- Professional Employer Organizations (PEOs) can save client companies, especially small businesses, a significant amount on payroll and HR costs
- The full cost of a PEO can be broken down into several components including salaries, taxes, compulsory contributions and PEO fees.
- PEOs charge their fees either as a percentage of total payroll, or on a fixed basis, per employee, per month.
Professional Employer Organization (PEO) solutions are one of the most popular forms of HR solution in both the US and internationally. This is especially true for small-to-medium-sized businesses (SMBs) that stand to make significant cost savings by using a PEO.
In this article, we break down the cost of PEO services and help businesses answer the question ‘Does engaging a PEO make good financial sense?’
How Professional Employer Organization (PEO) solutions work
A Professional Employer Organization (PEO) is a company that takes over a range of employment-related tasks on behalf of client companies. The client company remains the ‘worksite’ employer, with direct supervision responsibility for employees. The PEO takes over a range of payroll and HR tasks including payroll processing, employment tax withholding and compliance. Due to its legal responsibilities, the PEO is often known as the ‘Employer of Record’.
The presence of two employers means that this situation is often known as a ‘co-employment’ arrangement.
How PEOs save companies money
Before a considered decision can be made as to whether PEO presents good value for money, it is necessary to consider all the ways in which a PEO saves companies money.
1. Increased HR and payroll efficiency
PEOs specialize in HR, payroll and compliance, which gives them a comparative advantage in those areas compared to regular companies and small businesses carrying out the tasks in-house. As PEOs process payroll and carry out HR tasks all day every day, they are experts, and will inevitably carry out those tasks more efficiently than most firms who do so in-house.
Furthermore, their sheer size and breadth of clientele will mean that they have dealt with most payroll and HR problems before and know how to improve outcomes and control costs. Another factor is that stiff competition in the PEO market (an estimated 4,000 providers in the US alone), further fuels efficient practices.
This cost-saving is reflected in statistics maintained by the National Association of Professional Employer Organizations (NAPEO). In a 2016 report, NAPEO reported an average HR administration cost of $1,744 per employee for ordinary companies, compared to $1,295.73 for employees co-employed by a PEO.
2. Better value health insurance
Health insurance premiums are calculated by the number of employees versus those who file a claim. As PEOs are usually a co-employer for a pool of thousands of employees from numerous small businesses, the impact of any one claim on the business is reduced. To see how significant this impact can be, consider one case reported in Forbes, a business with 100 employees paid health insurance premiums of $45,000 per month without a PEO, versus $32,000 with a PEO.
As well as being “better bang for your buck”, their size compared to the smaller businesses they generally serve, means that PEOs are often able to negotiate and offer more comprehensive benefits packages than client businesses could directly.
3. Potential for lower unemployment taxes
The Federal Unemployment Tax Act (FUTA) and the State Unemployment Tax Act (SUTA) require that businesses pay into unemployment insurance programs at both the federal and state level. This is the ‘employer contribution’, which alongside an employee contribution makes up part of the payroll taxes that apply to employment.
As with health insurance premiums, the amounts that are paid depend partially on the number of former employees who have filed unemployment claims. The more claims, the higher the rate will be. As with health insurance premiums, the larger pool of employees in a PEO means that the impact of any one claim is diminished.
4. Reduced workers’ compensation premiums
Workers’ compensation premiums are determined partially through an ‘experience modifier’ which is higher if a company has had multiple workers’ compensation claims. Due to their size, where a PEO takes care of workers’ compensation, they will often have an experience modifier that is more beneficial to its co-employees.
In addition, PEOs may offer safety training which helps reduce the risk of injury and subsequent claims. There are even PEOs that provide “return to work” programs, compliant with Occupational Safety & Health and designed to get employees back to full health (and therefore off workers’ compensation), as quickly as possible.
5. Lower compliance costs
In any of its service offerings, PEOs save companies in compliance costs, by ensuring that employment taxes, compulsory contributions and benefits are filed and reported in line with the law, according to mandatory time frames. This reduces the risk and associated costs of any late fees or penalties. It also saves client companies time in needing to be on top of all applicable rules and regulations.
