What Is a PEO?

A full-time human resources team to handle payroll processing, benefits management and a host of other tasks is an investment many small businesses can't afford. That's where professional employer organizations (PEOs) step in. PEOs operate in every state, providing numerous services and employee benefits to small and midsize businesses. These services can help increase a business's growth, financial success and employee satisfaction.

What is a PEO?

A professional employer organization is a third-party human resources provider that assumes co-liability for its client's workforce. Whether managing unemployment and payroll taxes or providing workers' compensation insurance, PEOs offer numerous employee benefits that can provide more HR stability for your small business.

PEOs are great options for small businesses with understaffed HR teams because they take all the necessary HR responsibilities off their plates. Businesses that work with a PEO enter a co-employment arrangement. This means that while businesses are still responsible for running their own operations, their employees are technically also working for the PEO and are reported under the PEO's employer identification number (EIN).

Editor's note: Looking to partner with a PEO? Fill out the below questionnaire to have our vendor partners contact you with free information.

What does a PEO do?

PEOs can offer several HR services, depending on what you need. Some PEOs offer preset service packages, and others let you create a custom plan with the specific functions you need. Here are some of the things a PEO can do for you:

HR services

PEOs allow small and midsize businesses to outsource their HR and administrative needs. These typically include standard HR services like creating employee handbooks and policies, onboarding new hires, and terminating employees. These services can be tedious and time-consuming, so it can be advantageous to have a PEO take care of them for you.

Payroll and benefits administration

It's best to think of PEOs as independent companies that manage daily HR functions like payroll. They can process employee payroll and take care of payroll taxes. They also offer employee benefits, such as 401(k) plans, health insurance and workers' compensation. Some PEOs administer benefits directly to your employees, and others work with a benefits broker to administer your benefits.

FYI: PEOs can leverage group health insurance to offer your employees competitively priced insurance options.

Legal compliance

The partnership between a business and a PEO is known as co-employment, which means that the PEO becomes a co-employer of your business. While you continue to manage your employees' work and daily responsibilities, the PEO manages compliance, legal and HR-related policies. This co-employment arrangement relieves small business owners of some liabilities and allows them to focus their time on growing the company and generating revenue.

Many small business owners may cringe at the idea of a co-employment agreement, but it's not as daunting as it may sound. Your business remains the primary employer, while the PEO handles specific HR tasks outlined in the service agreement. This allows the PEO to manage employee benefits, payroll, and tax and government-related filings. They can also help ensure employment law compliance.

Training and development

Another feature that some PEOs offer is employee training and development. At the very least, most PEOs offer courses to help you with legal compliance like sexual harassment prevention training. Many PEOs also offer in-person and online development courses to help your employees improve upon or develop new skills.

What doesn't a PEO do?

While a PEO can provide a variety of HR functions, it is not responsible for your actual business operations. You will maintain ownership and responsibility for ensuring your business continues to operate.

A PEO also does not provide your business with labor like a staffing agency would. Some PEOs offer assistance with employee onboarding, but they do not staff your company.

Top PEO service providers

To help you find the best fit for your business, we researched and analyzed the best PEO service providers on the market. Here are our best picks:

How much does a PEO cost?

While the cost of a PEO varies, most have one of two cost structures: 

1. Per employee: Some PEOs that bill per employee (roughly $40 to $160 per employee per month) also charge a base fee. They are usually monthly costs that you negotiate directly with the PEO.
2. A percentage of payroll: With this cost structure, you pay a percentage of your total payroll (roughly 3% to 12%) for each pay period. This percentage includes workers' compensation, employer practice liability insurance, and local, state and federal taxes.

The cost of a PEO is not fixed because it depends on the company and its services, according to Matt Diggity, CEO of Diggity Marketing.

"Generally, there are two methods of charging – per employee or payroll percentage," he said. "Charges per employee mostly range between $1,000 and $1,500 per year. This approach has a benefit that while devising a business's yearly financial plan, you have an accurate expense of [your] PEO."

Payroll percentage, on the other hand, continuously changes according to your payroll amount that month. It's important to remember that PEO costs vary based on service offerings, the number of employees you have and the negotiated rate. These costs are usually less than those of hiring your own team to manage your human resources.

