Leaving Your PEO? How to Make a Smooth Transition
Eddy Team — August 1, 2024
Many startups and small companies choose to outsource their HR services using a PEO (Professional Employer Organization). While PEOs can be a great fit for a startup business, growing businesses will eventually outgrow the value of the PEO and the business may consider transitioning to an in-house HR team. That transition point can be different for each company. In this article we’ll review when PEOs make sense, when it is time to leave a PEO, and how that process can work.
When PEOs make sense
A great PEO service can provide many HR-related services, such as payroll, payroll tax management, health insurance, workers’ compensation insurance, and retirement savings plans. Here is a summary of the top advantages of partnering with a PEO.
1. A PEO can save you money.
PEOs make sense for some organizations and can be very cost effective. According to the National Association of Professional Employers Organization (NAPEO), the cost savings based on the expected return on investment (ROI) is about 27% for a PEO client.
2. A PEO can protect you from legal risks.
PEOs offer protection from some (but not all) business risks. A good PEO can protect your company from making tax errors and are insured for any mistakes they make in accounting and payroll. In addition, a good PEO can help with HR compliance and help you avoid lawsuits.
That said, while PEOs are responsible for administering payroll and filing payroll tax returns, if anything is mishandled, the consequences may be yours to face. Because your 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.
Why companies leave PEOs
It makes sense that as any company develops and grows, its HR needs will also evolve. If you are wondering if you have reached a point where it is time to transition to in-house HR, the following considerations can help you clarify your thinking. Here are the top 5 signs it is time to leave your PEO:
1. Employee count has reached 50 - 100: When the cost of using a PEO becomes disproportionately high compared to managing HR functions internally, it is time to move on. As a company grows, the percentage-based fees of a PEO can add up, making it more cost-effective to hire in-house HR staff and invest in HR technology.
Fees charged by PEOs are often based on a percentage of total payroll, which means that as a company's payroll increases, the absolute cost of PEO services can become substantial. Larger businesses typically have the resources and economies of scale to hire in-house HR staff and implement their own HR systems, which can be more cost-efficient in the long run. Additionally, with greater employee numbers, the fixed costs associated with maintaining an in-house HR department become more justifiable and spread out, reducing the per-employee cost of HR services.
When it comes to employee benefits, the PEO advantage for startups diminishes when a business grows to about 50-100 employees and becomes large enough to negotiate competitive benefit rates on its own. At this point insurers and benefit providers are willing to offer similar rates to those provided to PEOs. Some businesses with fewer than 50 employees might still negotiate competitive rates if they have low-risk employee demographics or if they join industry associations or purchasing coalitions that provide group benefits.
2. Need for Customization and Control: Another sign to leave your PEO is when your company requires more customized HR solutions and greater control over HR policies and procedures.
PEOs often apply a one-size-fits-all approach for clients because most smaller businesses have the same needs for simple payroll, benefits, and workers compensation.
As companies grow and scale, they evolve and require more customized and flexible HR solutions that can be tailored to their specific organizational culture and operational needs, which can be more effectively managed by an in-house HR team.
3. Sufficient Internal Expertise: When your company reaches the size where it has the resources and expertise to handle HR functions internally, it is time to exit your PEO.
Typically businesses make their first HR hire when they reach about 50 - 100 employees. One reason for this is that some legal compliance regulations take effect once you reach the 50-employee mark. The Family Medical Leave Act (FMLA), for example, applies to any private-sector employer with 50 or more employees. The Affordable Care Act (ACA) is another federal law that sets in at the 50-person mark. Many states will also have more localized laws that set in at this stage, too.
An in-house HR team makes sense when your company plans to implement strategic HR initiatives that require dedicated focus and specialized knowledge. These initiatives can include leadership development programs, advanced talent management strategies, and comprehensive employee engagement plans.
In addition, larger organizations will provide a better employee experience with an in-house team who can create a more direct and tailored approach that is more attuned to the employee’s specific needs and concerns.
4. Advanced HR Technology and Systems: If your company is ready to invest in and implement advanced HR technology and systems then you might be ready to transition. Larger companies can justify the expense of comprehensive HR software that can handle payroll, benefits administration, performance management, and other HR functions more efficiently than a PEO.
5. Compliance and Risk Management Capabilities: If your company is capable of managing compliance and risk internally then you are ready to move forward. As your business grows, you usually develop robust internal processes for compliance with employment laws and risk management, reducing the need for the PEO's services in these areas.
How to leave your PEO
1. Conduct a Comprehensive HR Audit:
As you plan your PEO exit, review all your current HR processes, policies, and compliance requirements managed by the PEO. This is key to help you identify the full scope of services provided by the PEO, including payroll processing, benefits administration, compliance support, risk management, and employee relations. Understand how these services are integrated into your company’s operations and pinpoint any gaps or areas needing enhancement.
2. Develop an In-House HR Strategy:
The next step is to create a detailed plan for transitioning HR functions from the PEO to in-house management. This is a challenging step for many organizations making the transition.
Where to begin:
- Outline the structure of your new HR department, including key roles such as HR manager, payroll specialist, benefits administrator, and compliance officer.
- Determine which of these roles can be done in-house or with a partner.
- Define clear responsibilities and workflows for each function, ensuring all aspects of HR are covered.
- Develop a timeline for the transition and identify milestones to track progress.
3. Invest in HR Technology and Systems:
HR + Payroll technology can save you a lot of time and money. This transition point is a key time to select and implement HR software that can handle hiring, onboarding, employee info, payroll, benefits administration, compliance tracking, and other essential HR tasks.
Where to begin:
- Evaluate various HR technology solutions to find those that best meet your company's needs.
