The short answer
A PEO becomes a co-employer of your staff and bundles payroll, HR administration, and benefits under one contract, often through a health plan offered by the PEO, and some PEO contracts let a client keep its own plan. An independent benefits broker helps your company sponsor and manage its own plan with carriers you choose; payroll processing and full HR outsourcing are arranged separately, and the broker relationship may include HR resources. A PEO tends to suit smaller companies that want one outsourced package. A broker tends to suit employers that want control of their own plan, carrier, and plan year.
My Advisor is an independent benefits brokerage, so we have a side in this question. This guide lays out when a PEO is the stronger choice as plainly as when a broker is.
What a PEO is and how co-employment works
A professional employer organization (PEO) takes on payroll, benefits, compliance assistance, and other HR services for small and mid-size businesses, as NAPEO, the industry’s trade association, describes it. The arrangement is called co-employment: your employees become co-employees of the PEO and your company.
Alabama’s Professional Employer Organization Registration Act sets out the split in Alabama:
- The written contract must disclose the PEO’s services, the total administrative fees, and each party’s rights and obligations.
- The PEO pays wages and withholds and remits payroll and unemployment taxes, to the extent your company has funded those obligations.
- Your company keeps every employer right and duty that the Act or the contract does not assign elsewhere, and it directs and supervises the work of its employees.
Certified PEOs and federal employment taxes
A Certified Professional Employer Organization (CPEO) is a PEO that voluntarily applied to the IRS and met its background, experience, business location, financial reporting, tax compliance, and bonding requirements.
Under Internal Revenue Code section 3511, a CPEO is treated as the sole employer of a worksite employee for federal employment taxes on the wages the CPEO remits. The IRS explains that the CPEO is then generally solely liable for paying those taxes, filing returns, and making deposits, using its own employer identification number (EIN).
What certification leaves out:
- Section 3511 applies to the employment taxes in one subtitle of the tax code, on wages the CPEO remits. It does not address your health plan, state law, or employment-law obligations.
- For individuals who are not worksite employees, the IRS says the CPEO and the customer may both be liable.
- With an uncertified PEO, the IRS says a business generally is not relieved of its employment tax obligations for wages paid to its employees through the PEO.
- You can check status on the IRS CPEO public listings.
Alabama requires PEOs to register
Under the Act, a business may not provide or advertise professional employer services in Alabama unless it is registered. The state’s registration rule requires audited or reviewed financial statements, proof of workers’ compensation coverage, and a minimum net worth of $100,000 (or a posted security amount). The Alabama Department of Workforce publishes a searchable list of registered PEOs.
How benefits work inside a PEO
NAPEO says PEOs give employees access to “Fortune 500-level benefits at an affordable cost.” Employees who take the PEO’s benefits enroll in plan options it makes available. Some PEOs also offer a hybrid: one PEO’s article says that if a client is happy with its current medical coverage, the PEO will carve out those services while still providing benefits administration, and will work with the client’s broker. Before you sign, check:
- Who sponsors the plan. Under the Alabama Act, the client and the PEO can each sponsor benefit plans, a health plan cannot be sponsored jointly by both, and the contract must identify which one sponsors each health plan.
- Whether it is a MEWA. A multiple employer welfare arrangement (MEWA) is a plan or arrangement that provides welfare benefits to employees of two or more employers. The U.S. Department of Labor’s MEWA guide states that a PEO plan covering employees of two or more client employers is a MEWA under ERISA, and that a PEO’s co-employer status under other laws does not change that result.
- Who regulates it. The same guide says a PEO arrangement may supply benefits to separate plans sponsored by each client, or may itself be an ERISA-covered multiple employer plan. If the arrangement is not itself an ERISA plan, ERISA does not preempt state insurance regulation of it. If it is an ERISA-covered plan, state insurance law can still apply, and the scope turns on funding: for a fully insured plan, states can apply standards for reserves and contributions; for a plan that is not fully insured, states can apply insurance law to the extent it is consistent with ERISA.
DOL’s guide also notes that a number of MEWAs have been unable to pay claims because of insufficient funding and inadequate reserves. That history concerns MEWAs as a category, and it is a reason to ask whether a PEO’s plan is fully insured or self-funded.
How PEOs price their services
PEOs describe their pricing as a recurring fee based on a percentage of payroll or a flat fee per employee (as in one PEO’s own comparison article). Alabama’s Act defines that administrative fee separately from wages, benefits, workers’ comp, and payroll taxes.
Compare total annual cost: the full PEO invoice against your own plan, payroll, HR support, and workers’ comp policy.
What leaving a PEO involves
Leaving unwinds whatever the contract bundled:
- Benefits. If employees were covered through the PEO’s plan, leaving means moving them to a new plan. If you move mid-year, ask the new carrier in writing whether it will credit deductible and out-of-pocket amounts employees already met under the PEO’s plan. If it won’t, those amounts can start over. If your contract let you keep your own medical plan, that plan can continue; ask how any benefits administration the PEO handled will transition.
- COBRA. Federal COBRA generally applies to private-sector group health plans of employers with at least 20 employees on more than half of their typical business days in the prior year, per DOL’s employer guide. Get in writing who will handle people already on COBRA through the PEO’s plan after you leave.
- Federal payroll taxes. When a CPEO contract ends, section 3511(b) treats your company as a successor employer with respect to worksite employees for the Social Security and federal unemployment tax wage bases, which affects how wages paid earlier in the year count toward those limits.
