Leaders at Santa Cruz City Hall have been trying to tackle pension debt — about $220 million as of June 2023. (Stephen Baxter — Santa Cruz Local file)
Editor’s note: Many Santa Cruz Local readers have asked about the role of unfunded pension debt in the budgets of the County of Santa Cruz and the cities of Santa Cruz, Watsonville, Scotts Valley and Capitola. This explainer aims to answer your questions.
Key takeaways
- Local governments across California, including those in Santa Cruz County, are burdened by millions of dollars in unfunded pension liabilities.
- Santa Cruz County and the four cities in the county have all taken measures to stem pension costs, and they are expected to pay back millions in pension debt over the next decade.
- Local governments across Santa Cruz County have asked voters to approve sales tax hikes to pay for rising city costs. Part of that tax revenue could go towards pension debt.
SANTA CRUZ >> Hundreds of city and county employees in Santa Cruz County earn retirement through CalPERS, California’s state-run pension system. Employers and employees contribute money to the system with each paycheck, and returns from CalPERS investments fund nearly two-thirds of pension payouts.
But for many employers, investments haven’t earned enough to cover payouts, leading local governments to dig into their budgets to fund pensions promised years ago.
Saving money for pension payouts is “our biggest challenge,” Capitola Finance Director Jim Malberg said at a Capitola City Council meeting in May. Capitola voters will consider a sales tax increase in the Nov. 5 election.
“The single most important reason we have the fiscal crunch that we have today, is that pensions — our pension liability — is impacting our ability to provide core services,” said Jim Reed, former mayor of Scotts Valley in 2021.
In the fiscal year that started July 1, local governments in Santa Cruz County are set to pay the equivalent of about 6% to 16% of their General Funds towards pension debt. Those annual payments are expected to gradually decline until the debt is paid off in the mid 2040s.
This explainer lays out how pensions work, some recent changes and why it will take years for pension challenges to subside.
Jump to a section:
- Why do pension liabilities matter in Santa Cruz County?
- What’s the problem with pension liabilities in Santa Cruz County?
- How did pension liabilities grow in recent years?
- How big are pension liabilities in Santa Cruz County?
- How have state and local governments responded to pension challenges?
- How and when will pension debts be paid?
Why do pension liabilities matter in Santa Cruz County?
Cities and counties must pay retirees their promised pension benefits, even if pension investments make less money than expected. Pension debt and health care costs can eat into city or county budgets and siphon money that would have been spent on other government services.
Across Santa Cruz County, local governments in recent years have turned to new taxes to help pay for crumbling roads, homelessness response and other needs. County staff and supervisors this year slashed their budget for road maintenance and took on record debt as the county awaits $125 million in federal reimbursements for disaster damages.
What’s the problem with pension liabilities in Santa Cruz County?
Hundreds of city and county employees in Santa Cruz County earn retirement income through CalPERS, California’s state-run pension system. Employers and employees contribute money to the system with each paycheck.
In the 1980s, markets were strong enough that employers contributed little or nothing to the fund. But after the 2008 financial crisis, investments massively underperformed expectations. Unlike 401(k)s, pensions guarantee retirees a certain amount of money each month for the rest of their life, regardless of investment returns. Some pensions also can be inherited by a surviving spouse or other beneficiary.
Employers like cities and counties are on the hook for the unfunded portions of retiree payouts and are effectively millions of dollars in debt.
Years after the 2008 financial crisis and Great Recession, “It’s an extraordinary moment in time where the plan has lost so much and it hasn’t recovered that yet,” said Santa Cruz County Budget Manager Marcus Pimentel.
Employers have reduced pensions for new hires, but are locked into previously promised payouts. “We can’t renege on the promises made to retirees,” said Scotts Valley City Manager Mali LaGoe. “I mean, this is their retirement income.”
California courts have ruled that employers cannot cut pension benefits that were guaranteed in prior contracts.
How did pension liabilities grow in recent years?
Before the 2008 financial crisis, CalPERS employers had assumed for decades that their contributions would adequately fund future pensions. But after the market crash, employers found themselves without the money to pay for promised pensions.
People are also living and drawing pensions longer than previously expected. Every few years, CalPERS issues new predictions on investments and mortality rates. As lifespans increase, so does the money that will have to be paid out in pensions and health care plans.
Pension plans negotiated across the state by law enforcement and firefighter union leaders in the 1980s have contributed to pension debt. Many employers offered generous pensions to attract new hires, LaGoe said.
Many city and county employees accrue about 2% of their salary in pension for each year worked. For example, a city employee who worked for 30 years and retired with a $100,000 salary might receive a $60,000 annual pension. But for some law enforcement officers and firefighters, for instance, up to 4% of their salary accrues annually, potentially entitling someone with the same salary and tenure to retire with a pension of $120,000 annually.
