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What is a PEO? A Guide to Professional Employer Organizations

What is a PEO? Use this guide to learn more about the benefits of using a PEO in the year ahead.
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As a business owner, you may think that comprehensive HR solutions and offering an impressive benefits package to help you retain top talent seem beyond your grasp, particularly when other areas of the business require your time and attention. That's why understanding what a professional employer organization (PEO) is and understanding the potential benefits of using one to outsource your HR functions may open a wider range of benefits to your team. This could involve improving your recruiting and employee retention, as well as freeing up time for your management team to focus on running your business.

There's also potential cost savings to consider. NAPEO suggests that companies using a PEO grow faster than their peers, are more likely to stay in business, and have less employee attrition. Additional NAPEO research reported that the annual return on investment for cost savings alone is 27.2%. This means that for every $1,000 spent on PEO services, a client can save an average of $1,272, yielding a cost savings of $272 for every $1,000 spent.

To take advantage of these and other potential benefits of using a PEO, review the following considerations.

What is a PEO and how does it work?

A PEO, or a professional employer organization, allows companies to outsource key human resource functions like payroll, benefits, training, and guidance to assist small and mid-sized companies with maintaining compliance with federal and state labor and employment laws.   Working with a PEO can help business owners and their management teams focus on the business.

In a PEO relationship, the client company and the PEO enter into a contract known as a client service agreement (CSA). The CSA stipulates that:

  • The PEO acts as the administrative employer for certain administrative services and the client acts as the worksite employer.
  • The client company maintains the responsibility for hiring and managing the employees and for handling all other non-employee related aspects of the business operations (such as sales, marketing, and customer service).
  • The PEO is now responsible for processing employee wages, benefits, and withholdings and for remitting and reporting taxes to any applicable state and federal authorities for the duration of the CSA.
  • Certain responsibilities, such as development of an employee handbook may be shared between the client company and the PEO as outlined in the CSA.

Is a PEO an employee leasing provider?

Professional employer organization may often be mistaken for an employee leasing provider. To understand the difference between employee leasing vs PEO, it helps to have a clear definition of what each employment arrangement entails. In a PEO arrangement the PEO and the client company share certain administrative responsibilities for employees. The PEO is generally responsible for processing employee pay and payroll taxes and benefits administration.  The PEO provides support to clients to assist in their compliance with applicable state and federal labor laws, privacy regulations, and HR policies that cover the employees, but is not responsible for providing employees directly to a client company. The client company is still responsible for managing their employees and retains control over when to hire, fire, or promote their employees.

In an employee leasing arrangement, employees are temporarily leased to a client company by a third party, such as a staffing agency. The staffing agency manages these employees completely, including remitting payroll, hiring, firing, and delegating work assignments. The staffing agency and the client company have a staffing agreement that stipulates how many employees will be provided, how long they will be provided, what type of work will be done by the employees, and how much the client company will need to pay for the leased services.

Benefits of a PEO

While it may be difficult to trust valuable aspects of your business operations to an external organization, business owners across the country are realizing the benefits that can be gained from working with a PEO. For time- and energy-strapped employers, working with a PEO can free up a considerable amount of company resources that would otherwise be spent on payroll and other required, but time-consuming tasks.

Paychex HR consultant Jillienne Allgäuer, SPHR, SHRM-SCP, outlines some of the most important benefits for business owners to consider: "A PEO offers support with administrative services that span the entire employment life cycle. From assistance with recruiting and hiring, employee handbook development, cultivating an attractive benefits package, and ongoing management training, to consulting on employee coaching and dismissal processes and handling unemployment claims, a PEO can provide businesses both substantial administrative relief and valuable resources."

Businesses that work with a PEO can expect many valuable benefits, including:

  • Time savings: Clients find that having the PEO absorb the time commitment associated with general HR tasks allows them to focus on other core business operations.
  • Cost savings: The buying power that a PEO can offer regarding workers' compensation and health insurance are generally beyond what's available to small businesses.
  • Peace of mind: Business owners feel at ease knowing they are not alone at any point throughout the employment life cycle.
  • Better benefit offerings for employees: Companies looking to offer competitive benefits packages gain access to Fortune 500-level benefits and professional administrative services.
  • Improved tracking and administrative functions: The PEO will generally conduct an in-depth HR assessment designed to minimize risk and maximize growth and development opportunities.

Do PEOs provide employee benefits?