PEOs can also charge for their services in other ways, such as by retaining the Section 125 benefit as a co-employer or with SUTA taxes, according to Michael Roloson, director of business development at PEO Focus.

"If you take into account all fees across the board, you can get a better picture of the total costs," Roloson said. "It's important not to evaluate purely on costs. Entering into a PEO relationship is about adding value and efficiency to your organization."

Roloson believes that by first identifying the PEOs that can bring the most value to your business, you will be in a better position to negotiate contract terms.

What are the pros and cons of using a PEO?

While there are a lot of benefits to outsourcing human resources activities, you surrender some control. Here are the primary pros and cons of using a PEO.

Depending on the size of your business and the services your prospective PEO offers, opting for a PEO over in-house HR might be a beneficial move for your small or midsize company. Generally, the relationship between a business and a PEO is established as a co-employment agreement. The PEO usually handles tax withholdings, employee wages, HR services and benefits administration, so you can focus on managing your employees and running your business. 

Did you know? According to the National Association of Professional Employer Organizations, small businesses that use a PEO have 40% higher revenue growth and are 16% more likely to report an increase in profitability.

What is the difference between a PEO and a staffing company?

A staffing company provides temporary employees, while a PEO is a full-time co-employer. The staffing company usually handles business operations, including day-to-day management, production, marketing and sales. PEOs typically manage employment operations, including tax affairs, HR services and benefits administration.

Roloson said that a PEO does not provide any workers, but rather partners with its clients as they enter into a co-employment partnership where both parties employ the workers together.

"Through the co-employment model, the company can then leverage the PEO for their HR expertise, payroll, administrative technology and employee benefit programs," he said. "The company can still dictate the culture that it chooses to instill as a small or medium-sized business while also gaining access to the expertise and economies of scale that a larger partner can bring to the table." [Read related article: What Services Can a PEO Provide to Your Small Business?]

What is it like for an employer switching to a PEO?

Depending on the size of your business and what the PEO offers, switching to a PEO can be a good thing. Most PEOs provide an implementation representative to assist with the onboarding process, according to Shraga Jacobowitz, managing partner of ARC PEO Consultants.

Jacobowitz said there are a few stages to this onboarding process:

1. Company decisions (health insurance plans, funding strategies and other HR policies)
2. Employee data input and online portal building
3. Orientation meetings with employees
4. Employee enrollment in HR platforms
5. Training on how to use the online portal (e.g., payroll processing, reports and transactional items)

A PEO can free up time and resources for employers, allowing them to focus on growing their businesses. This is one of the key benefits of a PEO in a business's early stages of growth. A PEO also plays a decisive role in managing a company's employee affairs.

PEOs can offer unique pricing on certain healthcare benefits, sometimes lower than what your business would pay outside of the PEO, according to Nicholas Tzoumas, president of ClearscopeHR.

"At the same time, in addition to the costs associated with these premiums, workers' compensation premiums and payroll processing, there are also administrative costs assessed by the PEO," Tzoumas said. "When comparing PEO versus non-PEO options, employers (or their benefits consultant) need to compare the costs inclusive of the PEO admin fees."

How to choose a PEO provider

A PEO provider plays an integral role in your company, so it is important to choose one that best matches the needs of your business. There are five steps you can follow to choose the right PEO service provider.

1. Identify your HR needs. Make a list of all the HR functions you will need to outsource to a PEO provider.
2. Research your options. Look at the various PEO service providers on the market and analyze their features, services and tools.
3. Consider your industry. Some industries have strict legal requirements when it comes to managing HR. If this sounds like you, consider looking for a PEO that caters to your specific industry.
4. Narrow down your top PEOs. Make a shortlist of the top providers you are interested in. Reach out to each company and inquire about what they have to offer. Be sure to ask about things like features, pricing, contracts and customer support.
5. Choose your PEO provider. After comparing your top options, choose the PEO provider that best matches your business's needs. 

Joshua Stowers contributed to the writing and reporting in this article. Some source interviews were conducted for a previous version of this article.