Police and firefighters “have a high risk job, and they unfortunately tend to have a lower life expectancy, and tend to have more health issues related to the work that they performed,” said LaGoe. Many police and firefighters also do not get Social Security benefits, because their employers do not pay into the system.
Public safety pension plans offered after state pension reform have higher retirement ages, require higher employee contributions, and give pensioners a smaller portion of their salary.
How big are pension liabilities in Santa Cruz County?
In the fiscal year that started July 1, local governments in Santa Cruz County are set to pay the equivalent of 6% to 15% of their General Funds towards pension debt. Those annual payments are expected to gradually decline until the debt is paid off in the mid 2040s.
Pension debts are not concrete numbers — they change according to CalPERS’ estimates of future investment returns.
A General Fund is a local government’s main operating fund, and pays for services like public works, police, parks and recreation. Cities and counties can also use other funds to pay off pension debt.
The City of Vallejo filed for bankruptcy in 2008 in large part because of tens of millions of dollars that it could not pay toward pensions and retiree health benefits. Santa Cruz County and its four cities do not appear to be on that track.
How have state and local governments responded to pension challenges?
In response to ballooning pension costs, California legislators in 2012 created the Public Employees Pension Reform Act, or PEPRA. Starting in 2013, CalPERS employees were enrolled in new PEPRA plans with lower payouts. As a result of the new plans, local governments’ pension debts are expected to stabilize or decrease by about 2030.
California courts have ruled that employers cannot cut pension benefits that were guaranteed in prior contracts.
Pension trust funds
In Scotts Valley and the City of Santa Cruz, money has been put aside in pension trust funds to supplement General Fund spending on pension debt. Consultants for the City of Santa Cruz estimated that the city could exhaust that money by mid-2028.
Pension obligation bonds
Local governments can issue pension obligation bonds and take on debt to pay CalPERS. However, many experts including the Government Finance Officers Association consider those bonds risky. If they have a higher investment return than CalPERS, the issuer saves money. However, mistimed pension obligation bonds can sink local governments into more debt.
Santa Cruz County and the cities of Santa Cruz, Capitola and Scotts Valley have all issued pension obligation bonds in the past 20 years. Most recently, Santa Cruz County in 2021 issued $125 million in pension obligation bonds.
Depending on future CalPERS returns, the bonds are expected to save the city of Santa Cruz about $3.2 million.
Taxable bonds
Taxable bonds are considered less risky than pension obligation bonds and are repaid by a local tax. Watsonville voters years ago approved a property tax to address pension costs, and in 2022 city leaders approved $40 million in taxable bonds to cover unfunded retirement costs. The city pays back the bonds with money from the property tax.
Sales taxes
Sales tax revenue is not specifically earmarked for pension costs, but the money goes to city and county General Funds and can be used to pay off pension debt.
Capitola voters will consider a sales tax increase in the Nov. 5 election. Saving money for pension payouts is “our biggest challenge,” Capitola Finance Director Jim Malberg said at a May 16 Capitola City Council meeting.
Pension costs were equivalent to about 10% of the City of Santa Cruz’s General Fund expenses in 2022. Santa Cruz voters rejected a sales tax hike in June 2022, but approved a similar one in the March 2024 election.
Voters also approved sales tax increases in the County of Santa Cruz this year and in Watsonville in 2022.
Staff from Santa Cruz County and the City of Santa Cruz have said pension costs weren’t the main force behind the sales tax increases. In Santa Cruz County, deferred maintenance on roads and buildings is a much larger issue, Pimentel said during the campaign for the county sales tax hike.
Cost sharing pension contributions
PEPRA pension plans require employees to pay in a larger portion of pension investments than previous CalPERS plans. Some local governments in Santa Cruz County have also negotiated with unions to have employees take on part of the employer’s share of pension contributions.
How and when will pension debt be paid?
Each year, CalPERS employers must pay in a matching percentage of employee salaries, and a portion of their pension debt. Payments on that debt are set to gradually decrease until the debt is paid off in the mid-2040s.
Even once the existing debt is paid off, pension costs could rise. When employers issue paychecks, they are required to match a percentage of an employee’s salary in CalPERS payments. When CalPERS projects a lower rate of return for its investments, that percentage increases. And if the fund underperforms projections, employers could face pension debt all over again.
What do you think?
Read more
- Less money for road maintenance in approved Santa Cruz County budget — June 6, 2024
- Rising pension costs in Santa Cruz: Your questions answered — June 4, 2021
- Scotts Valley leaders consider risks, rewards of pension bonds — Feb. 18, 2021
Jesse Kathan is a staff reporter for Santa Cruz Local through the California Local News Fellowship. They hold a master's degree in science communications from UC Santa Cruz.
