Most business owners know roughly what they pay employees. Fewer can tell you what each employee actually costs once you stack on payroll taxes, workers’ comp, health insurance, admin overhead, and all the other line items that make up true labor burden. That gap is exactly where PEO decisions go sideways.
You can’t evaluate whether a co-employment arrangement saves you money if you don’t have a clean picture of what you’re spending now. A PEO sales rep will hand you a proposal with projected savings highlighted in bold. What they won’t hand you is a framework for verifying those numbers against your actual cost structure.
This guide walks you through building a labor burden cost model from scratch, then restructuring it to reflect what changes and what doesn’t under a PEO arrangement. It’s not a pitch for PEOs. It’s a repeatable exercise you can run against any proposal, from any provider, at any point in time.
We’ll cover how to inventory every component of your current labor burden, calculate your true per-employee cost, map what a PEO actually absorbs, build a side-by-side comparison, stress-test the model, and weigh the tradeoffs the spreadsheet won’t capture on its own.
If you’ve been handed a PEO quote and thought “I have no idea if this is actually cheaper” — this is the exercise that answers that question.
Step 1: Inventory Every Component of Your Current Labor Burden
Before you can model anything, you need a complete list of what you’re actually spending. Most owners undercount this significantly. They know gross wages. They might remember health insurance premiums. But the full picture is usually scattered across payroll reports, insurance invoices, benefit statements, and internal time logs that nobody has ever pulled together in one place.
Start with the hard costs that show up on invoices or tax filings.
Employer-side FICA: This is 7.65% of each employee’s wages up to the Social Security wage base, per IRS guidelines, with the Medicare portion continuing beyond that threshold. It’s not optional and it’s not negotiable — it’s a fixed cost you pay on every W-2 employee.
FUTA: Federal unemployment tax is 6% on the first $7,000 of each employee’s wages per year, though most employers receive a credit that reduces the effective rate significantly. Pull your actual Form 940 filing to confirm what you paid, not what the textbook rate says.
SUTA: State unemployment tax rates vary considerably by state and by your company’s experience rating. A business with low turnover and few claims pays a much lower rate than one with frequent layoffs. Your state workforce agency can tell you your current assigned rate. Use that number, not the state average.
Workers’ compensation premiums: These are calculated by classification code, payroll volume, and your experience modification factor. A field crew in construction carries dramatically higher rates than an office administrator. Pull your actual policy declaration page and calculate the blended rate across your workforce. Don’t use a single average — the variation by role matters.
Health, dental, and vision insurance: Use your employer contribution amounts, not the total premium. What your employees pay is their cost. What you pay is yours.
Retirement contributions: If you offer a 401(k) match or profit-sharing, include the employer contribution. This is a real labor cost that gets overlooked frequently.
Life and disability insurance: Employer-paid premiums for group term life, short-term disability, or long-term disability coverage belong here.
PTO accrual value: This one trips people up. Accrued PTO is a liability on your books. The cost isn’t just the hours — it’s the hourly rate of the employee earning those hours, including their burden rate. For modeling purposes, calculate the annual PTO cost as: (average hourly rate × average annual PTO hours used) across your workforce.
Now capture the soft costs that rarely appear on any single invoice.
Payroll processing fees: What do you pay your payroll vendor per month, per run, or per employee? Pull 12 months of invoices.
HR staff time on compliance and administration: If you have an HR person spending 30% of their time on benefits enrollment, payroll questions, and compliance filings, that’s 30% of their fully-loaded salary allocated to labor administration. Estimate this honestly. If you need a structured approach to quantifying these internal costs, a detailed enterprise HR cost baseline analysis can help you benchmark what you’re actually spending before evaluating any PEO.
Benefits administration: If you use a broker or third-party administrator, include those fees. If you manage it internally, include the time cost.
Recruiting costs amortized per employee: Job board fees, agency commissions, and internal recruiter time add up. Divide your annual recruiting spend by your average headcount to get a per-employee figure.
Organize everything by employee classification. W-2 full-time, W-2 part-time, and 1099 contractors have very different burden profiles. Don’t blend them — the model only works if you keep classifications separate.
Step 2: Calculate Your True Per-Employee Burden Rate
Once you have your inventory, the calculation itself is straightforward. The burden rate formula is:
(Total Non-Wage Labor Costs ÷ Total Gross Wages) × 100 = Burden Rate %
If you pay an employee $60,000 in gross wages and spend $18,000 on all associated non-wage costs for that employee, your burden rate for that person is 30%. Their true cost to you is $78,000.
Run this at two levels: individual employee and company-wide average. Both matter, but for different reasons.
