A professional employer organization (PEO) can be a lifesaver for small businesses. PEOs provide access to human resources (HR) expertise, administer employee benefits, run payroll, and ensure compliance. However, as with any business partnership, there are times when working with a PEO may not make sense for your company. It’s worth exploring when might you engage a PEO, when does it make sense to cut your PEO loose, and what are the considerations for PEO exits? But first things first.

In this guide, Newfront will cover:

• What is a PEO?

• What is the difference between a certified PEO (CPEO) and a PEO?

• Why might a company choose to exit a PEO?

• How long does it take to exit a PEO?

• This sounds overwhelming—can I get help from a consulting partner?

•  How should I choose a PEO exit partner? 

• What about mid-year PEO exits?

• What are the most critical considerations for exiting a PEO?

• When should I communicate with employees about exiting a PEO?

• What are the key considerations regarding employee benefits compliance?

• How can Newfront help with PEO exits?

What is a PEO?

Small and mid-size companies often engage with PEOs to outsource HR. PEOs act as a co-employer and, depending on the range of services, might administer benefits or run payroll on behalf of their client’s business. Other PEOs have strategic offerings, keeping businesses compliant for payroll, taxes, insurance, benefits, and workers’ compensation. PEOs may also withhold and pay payroll taxes, offer risk and safety audits, provide HR support, or even hire, train, and manage the performance of employees. Most often, PEOs are paid a fee based on payroll totals. 

Because PEOs are co-employers and often run payroll, workers will typically get a check that doesn’t say their employer’s name but, rather, the name of the PEO.

The concept sounds like a win-win, but PEO relationships can be notoriously complicated because they are deeply intertwined with their client’s business. “PEOs are a Wild West,” said Brian Gilmore, Lead Benefits Counsel at Newfront. “The legal structure of having dual employment is murky. PEOs operate on instinct, interpretation, and industry norms.” 

What is the difference between a certified PEO (CPEO) and a PEO?

A certified PEO (known as a CPEO) is a PEO that has met specific background, financial, and reporting requirements from the IRS. The qualification is not an IRS endorsement, but rather a certification based on a series of tests. For example, CPEOs pay federal employment taxes on behalf of the organizations they serve, which provides financial protection for their clients. CPEOs also pay a bond of $1 million each year, which guarantees payment of federal employment tax liability. 

CPEO customers can claim specified tax credits, which customers of non-certified PEOs can’t. What’s more, and perhaps most critical for growing companies, is that customers of CPEOs can exit mid-year without wage-base restart. (More on that below.) The IRS publishes a list of all CPEOs, but make sure to ask if your specific PEO is certified.

Are there other certifications for PEOs?

PEOs may also be accredited by the Employer Services Assurance Corporation (ESAC). This accreditation requires compliance with more than 40 best practices. The ESAC conducts quarterly verification of federal and state employment taxes, health and workers’ compensation premiums, and retirement plan contributions.

Why might a company choose to exit a PEO?

While small businesses may find that PEOs fill in administrative gaps, as companies scale, they may want to customize their employee benefits or have more control over HR functions. In many cases, their needs have simply changed. “Employers go with a PEO if they’re a start-up or they’re growing, and they just don’t have the bandwidth to bring on an HR team,” said Jenni Ellis, Newfront Senior Vice President, Employee Benefits. “But at some point, your culture is important. And if your employees are all PEO employees, it's harder to manage and own that.”

Some advantages to exiting a PEO include:

• Developing a customized approach to employee benefits. PEOs tend to offer a uniform approach. “If you want to change something, you have to get it blessed by the PEO,” Gilmore said. “At some point, the lack of flexibility becomes a problem.” You may need a scaling strategy unique to your company or industry. You may also want policies and programs which are distinct to your culture.

• Better customer service. “We often hear that the customer service and expertise provided by PEOs can be lacking, and that can definitely play into a company’s decision to move out of a PEO,” said Heather Yates, Newfront Vice President and Administrative Services Practice Lead. In some cases, companies may want onsite, global, or compliance support not offered by the PEO.

• Cost benefits. PEO services typically base their fee on a percentage of total payroll or per employee. If your company has grown, so will the cost, especially if you have a highly compensated workforce. Eventually, paying the PEO may be more costly than an in-house solution. “You typically grow out of a PEO at around 100 employees, because that's the cost to bring somebody in house,” Ellis said.

• Eliminating redundant services. If you have or introduce an HR department, then that staff has likely already replaced some of the PEO services. 

• Employment autonomy. Once companies have exited PEOs, they have complete autonomy over their employees, without co-branding of their employment relationship. With this also comes control over employee records and more flexibility to scale the workforce. “Most companies want access to data,” said Dulcey Lester, Newfront Vice President and Executive Benefits Consultant. “Within the PEO, data isn’t available.”