Some PEOs even do claim management with respect to workers’ compensation and other potential claims, helping clients manage the ongoing cost of coverage.
6. Human capital-enhancing services
PEOs don’t just provide transactional HR and payroll services, they may also provide strategic and consulting services which can enhance firm profitability. This might include organizational development, performance management advisory, employee relations and training services. These help support the strategic goals of the firm and can increase profitability for the company.
What are the components of PEO cost?
PEOs differ in the exact services that they provide. For example, some PEOs provide recruitment, visa management, and HR consulting services, but others do not. Typically, when a PEO bills for its services, the invoice will cover the following components:
- Employee wages or salaries, which the PEO pays on behalf of client companies
- Withheld state and federal taxes, in relation to employee income
- Payroll taxes, including contributions in relation to Medicare, FUTA, SUTA, and the Federal Insurance Contributions Act (FICA)
- Workers’ compensation insurance — the PEO may provide workers’ compensation insurance coverage. This coverage is typically required by law and provides protection for employees who are injured at work
- Employee benefits — the PEO often offers a range of employee benefits, such as health insurance, dental insurance, and retirement plans, to the employees of client companies.
- Other compulsory deductions including child support and wage garnishments
- Any non-compulsory deductions including expense reimbursement
- Administrative or PEO fees — these are the fees that the PEO charges for its services. We discuss the different models or PEO fees in further detail below.
Key factors that influence the cost of a PEO
Some of the different features of a PEO service that may affect the cost of services include:
- Number of employees. Many PEOs offer volume discounts for larger numbers of employees. Not only does this reduce PEO fees, it usually reduces the overall amount a PEO needs to be paid due to reduced workers’ compensation and health insurance premiums
- Industry. Generally speaking, PEO fees will be higher for companies that co-employ individuals in highly regulated and higher-risk industries such as manufacturing and trades, to reflect the increased compliance costs. By contrast, PEO services may be cheaper where the service is designed for remote employees only
- Locations covered — some PEOs have broader coverage (across the US and even internationally), while some only cover employees in selected states
- Certification or accreditation. Engaging a certified PEO will generally cost more to reflect their scrupulous standards and their added tax responsibilities. Similarly, accredited PEOs can usually charge a higher rate than non-accredited PEOs
- Services included in the PEO package — PEO does not just mean one type of service. While all PEOs provide a core co-employment solution, they commonly provide other services including payroll, visa support, recruitment, HR strategy and claim assessment. Usually, their pricing is tiered based on the number of services chosen.
How much does a PEO cost? — the general range
There are two models that are common for setting the price of PEO admin/fees:
- Percentage of overall payroll — this is a percentage of the gross payroll for the company (sometimes called ‘payroll burden’, ‘labor burden’ or ‘total cost of employment’). This covers wages/salary plus all deductions (mandatory and voluntary). This is usually 3-15 percent
- Per employee fee. This flat fee can range from $49 to $1000 per employee per month, depending on the services offered.
Note also that PEO companies often charge set-up fees and termination fees in addition to the fees mentioned.
Some PEO companies offer distinct ‘tiers’ of PEO packages that companies can choose from. Others have an ‘a la carte’ approach, and let companies add services individually according to their needs.
PEO cost — making your decision
It is clear that engaging a PEO has the potential to mean significant savings for client companies, through reduced HR, payroll and compliance costs. The extent of the potential savings depends on the needs of the client and which tier of service they seek from the PEO
To directly compare PEOs on the price of their services, check out our Top 10 PEO Guide for 2023.
No. While PEOs often mean substantial savings for smaller businesses, for many larger businesses with existing HR and payroll functions, the savings may be minimal. For these businesses, it may make sense to engage a payroll company, rather than a PEO company (check out the top 10 payroll companies here).
For businesses that do not need the full co-employment/PEO solution, other options may be more cost-effective. This includes:
- Administrative services only — where a company only administers benefit plans
- Payroll outsourcing — where a payroll company processes payroll, but does not become the Employer of Record of a workforce
- HRIS software — where the client company uses a SaaS solution to help manage its own payroll and HR
- Human Resources Outsourcing (HRO) — where some smaller subset of HR tasks is outsourced to a third party company.