- Consider systems that offer scalability, ease of use, integration with existing software, and strong support services.
- Plan for training your HR team on the new systems to ensure a smooth implementation.
How to Build the Ideal HR Tech Stack
Looking for more guidance? Check out our guide: How to Build the Ideal HR Tech stack: a complete guide for your business
How to Build the Ideal HR Tech Stack
Looking for more guidance? Check out our guide: How to Build the Ideal HR Tech stack: a complete guide for your business
4. Hire and Train an In-House HR Team:
As you leave a PEO you will likely need to recruit experienced HR professionals to build your in-house HR team.
Where to begin:
- Focus on hiring individuals with expertise in areas previously managed by the PEO.
- Provide comprehensive training on your company’s policies, culture, and the new HR systems.
- Encourage ongoing professional development to keep your HR team updated on the latest industry trends and compliance requirements.
5. Communicate and Transition Gradually:
Plan to keep employees informed throughout the transition process. Employees appreciate stability and a significant transition such as existing a PEO can be disruptive.
Where to begin:
- Clearly explain the reasons for the transition and how it will benefit the company and its employees.
- Provide regular updates on the progress and any changes employees can expect.
- Ensure a gradual transition by overlapping some services between the PEO and the in-house team to minimize disruptions.
- Set up support channels for employees to address any concerns or questions during the transition.
Key PEO Exit Checklist
When the time comes to leave a PEO, there are several specific actions you’ll need to take to ensure a smooth transition, particularly concerning benefits, worker's comp insurance, unemployment insurance, payroll, retirement plans, taxes, the employee handbook, and COBRA. By meticulously handling each of these areas, a company can ensure a smooth and successful transition from a PEO to an in-house HR organization.
1. Find New Benefits Providers
An important first step is to identify and secure new benefits providers.
- Research and negotiate with health, dental, vision, and other benefits providers to secure competitive rates.
- Ensure there is no lapse in coverage for employees by timing the transition carefully.
- Communicate new benefits options and enrollment procedures to employees.
- Work with your broker to conduct an open enrollment period for employees to choose new benefits plans.
- Find a broker who can be a partner with you and who can work with your HR + Payroll technology stack.
2. Set Up a Worker’s Compensation Insurance Policy
When you exit your PEO you’ll need a new worker's compensation insurance policy.
- Shop for worker’s comp insurance that meets state requirements.
- Notify the new insurer of the transition from the PEO and ensure coverage starts immediately after the PEO coverage ends.
- Update all relevant posters and documentation to reflect the new policy.
- Implement or update workplace safety programs to comply with the new workers' compensation policy.
3. Register for Unemployment Insurance
As you exit the PEO, you will become responsible for your unemployment insurance. You will need to register for state unemployment insurance in each state you operate in.
- Ensure your company is registered with the state unemployment insurance program.
- Verify the PEO has transferred all necessary records and that there are no outstanding claims.
- Update your payroll system to handle unemployment insurance contributions.
4. Set Up a Payroll System
For payroll you’ll need to build an in-house payroll system or select a new payroll service provider. A reliable payroll system will handle all aspects of payroll processing, including tax withholdings, direct deposits, and reporting.
- Ensure all employee payroll records are accurately transferred from the PEO.
- Train your HR and payroll staff on the new system.
- Ensure all relevant tax IDs (EIN, state tax IDs) are correctly used in the new payroll system.
- Coordinate with the PEO to ensure all tax filings are up-to-date and no filings are missed during the transition.
5. Transition Retirement Plans
If your previous PEO managed your 401(k) or other retirement plans, you’ll need to establish a new plan or take over the existing one.
- Work with a financial advisor or retirement plan administrator to ensure a seamless transition.
- Communicate the new plan details to employees and assist with rollovers or new enrollments.
6. Handle Taxes
Your PEO previously will have managed your tax withholdings and filings under their own tax ID. As you transition, you’ll need to register your own Tax ID.
- Ensure your payroll system is set up to handle all federal, state, and local tax withholdings.
- Confirm that the PEO has provided all necessary tax records and that there are no pending filings.
- Stay compliant with all tax reporting deadlines.
7. Update Your Employee Handbook
With the change from your PEO it will be time to update your employee handbook and share the updated version with employees.It may take some time and effort to review and update your employee handbook to reflect the change from the PEO to in-house management.
- Ensure all policies are up-to-date and compliant with current laws.
- Distribute the updated handbook to all employees and obtain acknowledgments of receipt.
8. Set Up COBRA Administration
If the PEO previously managed COBRA benefits, you’ll need to set up your own COBRA administration process or hire a third-party administrator.
- Ensure all former employees currently on COBRA are notified of the transition and that there is no lapse in their coverage.
9. Transfer Employee Data and Record Keeping
- Ensure all employee records, including payroll, benefits, and performance data, are securely transferred from the PEO to your systems.
- Verify that all historical records and documents are accurately transferred and stored for compliance purposes.
- Ensure strong cybersecurity measures are in place to protect sensitive employee information.
10. End PEO Contracts and Agreements
- Carefully review the PEO contract for termination clauses, notice periods, and any associated fees.
- Provide formal written notice to the PEO as required by the contract.
11. Assess Compliance
- Conduct a compliance audit to ensure all employment laws and regulations are being followed with the new in-house setup.
- Update labor law posters to reflect current requirements and display them prominently in the workplace.
12. Review HR Processes
- Develop and document internal HR processes for recruitment, onboarding, performance management, employee relations, and offboarding.
Additional Resources
HR Encyclopedia
Professional Employer Organizations (PEO) & HR