How long does it take to exit a PEO?

Transitioning off of a PEO takes a minimum of four months—six is ideal. “The more time the better for a seamless transition,” Lester said. “Companies will need to review their current PEO contract terms, as there may be provisions related to termination.”

This sounds overwhelming—can I get help from a consulting partner?

Yes and, in fact, it’s highly recommended that you obtain a partner for your PEO exit. “I couldn't imagine a company doing this all by themselves,” Ellis said. “Unless they have an HR team that has done this multiple times, they definitely need a consulting partner.”

Exiting a PEO may feel like a juggling act. You are “basically starting fresh,” Gilmore said. “When it comes to moving out of PEOs, the only people who are experts are those who have done it and specialize in that type of market, because it's such a weird process.” The process requires implementing new technology, designing and managing benefits packages, navigating payroll nuances, developing employee workflows, designing a risk management plan, ensuring compliance with all local and national employment laws, and training executives and managers on the transition. You also want to ensure a smooth transition for employees. For example, Ellis said, “There's a lot of nuances and surprises that can come about with the flexible spending account transitions and changes to ensure people aren't losing out on funds they've set aside.”

“Exiting a PEO requires careful planning and coordination, and it is important to work with a trusted partner who can provide guidance and support throughout the process,” Lester said. PEO exit partners like Newfront can design and implement a post-PEO infrastructure for your business’ unique needs, including HR processes and systems, employee benefits, business insurance, and retirement plans. In some cases, a company may choose different vendors to handle different pieces—for example, one to handle workers’ compensation, another for property and casualty coverage, another for 401(k) services, and so on. Even if you bring on a partner (or several partners), expect your teams to take on some work. For example, even with full PEO exit outsourcing, the employer will still need to request reports, files, and data from the PEO. (Newfront provides clients with checklists indicating exactly what they need to request.)

How should I choose a PEO exit partner?

Lester advises that companies select a partner based on their expertise, flexibility for tailoring their services, responsiveness, and cost. “Look for a partner with a track record of successful PEO extractions and a deep understanding of the process, including any regulatory requirements and potential challenges,” Lester said. PEO extraction partners should have enough resources to manage the data migration and transition process, including the appropriate technology and staffing resources. Newfront clients, for example, have an entire service team, technology, and a financial advisor. Lester also recommends that prospective clients request references. “Speak with other companies who have worked with the partner to get a sense of their experience and level of satisfaction,” she said.

What about mid-year PEO exits?

Transitioning your workforce mid-year can be complicated, as it triggers a mid-year payroll tax restart. Using a CPEO eliminates the wage-base restart for customers that join or leave the CPEO mid-year. That means the client does not usually need to wait until January, potentially saving thousands of dollars in taxes. Typically, clients leaving non-certified PEOs will choose to exit at the start of the year to avoid complications.

Regardless of what type of PEO you’re exiting, it may be easiest to change payroll providers at the end of the year. If you switch at another time, there may be more work to make sure that your taxes are being done correctly and on time. Again, a PEO transition partner like Newfront can help answer questions about this and can advise about the timing of your PEO exit.

That’s a lot to take in. What are the most critical considerations for exiting a PEO?

Use this PEO exit checklist. It will help you reduce the risks and negative impacts of the transition. 

Stage one:

• Understand your organization’s motivation for leaving a PEO so you can deliver the right services and processes to replace those from the PEO. Involve all key stakeholders in the decision-making process, including HR, the finance team, and executives.

• Review the terms of your PEO agreement, including if your specific PEO is certified or not, for any terms or penalties associated with termination. There may be a notice period, and you will need to pay any outstanding fees.

• Find a partner for your PEO exit. You’ll want expert guidance throughout the process. Newfront understands your organization’s needs and can plan the right exit strategy with you.

Stage two: 

Newfront or another transition consultant can assist you with the following items. Alternatively, an experienced, in-house HR team may handle some of this process.

• Obtain your company’s data from the PEO. This is a typical part of the offboarding process, but don’t neglect to obtain payroll and tax information, PTO balances, and benefits information. Once your software and processes are set, you’ll need to migrate data related to benefits, payroll, and the HRIS system. (Your PEO exit partner may be able to take on data migration.)

• Time the switch to minimize the disruption to your business. Give yourself lead time so your new processes are up and running before your relationship with the PEO concludes.

• Select, implement, and manage your new technology. You may transition to an HR and payroll provider, or take over all of the services in house. Determine what services and technology you’ll need, including an HCM or stackable software, so you don’t have a gap in coverage or miss any deadlines. Plan what your staffing model will look like post-transition and be realistic about what work your team can absorb and what should be outsourced.

• Design, select, and manage HR processes. Consider your employee benefit plans and admin systems, 401(k) offerings, workers’ comp and employment practices liability insurance (EPLI) coverage, HRIS, and payroll. Plan how to transition employees to the new plans and systems.

