Professional employer organization (PEO)

The longer definition

The HR demands of running a business can really add up—especially with the increase in remote work, which requires managing compliance across multiple states. And without offering top-tier benefits, businesses struggle to recruit and retain top talent. A PEO can help. 

A PEO specializes in payroll, benefits, HR management, and labor compliance services, allowing a company to streamline a lot of employee-related administrative duties and free up time and resources for higher-value activities. By co-employing a company’s staff (more on that later), a PEO is able to take over and/or automate tasks like running payroll, enrolling employees in benefits, and managing other administrative functions. 

Outsourcing part of your HR administrative functions to an outside party may sound scary. But according to the National Association of Professional Employer Organizations (NAPEO), businesses that use a PEO actually have higher employee satisfaction and up to 14% lower employee turnover. 

And it’s not just employees that benefit. NAPEO’s recent 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 ($380).” Not surprisingly, the study also found companies that use a PEO grow faster and are much more likely to stay in business than companies that don’t.

So let’s dig deeper into how PEOs work, the benefits of using them, and whether one is right for your business.

How does a PEO work?

While PEO services and pricing structures vary, here’s a general overview of how a PEO works for small businesses and startups.

They co-employ your employees

When you join a PEO, it will co-employ your workforce for administrative services, like paying employees and filing payroll taxes. Importantly, you will still retain full control over who you hire, which benefit plan designs are offered to employees, and other important human resources decisions.

NAPEO defines the co-employment relationship as “a contractual allocation and sharing of certain employer responsibilities between the PEO and the client.” In other words, co-employment means that you and the PEO divide up employer responsibilities:

• The PEO acts as an administrative employer (or statutory employer, as defined by the IRS) for purposes of managing a variety of administrative processes. They employ your workers on record for tax purposes and usually process wages, benefits, withholdings, and taxes under their federal employer identification number (EIN).

• You act as the worksite employer, maintaining full authority over your employees, including who to hire (and let go) and how much to pay them. You also continue to handle your company’s overall strategy and business operations, including product research and development, marketing, sales, and customer support.

As NAPEO puts it, “each party will be responsible for certain obligations of employment, while both parties might share responsibility for other obligations and be ‘an’ employer, but neither party is ‘the’ employer for all purposes.”

They offer services that handle your HR tasks

In general, the PEO takes over or automates employment-related HR administrative work, including:

• Payroll: When you partner with a PEO, they take over paying employees, withholding and paying taxes, and more. Modern PEOs allow you to automate this in-house and spend only seconds on each pay run.

• Employee benefits: As a large group, a PEO can leverage its economies of scale to negotiate pricing with providers, streamline employee enrollment, process claims, and more.

• HR compliance: Labor and employment laws are complicated, different in every state, and often changing. A PEO helps you follow the rules and avoid costly fines.

PEOs bring technology, HR expertise, and established processes to the table, allowing you to save time on administrative functions and help keep your business compliant.

While down from peak levels during the COVID-19 pandemic, remote work remains popular. For small businesses and startups, navigating the various state and local laws surrounding employment regulations—like payroll, PTO, minimum wage, and final pay requirements—can be increasingly difficult.

According to Upwork’s Future of Workforce Pulse Report, 36.2 million Americans will be working remotely by 2025—an 87% increase from pre-pandemic levels. By 2026, it’s estimated that the number will grow to 40.7 million Americans—21 million above pre-pandemic levels. For businesses without in-house knowledge of each state’s specific regulations, leveraging a PEO’s expertise could be an important service to consider.

Your contract with a PEO, usually called a client service agreement (CSA), will define the exact services the PEO will provide and the specific responsibilities of each party. Read through it carefully and make sure you understand everything before signing. A good PEO will be willing to explain all the terms and answer any questions you have.

They save money through economies of scale

According to NAPEO, the over 500 PEOs in the United States co-employ 4.5 million people spanning 208,000 businesses. Because each PEO co-employs workers from so many individual businesses for purposes of benefits administration, they can negotiate with insurance providers to secure cheaper, higher-quality benefits for those small business employees—often lowering employment costs and boosting the bottom line for the business itself.

How much do they cost?

Your total cost will depend on a variety of different factors, including how big your company is, which services you’d like to take advantage of, and the PEO’s pricing structure.

PEOs typically use one of two pricing structures:

• Fixed monthly fee per employee

• Percentage of payroll plus applicable taxes, workers’ compensation, and employer practice liability insurance (EPLI)

Both methods can also come with various administrative fees, setup charges, and other costs if you want extra bells and whistles. Make sure to fully understand your contract and the total cost of working with the PEO before signing.

PEOs vs. internal HR teams

PEOs aren’t meant to replace internal HR teams. Most small to mid-sized businesses hire PEOs to streamline time-consuming tasks and help them stay compliant with each state’s unique labor laws. This frees your HR department to focus on strategic initiatives, like building a strong company culture to find and retain top talent.

