State pension plans will be unable to meet liabilities without a major infusion of cash and reform.
"If I was a public employee and I was relying on this pension as my primary source of retirement income, I'd be really scared," Stanford graduate researcher Howard Bornstein said.
More than 2.6 million state workers from Caltrans crews to highway patrol officers are affected.
The study indicates the state's three pension plans are facing a deficit of over $500 billion.
"If you want to make that up over the next eight years, that would probably require somewhere around $40 billion per year to be put into the system. That's half the state budget," Bornstein said.
The three pension funds are known by their acronyms: CalPERS, which is the largest, covering most state workers, CALSTRS, which manages teachers' retirement funds and UCRS, for University of California employees.
"What's been going on is decades of underreporting debt. We've seen this in the financial crisis recently where companies and even government agencies like Fannie Mae, Lehman and others underreported their debt," the governor's economic adviser David Crane said.
The funds were hurt by their stock investments. They count on 7.5 to 8 percent returns annually. To address the deficit, the report makes three major recommendations.
"What we recommend in the report is to apply potentially scaled-back benefits actually to newly hired employees," Stanford researcher Cameron Percy said.
It also suggests putting money into less risky investments, and giving state employees a hybrid plan that would include a self-directed 401K option.
Governor Arnold Schwarzenegger wants to work with the legislature on pension reform, so the state will not have to divert funds for education and other programs.
California is not the only state facing huge pension debt. Two other studies indicate nationally it's a $2 trillion problem.
"At some point that day of reckoning will come. At some point California will implode fiscally. We're on the edge of it right now, and unfortunately, this gets us even closer to that edge," Stanford faculty adviser Joe Nation said.
A spokesman for CalPERS in Sacramento says the agency disagrees with the Stanford study, saying Stanford's ideas are too conservative and would lead to major losses.
CalPERS noted that it has earned a 7.9 percent annual return on investments for the past 20 years.
