There are a lot of advantages to partnering with a professional employer organization (PEO). PEOs streamline and offload some of the most time-consuming HR functions, like compliance and payroll. They can also give small and midsize businesses the ability to punch above their weight, offering big-company benefits for reasonable prices. Whether you’re an admin hoping to offload HR tasks or a C-suite executive considering the bottom line, the data is on PEOs’ side.
According to the National Association of Professional Employer Organizations (NAPEO), businesses that use a PEO have higher employee satisfaction and up to 14% lower employee turnover. On top of that, NAPEO’s 2019 study found that “the average cost savings from using a PEO is $1,775 per year per employee, while the average PEO cost per employee is $1,395, yielding an annual ROI of 27.2 percent.”
But as with any average, there are outliers in the mix. Although many PEOs charge a fixed rate for services, some include hidden costs by tacking on fees or calculating rates for tax services in unusual ways. According to Deisy Bach, a former PEO executive, many companies fail to understand these hidden costs until they’ve already signed the dotted line.
Fear not. Simply by reading this post you’re arming yourself with the knowledge to ask the right questions. We’re going to cover some common hidden costs of PEOs, so you can feel confident in your purchasing decision.
The price of a PEO
PEOs will charge an administrative fee for their services, often using one of two pricing structures: a fixed monthly fee per employee, or a percentage of your overall payroll. And if that were always the case, the simplicity would be a beautiful thing. But the reality can sometimes become far more complicated—and costly.
Sometimes PEOs will exploit their unique “co-employer” status to generate additional revenue without fully disclosing this to clients. And depending on how the PEO defines and calculates items like “taxable wages” or “payroll tax fees,” your invoice could be a lot larger than expected. If that wasn’t enough, some also hide additional fees in the fine print for services that should be included in the first place.
Here are some of the common ways that PEOs may end up costing you more than you bargained for.
Taxable Wage Base Limit
A number of employer payroll taxes—like the State Unemployment Tax Act (SUTA), for example—have a maximum yearly limit against which taxes are calculated. This is called a taxable wage base limit. Businesses calculate and remit these taxes to federal and state tax agencies until each employee reaches the specified wage base limit. For the rest of the calendar year, they’re off the hook—they no longer have to contribute to that tax.
But the unique nature of PEOs complicates this. Usually when a company joins a PEO, the PEO assumes responsibility for filing and paying all employer and employee-related taxes as a service. It’s part of the co-employment relationship. But some PEOs will continue billing the employer after an employee’s taxable wage limit has been hit, and pocket the difference.
Billing on Gross Payroll
A common PEO pricing structure is to charge a percentage of your company’s payroll. And yet a PEO’s definition of payroll might differ from yours. Sometimes their definition can include deductions that are considered pre-tax.
Taxable wages are reduced by pre-tax benefits, like health insurance and Flexible Spending Accounts (FSAs). When employees enroll in programs like those, they not only score great benefits—they also save money in taxes by reducing their take-home pay. Employers save on payroll taxes, too.
But some PEOs will ignore deductions like these when calculating fees. Instead of charging a percentage of taxable wages (like the Internal Revenue Service does), PEOs might base their fee on a figure that includes pre-tax pay.
Consider how deductions normally work. If an employee earns a total of $3,000 per paycheck, they may decide to pay a $300 premium for health insurance and invest $200 in a FSA. That leaves $2,500, which is taxable for both the employee and the employer.
But a PEO’s contract might stipulate that it takes 15% of the gross wages, not the adjusted wages. This means that instead of 15% of $2,500 ($375), you’ll pay 15% of $3,000 ($450). And that’s just for one employee.
Administration Fees for Taxes
Another way some PEOs make a quick buck is by charging for the administration of taxes. Remember SUTA from earlier? It’s the payroll tax that funds a state’s unemployment benefits. In certain states, an employer might pay 6.2% for the first $7,000 of an employee’s wages. But a PEO might tack on a .05% as a tax administration fee. In that case, the employer would end up paying 6.25% on $7,000. Multiply this by an entire workforce, and the costs quickly add up.
In addition to their primary pricing structure, some PEOs also charge for routine services. These fees can be for things as ordinary as enrolling a new employee, running an off-cycle payroll, or changing a new hire’s start date.
But these aren’t special services. They’re what your HR team would typically do in a day’s work. Since the whole reason to partner with a PEO is to offload standard tasks, it doesn’t make sense to nickel-and-dime your company for them.
Leaving can be difficult. Most PEOs will let you exit the agreement with 30 days’ notice, but some carry term requirements. In those cases, getting out will result in a costly penalty. It’s just one more reason to look closely at that contract.
Do your due diligence
Is this making PEOs seem like more trouble than they’re worth? It shouldn’t. These hidden costs are exceptions, and don’t tell the full story. PEOs are an amazing way to offload administrative burdens so your business can focus on what it does best.
The question is how to determine which PEO is right for your business. That decision will probably include conversations about your company’s growth, the technology a PEO can offer you, and more. Cost is just one factor. But it’s also one of the easiest bluffs to call now that you’re knowledgeable about the different pricing structures.
As you’re narrowing down your PEO options, be sure to ask these five questions:
1. “What is the PEO’s pricing structure?”
This might be a fixed monthly fee per employee, or it might be the percentage of payroll. If it’s the latter, make sure the PEO charges based on the adjusted payroll, not a gross amount that includes pre-tax contributions.
2. “Will I be charged for tax administration?”
The tax administration burden is probably one of the reasons you’re considering a PEO. Make sure this service is included and that your PEO honors wage base limits, as well as federal and state tax rates.
3. “What other services will I be charged for?”
Changing a new employee’s start date shouldn’t cost you. Some PEOs tack on additional fees for routine services like this, but they should simply be part of the package.
4. “Do I know how much I’ll be paying every month?”
A PEO’s nominal pricing structure can give an incomplete picture. Before you partner with a PEO, try to understand what the actual monthly cost will be. When shopping around, it never hurts to ask for a sample invoice or fee schedule.
5. “Do I believe I’m being charged fairly?”
You’re looking for a partner, not a penny pincher. A PEO should ultimately spare you and your admins from busy work and leave your business in better shape.
The Rippling PEO
At Rippling, we make it easy for high-growth companies to hire remotely and provide great HR and benefits without high costs or compliance headaches.
We partner with leading benefits carriers to provide access to large group health plans, often at lower costs than small group. And unlike with many other PEOs, what you see is what you get. At Rippling we only charge a flat fee for our PEO services, with no hidden costs buried in the fine print.
We’re also experts on the increased HR, payroll, and risk management complexities that come with hiring remote workers—like staying compliant with employer tax filings, workplace labor law posters, and state and local tax accounts when you hire your first employee in a new state. While other PEOs often charge an extra fee and rely on sending PDFs back and forth to set up state and local tax accounts, Rippling does it all automatically using our modern software.
In addition to simplifying compliance, Rippling streamlines everything from setting up new hires’ devices and accounts, to running payroll, to enrolling employees in benefits. We’ll even help you resolve any employment claims quickly and cost-effectively—though our on-staff HR Advisors will also advise you on best practices to avoid claims altogether.