 30 years.9CalPERS. Actuarial Amortization Policy
Longer schedules mean lower annual payments and short-term budget relief, but more interest accrues on the balance. It works like a mortgage: a 30-year term has smaller monthly payments than a 15-year term, and a larger total cost.
Why California Can’t Just Reduce Benefits
The legal doctrine known as the California Rule is the reason pension reform in California operates almost entirely on new hires. Under this rule, a public employee’s pension benefits are treated as a contractual right protected by the contract clauses of the California and U.S. Constitutions. Once you start working, the benefit formula in place at that time cannot be reduced for your future service unless you receive a comparable new advantage in exchange.
The doctrine traces to the California Supreme Court’s 1955 decision in Allen v. City of Long Beach. In 2020, the Court reaffirmed the rule in Alameda County Deputy Sheriffs’ Association v. Alameda County Employees’ Retirement Association, stating that the Allen test “remains the law of California.”10Justia Law. Alameda County Deputy Sheriffs Association v. Alameda County Employees Retirement Association The Court in Alameda allowed the elimination of certain pension-spiking practices under PEPRA, but did so within the existing framework.
The practical result: California’s governments cannot cut benefits to close the funding gap. The available levers are higher contributions, better investment returns, or less generous benefits for future hires.
What PEPRA Changed
The Public Employees’ Pension Reform Act of 2013 (PEPRA) is California’s most significant attempt to slow the growth of pension costs. It did not touch benefits for existing employees. Instead, it created a less generous structure for anyone hired into a California public retirement system on or after January 1, 2013.11CalPERS. Summary of Public Employees’ Pension Reform Act of 2013
For new non-safety employees, PEPRA set the benefit formula at 2% of salary at age 62, with early retirement starting at 52 and a maximum benefit factor of 2.5% at age 67. For safety employees such as police and firefighters, it established new formulas with a normal retirement age of 50 and a maximum benefit factor at age 57. All new members must contribute at least half the total normal cost of their benefit, and final compensation is averaged over 36 consecutive months rather than the shorter periods some classic members use.12CalPERS. 2025-26 State Employer and Employee Contribution Rates
PEPRA also caps the salary that counts toward pension calculations. For 2026, the pensionable compensation limit is $159,733 for employees who also participate in Social Security and $191,679 for those who do not.13CalPERS. 2026 Compensation Limits for Classic and PEPRA Members Once an employee’s compensation hits that ceiling in a calendar year, neither the employer nor the employee reports further pension contributions for the rest of that year.
The savings phase in slowly. Every “classic” member hired before 2013 keeps the more generous formula for their entire career. Full cost savings won’t arrive until the last pre-PEPRA employee retires, decades from now. In the meantime, the existing unfunded liability keeps compounding under its own rules.
What Rising Pension Costs Do to Local Budgets
The debt shows up most visibly in the contribution rates employers owe each year. California’s public employers must make actuarially determined contributions covering both the normal cost of benefits earned that year and a payment toward the existing unfunded liability.14California Legislative Information. California Government Code 20814
For state employees in fiscal year 2025–26, CalPERS employer contribution rates range from 21.42% of payroll for State Industrial members up to 70.61% for the California Highway Patrol.12CalPERS. 2025-26 State Employer and Employee Contribution Rates For school districts under CalSTRS, the employer rate is 19.10% of creditable earnings plus a supplemental contribution. Those are percentages of payroll dedicated to retirement alone, unavailable for hiring, equipment, or services.
When pension contributions consume a growing share of a city or school district budget, something else has to give. Researchers have documented a crowd-out effect where rising pension costs force cuts to other public services and infrastructure. A city that once spent 8% of its budget on pensions and now spends 15% has to find that extra 7% somewhere: higher taxes, thinner police and fire staffing, deferred road maintenance, or some mix. By one estimate, at least a third of school districts nationally have experienced funding cuts linked to growing pension costs.
The pressure is self-reinforcing. Cities that cut services to fund pensions become less attractive to residents and employers, which can erode the tax base and make the next round of contributions harder to afford. That dynamic pushed Stockton and San Bernardino into bankruptcy earlier in the last decade. Conditions have improved since, but the underlying math has not fundamentally changed for the most stressed municipalities.