The individual calculation reveals where your actual cost exposure sits. A warehouse worker with a high workers’ comp classification code, lower wages, and full benefits might carry a burden rate of 45% or higher. A senior software engineer with a low comp rate, high wages, and minimal overtime might sit closer to 22%. Averaging those two together produces a number that accurately describes neither.
The company-wide average is useful for comparing against a PEO’s per-employee pricing model, which is typically expressed as a flat fee or percentage of payroll applied across your workforce. But don’t let that average obscure the fact that a PEO may save you significantly on some roles and cost you more on others. Understanding how PEOs change your labor cost reporting structure is critical for making this comparison meaningful.
A few errors that show up consistently when owners run this calculation for the first time:
Forgetting SUTA rate increases: If your experience rating has been climbing, your current rate isn’t necessarily your future rate. Model what you’re paying now, but flag it as a variable that could move.
Excluding COBRA administration costs: If you’ve had departing employees elect COBRA coverage, there are administrative costs associated with managing those elections and payments. Small, but real.
Underestimating PTO liability: Companies that allow PTO to accumulate without caps are carrying a growing balance sheet liability. If you’ve never calculated the dollar value of your outstanding PTO obligations, do it now. It often surprises people.
Ignoring workers’ comp audit adjustments: Workers’ comp premiums are estimated at the start of the policy year and reconciled at audit. If your payroll grew mid-year or you had classification changes, your actual cost differs from what you paid in premiums. Use the audited figure.
Once you have your burden rates by role and by company average, you have a baseline. Everything in the PEO comparison is measured against this number.
Step 3: Map Which Cost Lines a PEO Actually Absorbs or Changes
This is where a lot of PEO evaluations go wrong. People assume that because a PEO handles payroll, benefits, and HR administration, all of those costs go away. They don’t. Some shift. Some get replaced by the PEO’s fee structure. Some stay exactly where they are.
Understanding the difference is what makes the cost model meaningful.
Costs that typically shift to the PEO’s master policy: Workers’ compensation coverage is one of the clearest examples. Under a PEO arrangement, your employees are covered under the PEO’s master workers’ comp policy rather than your standalone policy. The PEO charges you for this coverage as part of their fee structure. Whether that’s cheaper depends on your current experience modification factor and your industry classification codes, and the PEO’s pricing for your specific workforce profile. It’s not automatically better.
Health, dental, and vision insurance is similar. PEOs offer access to their group plans, which pool employees across all their client companies. For small employers who’ve been buying coverage as a group of 15 or 20 people, this pooling can improve access to plan designs and sometimes improve pricing. But the actual savings depend on your current carrier arrangements, your employees’ claims history, and what the PEO’s specific carrier offers. Ask for the plan documents, not just the summary.
Employment practices liability insurance (EPLI) is often included in PEO arrangements, which is a real value-add for companies that don’t currently carry it.
Costs that stay with you: Base wages don’t change. Your PTO policy decisions remain yours — the PEO administers them, but you set the terms. Role-specific tools, equipment, and professional development costs are outside the PEO relationship entirely.
The admin fee line item: PEOs charge either a flat per-employee-per-month fee or a percentage of payroll. This is a new cost that didn’t exist before. It replaces some of your internal costs, but it’s not a one-for-one swap. If your internal HR administration costs are low because you have a capable in-house team, the PEO admin fee may not offset cleanly. A thorough comparison of internal HR versus PEO expenses can help you determine whether the tradeoff makes sense for your specific situation.
SUTA and FUTA implications: This one requires careful attention. Many PEOs file employment taxes under their own EIN, which means your employees’ wages are reported under the PEO’s tax identification number. This can reset your SUTA experience rating, which cuts both ways. If your current rate is low because of a strong claims history, moving to a PEO could actually cost you more in unemployment taxes. If your rate is high, you might benefit from the PEO’s pooled rate. Ask the PEO directly what SUTA rate your employees would be assigned under their arrangement, and compare it to your current rate.
It’s worth noting that IRS-certified PEOs (CPEOs) maintain sole liability for federal employment tax obligations under IRC Section 3511, which provides a specific legal protection for clients. Not all PEOs are CPEOs. If federal tax liability transfer matters to you, that certification status is worth verifying.
For a broader explanation of how co-employment works structurally, you’ll want to review foundational PEO content that covers the employer-of-record model in detail. This guide assumes you’re already past that stage and ready to run the numbers.
Step 4: Build the Side-by-Side Cost Model
Now you build the actual comparison. Keep it simple. A spreadsheet with two columns works fine: Current State and PEO State. Every burden component from your inventory is a row.
