Is a PEO the right HR solution for your business? Learn about the pros and cons of PEOs.
- One of the primary reasons many small businesses choose to work with professional employer organizations is to provide high-quality benefits to their employees at a lower cost.
- PEOs manage many HR-related services, such as payroll processing and payroll taxes, health insurance, workers' compensation insurance, and retirement plans like 401(k)s.
- The alternative to using a PEO is hiring an in-house HR team. Some small businesses choose this so they can hand-select HR specialists who will understand and act in the best interest of their businesses.
A professional employer organization (PEO) isn't right for every business, but this HR solution can elevate your employees' experience with your company. Before deciding to turn over the keys of your HR department to an outside service, it is important to understand the pros and cons of using a PEO compared to offering the same services in-house.
Managing a human resources department, employee onboarding, payroll and benefits can be a lot to handle for many small and midsize businesses, as it requires in-depth knowledge and support that may be difficult to come by. PEOs can relieve some of the stress and take on many HR responsibilities, making it easier to keep your business operating smoothly. However, while there are a lot of benefits to partnering with a PEO company, there can also be some downsides.
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Professional employer organization pros and cons
One of the primary reasons many small businesses choose to use PEOs is to provide high-quality benefits to their employees at a lower cost. However, business owners should consider whether partnering with a PEO will be more beneficial in the long run than keeping their human resources in-house.
While PEOs usually offer comprehensive employee benefits and lower compliance risks, many business owners want to remain in complete control of these benefits and risks. These businesses may choose to keep all their HR services in-house. An in-house HR team can also be a valuable resource for employees who prefer to interact with someone face-to-face when they have HR questions or concerns.
The common goal between PEOs and in-house human resources is to provide the services and benefits employees need, but which option is more suitable for your business? Below, we compare the pros and cons of using a PEO and offering the same services in-house. [For more information on PEO services, read our review of The Best PEO Service Providers of 2019.]
What does a PEO do?
A professional employer organization is an outsourcing company that provides human resources for small and midsize businesses through co-employment agreements. These are some ways a PEO simplifies your business's HR duties:
- It reduces the number of administrative and HR tasks your business has to handle itself.
- It helps you adhere to federal regulations, reducing your compliance risk.
- It offers comprehensive benefits for all employees.
By partnering with a PEO, small business owners gain more control over their companies because they have more time to lead and focus on driving employee performance, according to Brian Michaud, senior vice president of ADP TotalSource.
"A PEO offers built-in protections and helps ensure holistic compliance, from payroll to HR (i.e., discrimination and harassment) to insurance," Michaud told business.com. "PEOs allow owners to focus on knowing and executing on their business, rather than needlessly worrying over potential fines and lawsuits that can come unexpectedly."
What are some PEO benefits?
When choosing a solution to manage your HR processes, it's important to consider the benefits of using a PEO and evaluate whether those benefits are the best fit for your business. Your PEO options will depend on your business's size and goals. PEOs offer many employee HR-related services, such as payroll processing and payroll tax management, health insurance, workers' compensation insurance, and 401(k) and retirement plans.
The annual return on investment associated with cost savings alone is one of the most common factors that small business owners assess when deciding whether to use a PEO, according to the National Association of Professional Employer Organizations.
NAPEO's research found the estimate of the expected ROI for PEO clients, based on cost savings alone, is 27.2% per year. This estimate is based on the cost savings of businesses that entered into co-employment agreements focused on five areas:
- HR personnel costs
- Health benefits
- Workers' compensation
- Unemployment insurance
- Other PEO services, like payroll and retirement plans
An ROI of 27.2% means that for every $1,000 spent on PEO services, the average business owner would save roughly $1,272, resulting in a net benefit of $272 for every $1,000 spent.
Protecting against risk
PEO benefits offer a number of risk protections. For one thing, the IRS charges small businesses billions of dollars every year in payroll fines. A good PEO service can protect your company against this issue. Reputable PEO services are insured for mistakes they might make in your accounting and payroll. If something is off, the PEO eats the cost rather than you. You should confirm that your chosen PEO offers this guarantee before you commit to using the service.
Similarly, PEOs reduce your risk with HR compliance. HR failures can lead to fines and even lawsuits. The average lawsuit for Family Medical Leave Act violations is around $80,000. That's just one common mistake. Even discounting penalties, HR issues can hurt employee retention and drive up turnover costs. When the work is properly outsourced, that insurance provides a layer of protection. Since you are not directly responsible for these problems when they arise, you are not on the line for their costs.
Indirectly, PEOs insulate your company against certain risks by saving you time. The resources you aren't putting into PEO services are free to be reallocated. That can empower you to improve margins and/or cash flow, and both of those outcomes give you additional risk protection. The time your PEO saves is potentially more valuable than the direct spending you can cut for these services. This is why proper outsourcing is one of the best ways for a small or midsize business to improve its ROI in general.
Managing workers' compensation
The benefit of using an employer organization is that it takes care of time-consuming tasks like vetting and purchasing workers' comp policies, according to Bryan Bowles, founder and CEO of Transactly.
"Prior to utilizing a PEO, we had to manually sit through the annual audits, which consumed a significant amount of our accounting staff's time," Bowles said. "In addition to the time savings, we've noticed a significant cost savings as compared to purchasing a policy directly."
PEOs have experience with workers' comp programs, so they have policies in place for situations you may not have yet encountered at your business. One example of this is return-to-work programs that help employees transition from medical leave back to work through modified, low-risk or light-duty jobs.
Improving the employee experience
PEOs add value to your business by providing a great employee experience. Since a PEO handles much of the grunt work of human resources, it allows you to focus on your company's culture and employee management.