Benefits of a PEO for small businesses and startups

According to NAPEO, 98% of PEO clients would recommend a PEO to small business owners. From happier employees, to cost savings, to peace of mind, here are some of the major benefits of PEOs.

PEOs offer better employee benefits and a smoother HR experience

As a small to mid-sized business, it can be hard to compete for the best talent if you can’t offer competitive salaries or benefits—especially since more and more companies are increasing their benefits, according to the Society for Human Resource Management (SHRM).

Because PEOs co-employ so many workers, they’re able to harness the buying power reserved for much larger companies and provide access to more robust benefits for small business employees, allowing them to access a wider range of high quality, affordable options. Most PEOs provide some combination of the following: 

• Healthcare plans

• Life insurance and disability insurance

• Voluntary or supplemental  benefits

• Mental health support

• Retirement plans

• Commuter benefits

• Dependent care (flexible savings accounts)

Often, these PEO-provided benefits end up being more cost-effective for employees than their non-PEO counterparts. By providing access to benefits on par with Fortune 500 companies, a PEO can help keep you competitive in your search for new talent and keep your current employees happy.

Outsourcing HR to a PEO can lead to a better employee experience as well. Since PEOs are experts in all things HR, they’re well-equipped to answer questions and process benefits claims quickly.

Save money

Another benefit of PEOs co-employing so many workers is that they’re often able to negotiate better rates with health insurance companies and other benefits providers. 

NAPEO also states that “administrative costs are around $450 lower per employee for businesses that use a PEO,” likely because PEOs are HR experts able to use their existing infrastructure to perform administrative tasks more efficiently than a small HR team could. 

Maintain payroll tax compliance

Federal and state employment laws are complex and constantly changing, and if you don’t follow them, you may have to pay costly penalties. The IRS estimates that a whopping 40% of small to mid-sized businesses pay payroll-related tax penalties each year—and it’s possible the increase in remote work will cause that number to grow as more employees are hired and/or move out of state.

Staying compliant takes a lot of time. According to a recent survey, HR and payroll departments spend an average of 36 hours per week on compliance-related work, whether that’s tracking regulatory changes or creating and communicating new policies.

A PEO can help with both compliance-related tasks, streamlining business operations, and giving you peace of mind. PEOs typically have compliance experts who monitor employer-related laws and assist with payroll tax and benefits-related compliance. Many assist with tasks like:

• Payroll tax compliance: Issuing and filing tax forms, and reporting/collecting/depositing taxes with the appropriate authorities.

• Benefits compliance: Helping you follow Affordable Care Act (ACA), COBRA, FSA, HSA, and other benefits-related requirements

• Labor compliance services: Assisting with workers’ compensation compliance and Equal Employment Opportunity (EEO) laws by providing you with state-required labor posters and leave policies

• Out-of-state compliance: Registering with the relevant state’s unemployment agencies and assisting with local minimum wage, meal break, and sick leave requirements.

Save time

Let’s face it: you and your HR team have better things to do than file paperwork, negotiate with benefits providers, and sift through ever-changing employer-related laws. While the cost savings are important, another big benefit of using a PEO is freeing up time to focus on growing your company.

With PEOs, you can save time on a lot of HR administrative duties. PEO services often span:

• Payroll: Tracking hours and PTO, paying employees, reporting wages, withholding and paying payroll taxes, and sometimes helping to pay vendors and contractors

• Benefits: Streamlining benefits administration, from negotiating with providers to enrolling employees and processing claims

• General employee management: Administering unemployment and workers’ compensation, and sometimes managing leave of absence requests, creating an employee handbooks, running performance evaluation appraisals, and more

• Risk and safety: Reviewing safety practices, training employees to help limit claims, and providing compliance support during Occupational Safety and Health Administration (OSHA) inspections

How to choose a PEO

No two PEOs are exactly alike. If you’ve decided a PEO is right for you, be sure to compare different options and choose the best one for your business. Here are some ways to determine which is right for you.

Make sure they offer all the services you need

Some PEOs tailor their services to specific company sizes, industries, or geographic locations. Be sure the PEO is experienced with your company profile and can continue supporting you as you scale.

Look at their pricing structure

PEOs charge either a flat fee per employee or a percentage of your payroll. In general, the flat fee structure is more predictable, making it easier for you to budget. However, many flat rates also come with hidden fees, like extra costs associated with State Unemployment Taxes (SUTA). It might help to ask for a sample invoice so you can see whether they’re detailed enough and easy to understand. 

Watch out for any requirements on your end

For example, some PEOs require you to have a minimum number of employees. You may also need to give them advance notice if you want to cancel their services or risk paying a hefty fine.

Make sure they’re easy to use

Many PEOs run on software built in the 1980s. Since you and your employees will probably use the PEO’s software to access paystubs and tax forms, ask for a demo of the product and ensure that it’s easy for both your HR team and all other employees to use. You may also want to see whether they integrate with software you’re already using.