What Are Legacy Costs?

Legacy costs are company costs associated with health care fees and other benefits for its current employees and retired pensioners. These costs are typically ongoing and will increase the company's spending, while not adding to revenue. Pension plans are a prime example of a legacy cost.

Key Takeaways

  • Legacy costs are corporate expenses for pensions or health care programs.
  • Corporations become less competitive as legacy costs increase because these expenses do not contribute anything to revenues, growth, or profits.
  • Larger and older corporations typically have the biggest burdens when it comes to legacy costs.
  • Many companies are taking steps to reduce legacy costs, such as changing their employee retirement plans from defined-benefit to defined-contribution.

Understanding Legacy Costs

Escalating legacy costs can be a large contributing factor towards limiting a company's competitiveness because such items do not contribute to revenue, growth, or profits. However, while these costs can have a negative impact on a company's bottom line, workers’ rights advocates argue that employers have an ethical obligation to support their employees with these types of funding activities.

Larger, older, and more established companies can sometimes have problems with spiraling legacy costs. That's because they have the most pension and health care liabilities. In the face of these costs, many companies are taking measures to lower legacy costs as much as possible. One example of this can be seen by the trend of companies changing their employee retirement plans from defined-benefit plans to defined-contribution plans.

Real-World Example of Cutting Legacy Costs

In 2016, the Citizen’s Budget Commission (CBC), “a nonpartisan, nonprofit organization pursuing constructive change in the finances and services of New York City and State,” published a report titled "The '20-20-20-20' Dilemma: Legacy Costs in the New York City Budget." In the report, the CBC shows that a “giant slice” of the NYC budget is dedicated to legacy costs, which then claimed more than 20% of the annual budget and was projected to grow by 20% to more than $20 billion by 2020.

In this case, legacy costs include pension contributions and retiree health benefits but are also “debt service payments repay[ing] bonds issued for past capital projects.” In CBC’s analysis, the challenges of lowering legacy costs include possible credit downgrades if debt service payments aren’t made. The CBC, of course, supports paying out pensions and points out they are protected by the state constitution, but the commission suggests its possible for “some infrastructure improvements” to be “funded through current year resources” and that “annual proposals to enhance benefits can be rejected.”

Furthermore, the CBC suggests “bringing retiree health costs in line with those of other state and local governments” by asking retirees to share the cost of health premiums; “reform of union welfare funds” by “consolidating supplementary health care benefits under the city’s health plan”; and eliminating Medicare Part B premium reimbursements, a benefit they claim is “unheard of in the private sector and uncommon even among public employers.” CBC estimates that these budget shifts would save the city up to $1.6 billion by 2020.