As mentioned above, a company's employees can gain access to benefits normally available only to large companies when they leverage a PEO. This can include health insurance, disability insurance, employee assistance and discount programs, 401(k) plans, and others. Beyond these, the PEO also provides online access to employees' payroll reports, pay stubs, and W-2 forms without requiring the client company to purchase and set up the infrastructure to provide these services to their employees.

Companies that work with a PEO usually experience lower group insurance costs, since PEOs can negotiate excellent rates with insurance companies with their larger employee count. In most cases, PEOs can also negotiate a lower state unemployment insurance (SUI) rate because their employees are listed under the PEO's federal ID number for payroll purposes.

How much does a PEO cost?

The PEO cost is determined by several factors, including the size of the business, which services will be outsourced, and the number and type of employees on the payroll. PEOs typically charge either a flat fee per employee or a percentage of the total payroll.

If the PEO charges a flat fee per employee, businesses can expect to pay between $40-$160 per month (per employee). Flat-fee charges are more predictable and can help companies budget their HR costs better. Depending on the number and type of employees, the invoice savings with a flat rate can be particularly advantageous for businesses.

If the PEO charges a percentage of total payroll, businesses can expect to pay between 3-12% of the total monthly payroll for all employees. This will result in a fluctuating fee each month, especially if the business has many part-time hourly workers.

To evaluate the expected PEO cost, calculate the yearly expenses using both pricing models. Many PEOs are willing to be flexible on their pricing arrangement when starting a new contract, so it can be helpful to know which option makes the most financial sense for your business.

Selecting a PEO

Although PEOs offer multiple cost, time, and administrative savings, working with a PEO may not be right for every business. Even after determining that a PEO can benefit your company, it's important to select the PEO that offers the right combination of add-on services, range of benefits, and flexibility in service agreements. Since a PEO will have a significant impact on the experience of your employees, consider these best practices to help choose the right PEO that can deliver on your most important needs.

Examine accreditation, auditing, and performance

PEOs are a highly regulated industry, and they will be handling sensitive employee data, complex documentation and tax forms, and a large amount of cash flow. Your first line of due diligence when choosing a PEO is to ensure they are as well-run as possible. You might consider the following:

  • Are they a member of the National Association of Professional Employer Organizations (NAPEO)?
  • Are the PEO's financial statements and operations verified by an outside source? Wherever possible, ensure the PEO's financials are reviewed and approved by an objective auditor.

Compliance expertise

Failing to comply with all applicable state and federal tax and employment laws can have time-consuming and costly consequences for your business. That's why working with a PEO provider that has compliance expertise is integral. A PEO should have the knowledge to help you with your compliance concerns and the ability to support you as you develop systems and processes that make compliance easier, from monitoring changes to meeting critical compliance deadlines.

Range of benefits

Another important area to consider is what benefits the PEO offers. A major reason companies choose to work with PEOs is to obtain access to a larger pool of benefits options. Take the time to learn what programs the PEO offers, how those programs compare with your current offerings, and what the costs will be. Consider any value-add services offered by the PEO, such as pet insurance or employee assistance programs, that can help you recruit or retain high quality employees.

Client and professional references

Ideally, you want to work with a PEO provider that has an established track record working with businesses like yours. Factors to consider could include your industry, company size, or specific goals and business challenges. Look for case studies that can demonstrate how they'll solve your challenges – then speak to customers, references, and business partners to get an outside perspective on their performance. By getting another opinion, you'll be able to better verify the information you've gathered on your own and have a better understanding of what to expect before entering into a PEO services agreement.

Service-level agreements and how they can help your team

A service-level agreement (SLA) is the operating document that drives the relationship between a business and PEO, so it's critical to understand its contents. In addition to the services provided, an SLA also provides insight into how much assistance, consulting, and guidance the PEO will provide your team. It will define the responsibilities of each of the parties and outline which responsibilities your PEO will take over for you. Look for PEOs that provide a clear, straightforward SLA, and don't be afraid to ask questions when something is confusing. If a PEO is willing to help you understand all the terms of the SLA on the front end, it's a good indication of a good working relationship to come.

Choosing the right PEO can take your human resources, payroll, and capital management efforts to the next level--resulting in happier employees, better benefits, and significant cost savings for your business.

Investing time now to learn more about some of today’s leading PEOs can help you identify your requirements in a PEO. This investment can reap significant rewards for your small business moving forward and free you up to focus on continued growth in the future.



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* This content is for educational purposes only, is not intended to provide specific legal advice, and should not be used as a substitute for the legal advice of a qualified attorney or other professional. The information may not reflect the most current legal developments, may be changed without notice and is not guaranteed to be complete, correct, or up-to-date.

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