- Alabama unemployment tax. Under the Act, a PEO pays Alabama unemployment contributions using its own state account number and rate. When the contract ends, the client is treated as a new employer without a previous experience record, unless it is otherwise eligible for an experience rating.
- Workers’ compensation. If the contract assigned workers’ comp to the PEO, the Act requires the PEO to provide loss-experience records at the end of the agreement on request.
- Contract terms. Check the notice period, termination fees, and exit timing.
What an independent benefits broker does
A benefits broker helps your company design, shop, and manage a group plan your company sponsors. The plan, the carrier contract, and the plan year are yours. A broker can compare carriers and funding arrangements, support enrollment, and help resolve claims and billing problems.
How brokers are paid:
- Compensation can come as commissions from carriers, fees your company pays directly, or both.
- Since December 27, 2021, brokers and consultants to ERISA group health plans who reasonably expect $1,000 or more in direct or indirect compensation must disclose it to the responsible plan fiduciary reasonably in advance, as explained in DOL Field Assistance Bulletin 2021-03.
The tradeoffs are real:
- Payroll and full HR outsourcing are arranged separately. Your company contracts for these on its own, which takes money and attention. Broker relationships can include HR resources, so ask what is covered.
- Your company holds the plan-sponsor role. DOL’s fiduciary guide says most employers that sponsor fully or partially self-funded plans are fiduciaries, that fiduciary status for a fully insured plan depends on whether the employer exercises discretion, and that hiring a service provider is a fiduciary function that carries a duty to monitor the provider.
PEO vs. independent broker at a glance
| Factor | PEO | Independent broker |
|---|---|---|
| Who employs your staff on paper | The PEO and your company, as co-employers | Your company alone |
| Health plan ownership | The contract names the sponsor; a PEO plan covering two or more clients’ employees is a MEWA under DOL’s reading | Your company sponsors its own plan |
| Carrier and plan choice | You choose among the plans the PEO offers; some contracts let a client carve out and keep its own medical plan | You choose among carriers, plan designs, and funding arrangements available to your group |
| Pricing model | Administrative fee (often a percentage of payroll or a per-employee fee) plus wages, taxes, benefits, and workers’ comp costs | Premiums or plan costs; broker paid by commissions, fees, or both, subject to federal disclosure rules |
| Compliance responsibility | Some duties shift by contract; a CPEO is generally solely liable for federal employment taxes on wages it remits to worksite employees, and liability can be shared for other workers; your company keeps the employer duties the contract does not assign | Your company holds employer and plan-sponsor duties; the broker advises and supports |
| HR and payroll | Payroll and HR administration included in the package | Payroll processing and full HR outsourcing arranged separately; the broker relationship may include HR resources |
| Flexibility to leave | Exit moves payroll tax accounts, benefits provided through the PEO’s plan, and possibly workers’ comp together, on the contract’s terms; a medical plan your company kept can continue | Carriers, vendors, and advisors can be changed one at a time, subject to plan-year and contract timing |
| Fit by company size | NAPEO research places most PEO clients at 10 to 99 employees, with roughly a quarter smaller or larger | Any employer that sponsors its own group plan |
When a PEO is the better fit
A PEO is often the stronger choice when:
- You have little or no HR or payroll staff and want payroll, HR, benefits, and workers’ comp under one contract.
- You want a certified PEO to take on federal employment tax liability for wages it remits to worksite employees.
- You are offering benefits for the first time and want a ready-made package.
- You have priced both paths and the PEO’s total cost holds up.
When a broker is the better fit
A broker is often the stronger choice when:
- Payroll and HR already work well for you.
- You want your own plan: your carrier, your plan designs, your plan year, and your renewal calendar.
- You want to evaluate level-funded or self-funded arrangements for your own group.
- You want to change one piece, such as a carrier or payroll vendor, without unwinding everything else.
Questions to ask either one
Ask a PEO:
- Are you IRS-certified, and do the name and EIN on our contract match the IRS active list?
- Are you registered with the state of Alabama?
- Who sponsors the health plan, and where does the contract say so?
- Can we keep our own health plan and broker, and what does that cost?
- Is the health plan fully insured by a licensed carrier or self-funded, and which state regulates it?
- What are the total administrative fees, shown separately from wages, taxes, benefits, and workers’ comp?
- What does leaving require: notice, fees, COBRA handling, and records?
Ask a broker:
- How are you paid, and will you give us your compensation disclosure before we sign?
- Which carriers and funding arrangements will you quote for our group?
- Who handles compliance questions, enrollment, and claims problems during the year?
- What HR support is included, and what will we need to buy separately?
Ask both:
- Can you show our total annual cost, line by line, for our census?
How My Advisor helps
My Advisor is an independent brokerage in Birmingham that helps employers design, implement, and manage employee benefits across fully insured, level-funded, and self-funded arrangements. If you are weighing a PEO, we can set your current or proposed arrangement next to the plan designs and funding arrangements that fit your company, and show you the math we ran. If a PEO is the route you prefer, we can also advise you on which PEO is best suited to your company, comparing their health plans, total costs, contract terms, and service side by side before you sign. Our clients get compliance support on ERISA, the ACA, HIPAA, and DOL requirements, backed by legal experts on retainer, plus HR consultation, HR Q&A including the HR hotline, employee handbooks and individual employment policies, and on-demand resources through the Zywave client portal. In most cases our compensation is paid by the carrier as part of the plan’s pricing, and we disclose it to you.
This guide is general information for employers. It is not legal or tax advice for any specific plan.