Additionally, PEOs may allow you to offer employee benefits that typically wouldn't be affordable for a small business, according to Samantha Reynolds, communications coordinator for Helpside. These include "not only traditional benefits like health, dental and vision insurance, but also conveniences like online access to paycheck stubs, direct deposit and assistance with verifications of employment."
According to NAPEO, employees of businesses that use PEOs are significantly more likely to report higher scores on key measures related to employee satisfaction and confidence in company management:
- Higher levels of employee engagement
- Higher retention rates
- Improved trust in their employers
- More confidence in the business's approach to company growth
Considering all of the ways that your PEO can improve the employee experience, it is clearly an opportunity to empower your recruiting efforts. The employee benefits that your PEO manages for you all make your business more attractive to new recruits. Whether it becomes a focal point of your recruiting efforts is up to you, but every improved benefit is a small upgrade to your investment in employee satisfaction, and potential hires notice these things when they compare companies.
Additionally, your outsourced HR can handle a chunk of the recruiting and hiring workload, making the process substantially more efficient. You're likely to retain good employees by having a better working environment, and you have more resources to go after top talent that can make the whole business run better. It's a major win-win.
Peace of mind
Outsourcing, when done right, comes with a unique opportunity for business operators' peace of mind. The risk management and efficient handling of administrative tasks lets you rest assured that you are compliant with regulations and the busywork of your company is in good hands. You aren't losing out to bloated HR or benefits management, you're investing in employee satisfaction, and you're doing right by your company with the right tools for these integral jobs.
What are some professional employer organization disadvantages?
It's important to conduct extensive research before partnering with a PEO. Business owners need to understand that they will be entering into a co-employment agreement with the PEO, which means relinquishing some control over their businesses. Here are some PEO disadvantages to carefully consider before deciding to use one.
PEOs don't ...
- Only manage the HR of your company, as they have many other clients. There's no exclusivity, so your business may not receive the personal, in-depth attention it needs.
- Take on all the risks and responsibilities when issues arise. Since it's a co-employment agreement, you're in it together.
- Relieve you and your business of standard corporate responsibilities. PEOs are an additional line of management that assists with your HR and administrative tasks. They don't completely replace your responsibilities; they just support you in specific areas.
Another disadvantage of a PEO is that it owns your loss run and payroll data, according to Jon Brodsky, CEO of Finder.
"Because the PEO would own the data, we would have had to start from scratch when we were ready to get insurance and benefits on our own, which would have likely meant higher rates for us," Brodsky said. "So, we decided to take the short-term pain of administering our own healthcare and receiving slightly less-than-favorable rates on our insurance in order to have the best long-term potential cost savings for Finder." [Read related article: How to Manage Risks and Maximize Rewards of Co-Employment]
PEO tax issues
PEOs are responsible for administering payroll and filing payroll tax returns, which can be one of the greatest benefits of partnering with one, according to Tammy Dain, co-founder and CEO of Rabble.
"Since employees are considered co-employees of both the PEO and your business, the IRS still considers you liable if there are any errors in those filings," Dain said. "Thus, it's incredibly important that you have verified the PEO's practices with regards to taxes. It is completely within your right to audit the payroll tax returns that the PEO has filed on behalf of your employees."
The IRS currently offers a voluntary certification program for professional employer organizations, which ensures tax liabilities remain entirely with the PEO rather than your business.
Outsourcing payroll issues
PEO payroll services can free up time for you to focus on your daily business operations and ensure that your payroll is done correctly. However, there can be downsides to outsourcing payroll services if you partner with the wrong provider.
"If you select an inexperienced payroll vendor, you run the risk of them making costly mistakes with payroll," Dain said. "It'd serve your business well to partner with known leaders in the payroll space, like ADP or Paychex. Particularly if you're an emerging startup, look for a vendor that will create a customizable solution."
Dain recommends using a PEO solution that offers customization rather than preconfigured service bundles so you pay only for the services you need and not for features that don't fit your business.
What are some in-house HR benefits?
For some businesses, keeping human resources in-house is the better choice. Managing your own HR department offers you more control over your workplace policies. An in-house HR team is completely dedicated to your business, and you can hand-select HR professionals who understand and act in the best interest of your business. In-house HR can improve the employee experience by providing the following:
- Face-to-face interactions
- Fast execution of technical operations, like policy and compliance changes
- In-person assistance with recruiting, interviewing and training new employees
What are some in-house HR disadvantages?
Human resources departments are costly to run, and the additional salaries of an entire department can be a burden to small businesses. If your business has grown at a manageable rate and needs little HR management, hiring and maintaining an in-house HR team may be unnecessary. Here are three disadvantages of in-house HR:
It's time-consuming. Maintaining HR duties in-house takes up time and manpower that many small businesses simply can't afford.
It may cost more than a PEO over the long term. While standard payroll services or human resources may seem affordable in the beginning, you must account for long-term sustainability. Employing knowledgeable and experienced HR workers to ensure labor law compliance, administer benefits, and draft company policies and procedures can cost business owners more out of pocket than they would like.
- It's not easy to find top talent. Finding quality employees may be difficult, especially for small businesses. Top employees usually seek numerous high-quality benefits, such as medical and dental insurance and a 401(k) plan match, that small businesses can't always offer.
By partnering with a PEO, businesses receive access to a team of experienced HR professionals and a wide range of support that may otherwise be out of reach for small organizations. Alternatively, keeping HR services in-house can raise employee satisfaction by providing face-to-face interactions, which can strengthen the bond between the employee and employer. Consider the size and needs of your business when making the final decision between using a PEO and keeping HR work in-house.