Public Pensions vs. 401(k)s: Who Pays for Underfunded Retirement Promises?

Public pensions promise retirement security to millions of government employees. The difficult question is who bears the risk when those promises grow faster than the assets set aside to pay them.

In this Saving America report, Dr. David D. Schein connects the debate over public pensions to the broader condition of the U.S. economy, household retirement savings, Social Security, and the long-term burden placed on taxpayers when state and local retirement systems are underfunded.

What did the June 2026 inflation report show about the economy?

The episode begins with a rare piece of encouraging economic news. The U.S. Bureau of Labor Statistics reported that the Consumer Price Index fell 0.4 percent in June 2026 after rising 0.5 percent in May. Over the previous 12 months, consumer prices were still up 3.5 percent.

Energy prices were the largest contributor to the monthly decline, which is important because one good month does not necessarily mean the inflation problem is solved. Food prices still rose during the month, and many households continue to feel pressure from housing, borrowing costs, insurance, and everyday expenses.

Read the Bureau of Labor Statistics Consumer Price Index report.

DDSA has been following the difference between economic headlines and household experience. For related analysis, see It’s the Economy, Stupid: Will Voters Decide With Their Wallets? and the DDSA Economy archive.

Why are public pensions different from 401(k) retirement plans?

A traditional public pension is generally a defined-benefit plan. The benefit is calculated using a formula tied to factors such as salary, years of service, and retirement age. The employer sponsoring the plan is responsible for making sure enough money is available to pay promised benefits.

A 401(k) is a defined-contribution plan. Employees contribute to individual accounts, employers may contribute or match contributions, and the retirement outcome depends on contributions and investment performance.

That difference shifts risk. In a defined-benefit pension, investment shortfalls, demographic changes, benefit increases, or inadequate contributions can create large unfunded liabilities for the sponsoring government. In a defined-contribution plan, investment risk is borne much more directly by the individual account holder.

The IRS says the employee elective-deferral limit for most 401(k) plans is $24,500 in 2026, while the overall annual contribution limit for one employer’s plan is generally $72,000 before certain catch-up contributions.

How underfunded are Chicago’s public pension systems?

Chicago provides a vivid example of the long-term problem. Public reporting based on the city’s 2025 financial statements placed Chicago’s total unfunded pension debt at roughly $36.4 billion. The police pension fund was about 25.5 percent funded, the firefighters’ fund about 25.2 percent, the municipal fund about 28.2 percent, and the laborers’ fund about 44.1 percent.

Those numbers matter because pension contributions compete with every other local priority. Money required to close pension gaps cannot simultaneously fund public safety, infrastructure, housing, parks, or tax relief.

Chicago’s own municipal code anticipates increasing pension-related property tax levies as the city works toward statutory funding targets. The fiscal debate is therefore not theoretical. It reaches directly into future budgets and tax bills.

Why are California Highway Patrol pension costs part of the debate?

California illustrates another side of the issue: the generosity of some historical benefit formulas and the cost of maintaining them.

CalPERS publishes a state-safety retirement formula of 3 percent at age 50. Under that formula, 30 years of service can produce a benefit equal to 90 percent of final compensation, subject to plan rules and eligibility.

For fiscal year 2026-27, CalPERS lists the budgeted employer contribution rate for California Highway Patrol members at 65.13 percent of payroll. That is an employer pension contribution rate, not a dollar-for-dollar 401(k) match, but it shows how expensive defined-benefit promises can become for government employers and taxpayers.

Review the CalPERS 2026-27 state employer contribution rates and the CalPERS 3 percent at 50 benefit-factor chart.

Should governments replace traditional pensions with defined-contribution plans?

Dr. Dave’s position is direct: governments should honor benefits already earned and promised, but they should stop creating new open-ended pension liabilities and move future public employees toward participant-directed retirement savings plans.

That is a policy choice, not a purely accounting question. Supporters of traditional pensions argue that predictable benefits help governments recruit and retain teachers, police officers, firefighters, and other public employees. Critics argue that defined-benefit plans make it too easy for elected officials to promise compensation today while shifting part of the cost to taxpayers years or decades later.

A transition can take several forms. Governments can close a defined-benefit plan to new workers, create hybrid plans, increase employee contributions, alter formulas for future service where legally permitted, or adopt defined-contribution accounts for new employees.

The crucial principle is funding discipline. Whatever benefit a government promises should be accompanied by a credible plan to pay for it.

How does the public-pension debate connect to Social Security?

The retirement discussion becomes more urgent because Social Security has its own financing challenge. The 2026 Social Security Trustees Report projects that the Old-Age and Survivors Insurance trust fund reserves will be depleted in the fourth quarter of 2032 under the intermediate assumptions. After depletion, incoming revenue would still finance benefits, but not the full amount scheduled under current law.

Read the 2026 Social Security Trustees Report summary.

That does not mean Social Security suddenly disappears. It means policymakers face a financing gap that will eventually require some combination of revenue changes, benefit changes, or other reforms.

DDSA has addressed pension policy in earlier coverage as well, including Saving America Week 22: AI Lawsuits, NATO Tensions, Congressional Pensions and Education Reform.

Who ultimately pays when a public pension is underfunded?

There is no disappearing pension liability. If assets and contributions are insufficient, the pressure eventually reaches some combination of taxpayers, employees, retirees, government services, or future budgets.

That is why the funded status of a pension plan matters before a crisis arrives. Strong investment returns can help, but markets also decline. Contribution holidays, unrealistic assumptions, retroactive benefit increases, and delayed reforms can magnify the problem.

The broader taxpayer question is one of fairness across generations. Current elected officials can approve benefits whose full cost may not become visible until long after those officials have left office.

What is the Saving America takeaway on public pensions?

The debate should not be reduced to attacking public employees or dismissing taxpayers’ concerns. Workers deserve clarity about the benefits they have earned, and taxpayers deserve clarity about what those benefits will cost.

Dr. Dave argues that existing commitments should be handled responsibly while governments reconsider whether traditional defined-benefit pensions are sustainable for future workers. Whether policymakers agree with that solution or choose another one, the underlying obligation is the same: promises should be funded honestly when they are made.

Financial and policy disclaimer: This article is for informational and commentary purposes only. It is not financial, investment, tax, or retirement-planning advice. Pension rules, funding requirements, and retirement benefits vary by plan and jurisdiction.

Watch the full Saving America episode: Public Pensions vs. 401(k)s: Who Pays for Underfunded Retirement Promises?

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