(Bloomberg) -- Letters sent by certified mail usually aren’t howstate and local governments signal they’re about to breach thepromise that public workers consider ironclad when it comes toretirement benefits.

Related: CalPERS CIO says funding gap to widen forforeseeable future

But that’s how Patsy Jardin, 71, of Loyalton, California, foundout that she may lose much of her $48,000 annual pension becausethe town government failed to fund its long-term liabilities.Reading the letter delivered to her rural home made the formerclerk "sick," she said in an interview. "It’s my livelihood."

The board of the California Public Employees’ Retirement Systemon Wednesday voted to cut the retirement benefits of Jardin andfour others who worked for the former sawmill town of about 700people in the Sierra Valley that quit the program. It may be thefirst time the largest U.S. public pension has taken such a step.Recent California municipal bankruptcies kept pensioners whole,underscoring the sanctity assigned to benefits earned byworkers.

Related: What would a government bailout of thePension Benefit Guaranty Corporation -- PBGC -- looklike?

However, mounting retirement costs give many municipalitieslittle choice, especially if they must make up for lacklusterinvestment returns that were supposed to pay for the lifetimechecks, said State Assemblyman Brian Dahle, a Republican whorepresents Loyalton.

"They can’t bail everybody out in the same situation," Dahlesaid of CalPERS before the decision. "There’s a lot ofmunicipalities in California, counties and cities, that are puttingout a lot of their income to pensions."

Across the country, local governments are short about $2trillion what they need to cover retirement benefits granted inboom times. Investment losses during the recession that ended in2009, benefit increases, years of governments failing to makeadequate contributions, rising retirements and fewer currentworkers paying into the systems have exacerbated the gap.

Sawmill closing

Loyalton, like many other municipalities, extended retirementbenefits decades ago -- in 1985 -- and then struggled to pay forthem. The city’s economic base dwindled with the 2001 closing ofthe Sierra Pacific sawmill and the waning of the regional timberindustry.

At the most, the community employed three full-time staffers.Currently it has one full-time worker and four part-timers, saidBrooks Mitchell, a councilman first elected in 2009. The CityCouncil decided to leave CalPERS because continuing to pay thesame level of benefits and salaries would bankrupt the town, saidMitchell, who was picked by fellow council members to serve asmayor at that time.

In March 2013, city officially exited the retirement system. Thenext year, CalPERS sent Loyalton a bill to cover the cost ofthe benefits and the unfunded liability: $1.6 million.

That’s money Loyalton doesn’t have. A spreadsheet from the cityshows it projects ending November in the red by $2,700 as expensesexceed its cash flow of $50,600.

CalPERS notifications

"I didn’t realize we would be billed right off the bat for the$1.6 million," Mitchell said. "Looking back we probably should havedone a little more research."

CalPERS staffers told the agency’s board members that they triedto compel Loyalton to pay through 50 telephone calls and 10collection notices, without success. Finally, on Aug. 31, they sentletters to the city saying it has 30 days or it will be in default.They also sent notices to the five former employees, four of whomhad been receiving pensions, that their benefits would bereduced.

The three-paragraph missives came as a shock to Jardin and JimCussins, who retired in 2011 as a maintenance foreman. The councilhad told them pulling out of CalPERS wouldn’t affect them,they said.

While they blame the city’s leaders, they also said the publicpension system should have acted more quickly.

Benefit reductions

"They let this go for three years and they don’t contact usuntil the last minute?" said Cussins, 55, who relies on his $36,000annual pension. Cussins, who filled an open council seat in 2015,didn’t run for election last week and is departing the board inJanuary.

Under the law, the pensioners could see their checks cut by 60percent since the city is falling short by that rate to make thebenefits fully funded.

In less than five minutes, the CalPERS board dispatchedwith the Loyalton matter. It’s municipal employers who make thepromise of benefits, said board member JJ Jelincic.

"If they won’t fund it, there’s not much we can do about it," hesaid.

Possible recovery

There’s a chance the retirees may recoup some of their lostmoney. CalPERS’ Chief Financial Officer Cheryl Eason told boardmembers the city pledged to cover what the pension system iscutting. But Cussins said after the meeting there was no councilvote to do that, and he’s considering a lawyer to sue Loyalton.

Mitchell, the councilman and former mayor, said before the votethat the pension system is playing hardball because of itsfinancial troubles. The system has about 68 percent of the assetsit needs to meet obligations, and its staff has warned returns maylag the 7.5 percent target for a third year. Lower income frominvestments means higher payments from taxpayers to bridge thegap.

"They’re going to make an example out of the little city ofLoyalton," Mitchell said.

Wayne Davis, a CalPERS spokesman, said the agency can’tcategorically say it would be the first time it cut benefits in its84-year history, Eason characterized the situation as "unchartedterritory" during a September board meeting.

The pension system "would be basically stealing money fromsomebody else to pay somebody who wasn’t their employee" if theylet the Loyalton checks continue because of the "really baddecision" by the municipal government, said Dave Low, chairman ofCalifornians for Retirement Security, a group representing publicworkers.

"If it can happen here, it can happen someplace else," hesaid.

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