PEO versus payroll service: How to pick the best option for your business

For business owners, payroll is one of many responsibilities to be dealt with, and it’s also one of the most time-consuming. Calculating gross and net pay, ensuring proper withholding for state and federal taxes and ensuring employees are paid on time, not to mention managing benefits, can be arduous. The more employees you have, the longer it takes and the higher the risk of a potentially costly mistake.

Many entrepreneurs and small business owners decide to outsource payroll, not only to free up valuable time to focus on revenue-generating tasks, but also to be sure that it is handled accurately and on time. When it comes to selecting a payroll service for your business, there are two main choices: payroll service providers, also known as PSPs, and professional employer organizations, commonly referred to as PEOs. 

Choosing between a PSP and a PEO depends on a few key variables, such as the cost, the size of your business, whether a client seeks to keep their employer of record status and the amount of flexibility needed. While both options manage certain employee responsibilities, where they differ is in the degree of responsibility being outsourced.

How a PSP can help your business

Many PSPs require no contract. Service usually runs from each pay period to the next, and there is no cancellation penalty.

Another important differentiator of a PSP is that the client or hiring business keeps its status as the employer of record. This means the level of state unemployment tax rate paid is based on that of the client, not the payroll service. And because the client remains the employer of record, with good practices, your state unemployment tax rate could drop over time.

A PSP primarily offers just payroll processing services. Some, but not all, will also manage workers’ compensation, which provides another type of valuable flexibility for employers. 

Workers’ comp plans are typically funded either on a pay-as-you basis based on actual payroll or with a down payment and monthly payments by the hiring business.

What a PEO can do for your business

PEOs offer much more comprehensive HR-related services than a PSP. The service is intended to take the heavy lifting out of many duties in addition to payroll, such as managing employee benefits, tax compliance and workers’ compensation.

Additionally, unlike a PSP, the PEO itself becomes the employer of record. This means employers will pay at the PEO’s rate for state unemployment tax. It also means the client uses whatever plans the PEO uses for benefits and insurance once the contract is signed. Further, the client’s name and employee data become facets of the PEO once it becomes the company of record.

Unlike a PSP, a contract with a corresponding cancellation policy is required to engage the service of a PEO. 

Most PEOs have a large volume of customers per representative. But they are usually a good option for new or smaller firms as they make sure that all aspects of HR are covered. They also tend to be able to offer more affordable 401(k) and health insurance plans than would otherwise be available to a small employer.

Estimated costs for a PSP versus PEO

Payroll service provider: Annual per-employee fees start at about $150 to $200. 

Professional employment organization: Fees are usually based on the hiring firm’s number of employees. They range from about 2% to 12% of wages.

Recap: Choosing between a PSP and a PEO

Whether to opt for a PSP or PEO depends on your budget, the size of your staff and the complexity of the HR-related issues you seek to have handled. 

PSPs tend to be the most popular choice among smaller and new businesses because they liberate employers from the time-consuming responsibility of running payroll while also eliminating paperwork and minimizing the risk of fraud.

In general, a professional employment organization or PEO is generally recommended for companies with less than 100 employees. This is because a larger staff makes bringing HR functions in-house a less economically viable option.