• Develop employee workflows, including onboarding, training, and performance reviews.

• Build a risk management plan. This includes safety plans, as well as illness and injury prevention plans.

• Ensure compliance with local and national employment laws. Evaluate your HR policies, processes, and handbook for compliance. There may be different regulations depending on where your employees are based.

• Communicate with employees throughout the process, and train executives and managers on the transition. Be clear about any changes to employee benefits or payroll processes. Provide resources that cover employees’ options and address any questions which may arise.

When should you begin to communicate with employees about exiting the PEO?

“Communicate as early as possible and then continue to communicate often,” Yates said. For employees, changing benefits programs can be a big shift. Communicating with them throughout the process can make the transition easier.

“Change needs to be communicated, including system changes, payroll, benefits, resources, transition of care, new benefit plans, and the enrollment process,” Lester agreed. Companies should plan on training employees on the new systems and processes, and to also host informational sessions as needed.

What are the key considerations regarding employee benefits compliance?

Because you will establish, administer, and maintain your own, employer-sponsored plan, there are some special considerations. Remember: A PEO transition partner like Newfront can help navigate these questions and others.

• Documentation and compliance: This includes documents for HIPAA compliance, FSA administration, beneficiary designations, and other aspects of employee benefits.

• Full-time status: Which measurement method did the PEO use for determining employees’ full-time status under the ACA pay or play rules? You’ll need to ask which measurement method you will use—and whether it will require a transition period.

• ACA reporting: You are responsible for ACA reporting for the period after leaving the PEO. It’s recommended that you partner with a vendor to complete, distribute, and file the Forms 1094-C and 1095-C, and help with the COBRA transition.

COBRA administration: Most PEOs offer the option to continue administering COBRA for existing qualified beneficiaries under the PEO plan for the remainder of the maximum coverage period. You can choose to pay the administrative fee for COBRA through the PEO or move these qualified beneficiaries to the new health plan, but Yates recommends “moving it to a new COBRA administrator so that everything is in one place. Once you leave a PEO, the service tends to go downhill, and the fact that the client is no longer on the PEO gives them very little leverage for escalated support should something go wrong,” she said. Regardless of what you decide to do, communicate with any existing COBRA participants to ensure a smooth transition.

How can Newfront help with PEO exits?

Newfront breaks down the PEO transition into four project tracks (Systems, Employee Benefits, Business Insurances, and Retirement) and assigns a dedicated project leader, implementation plan, and change management plan for each. By taking on that burden, Newfront frees up the client company to focus on their staff and messaging the transition plan to stakeholders. Newfront can engage in full outsourcing, partial outsourcing, or retainer support, depending on whether clients have an internal HR team. “We are experts in this field,” Lester said. “We offer a seamless approach and do all the heavy lifting.”

In addition to Newfront’s robust employee benefits, business insurance, and retirement services, Newfront can also handle:

• HCM needs analysis to help clients identify and then implement new technology. “We can support this project from start to finish and have partnerships with several vendors that we work with all the time,” Yates said. “We have deep expertise in these systems and can help obtain discounted pricing with those partners.” Newfront’s support includes data audits, best practice expertise in module setup, and overall project management.

• Tax registration. Newfront can register for all required state and local taxes on behalf of clients, and can also work with the new technology vendor to set everything up correctly.

• HR support. “Depending on the client size our team can offer full HR outsourcing to the client when they come off the PEO, essentially managing their HR function while they are still the employer of record,” Yates said. “Or, if they do have an internal team, we can support in certain areas, or just provide consulting on an hourly or retainer basis.” Newfront’s HR support covers the full employee lifecycle, including onboarding, benefit administration, policies and handbooks, employee relations, compliance, and offboarding.

• Payroll processing. Once companies are off PEOs, they must process their own payroll. If clients don’t have that expertise internally but are on one of our supported systems, Newfront can manage the full payroll function on their behalf. “We have deep payroll expertise on our team and can handle complex multi-state payroll processing from start to finish,” Yates said.

• Leave of absence management. “This is an area that many clients struggle with due to the complexity of leave compliance and regulations, especially if they are in multiple states,” Yates said. “Our team of leave experts provides a very high-touch service for a client’s employees as they navigate the leave of absence process.”

• Project and hourly consulting. Newfront can develop custom handbooks; draft custom policies; support job description development, FLSA classification review, and EEO-1 reporting; and serve as supplemental support to the client’s internal team on an hourly or retainer basis for any guidance they may need as they navigate HR and payroll.

Meet our experts:

• Heather Yates, Newfront Vice President and Administrative Services Practice Lead

• Jenni Ellis, SVP of Employee Benefits

• Brian Gilmore, Lead Benefits Counsel

• Dulcey Lester, Vice President, Executive Benefits Consultant