The discipline here is using actual numbers in both columns. In the Current State column, you’re pulling from the inventory you built in Step 1. In the PEO State column, you’re pulling from the actual PEO proposal — not their projected savings summary, but the specific line items they’ve quoted: per-employee admin fee, workers’ comp rate under their program, health plan contribution amounts, and any other fees buried in the agreement.
Structure your rows something like this:
Gross wages: Same in both columns. This doesn’t change.
Employer FICA: Same in both columns. This is a statutory cost that doesn’t change regardless of PEO arrangement.
FUTA: Same in both columns, unless the PEO’s CPEO status creates a specific liability transfer benefit you’ve confirmed with your accountant.
SUTA: This may differ. Use your current rate in the left column and the PEO’s quoted rate in the right column.
Workers’ comp premium: Your current standalone rate in the left column. The PEO’s quoted workers’ comp charge in the right column. For businesses with complex comp structures, understanding how to track and verify workers’ comp accounting through a PEO will help you ensure the quoted figures hold up at audit.
Health insurance employer contribution: Your current contribution in the left column. The PEO’s plan contribution in the right column, using the same coverage tier for a fair comparison.
PEO admin fee: Zero in the left column. The quoted fee in the right column.
Now add two special rows that most people miss:
Costs that disappear under the PEO model: Your standalone payroll software subscription, your HR consultant retainer, your benefits broker fee if the PEO replaces that relationship, your workers’ comp audit administration costs. These go as negative values in the PEO column — they reduce the PEO’s net cost.
Costs that appear or increase: Minimum participation requirements if the PEO requires a certain percentage of employees to enroll in their health plan. Termination fees if you exit the PEO contract early. Any setup or implementation fees in year one.
Once both columns are complete, calculate the total per-employee annual cost in each column. Then run the burden rate formula from Step 2 on both columns. You now have a directly comparable burden rate for your current model and your PEO model, built on the same formula, using real numbers from both sides. If you want a structured framework for building these projections, a PEO savings projection model can formalize this process.
If the PEO’s column is lower, by how much? Is the difference material enough to justify the transition? If it’s higher, the model has answered your question clearly.
Step 5: Stress-Test the Model Against Real Scenarios
A static comparison only tells you what the numbers look like today. The more useful question is how the model behaves under different conditions, because your business isn’t static.
Headcount changes: Run the model at your current headcount, then at headcount plus five employees, and headcount minus ten. PEO pricing often has minimum employee thresholds, and per-employee fees can shift at certain volume tiers. If you’re growing, does the PEO model scale favorably? A dedicated PEO HR scalability financial model can help you project how costs shift as your headcount grows. If you’re in a volatile industry where headcount fluctuates, what happens to your costs when you’re below their minimum?
Workers’ comp claim scenario: This is one of the most important tests. Model what happens if you have a significant workers’ comp claim. Under your standalone policy, a serious claim affects your experience modification factor at renewal, often meaningfully. Under a PEO’s master policy, your individual claim is pooled across their entire client base, which buffers the impact on your specific renewal cost. Whether that buffering is worth the ongoing cost difference depends on your industry’s claim frequency and severity. If you’re in a low-risk office environment, this may be less relevant. If you run field crews or manufacturing operations, it’s a significant factor.
Health premium escalation: Health insurance costs tend to increase year over year. Model what happens to your total cost under both scenarios if premiums rise. Under a standalone plan, your small group renewal is driven heavily by your own employees’ claims history. Under a PEO’s pooled plan, your renewal is influenced by the claims experience of a much larger group. That pooling can work in your favor if your employees have been expensive claimants. It can work against you if your group has historically been healthy and you’ve been subsidizing the broader pool. Ask the PEO for their renewal history on the health plans they’re proposing.
The breakeven analysis: Identify the specific employee count, cost threshold, or scenario where the PEO model stops making financial sense. Building a full PEO scenario analysis financial model lets you test multiple variables simultaneously rather than running one-off calculations. Knowing that threshold helps you make a time-bounded decision rather than treating the PEO arrangement as permanent.
The stress tests often reveal more than the static comparison. A model that looks marginally better under the PEO at current headcount might look significantly worse under a realistic growth scenario. That’s information you need before you sign.
Step 6: Evaluate the Non-Financial Tradeoffs the Model Won’t Show You
The spreadsheet is essential. It’s also incomplete on its own.
There are real operational and strategic tradeoffs in a PEO arrangement that don’t show up as line items, and ignoring them produces a decision that looks rational on paper but creates friction in practice.
Loss of direct control over benefits selection: When you’re in a PEO, you’re choosing from the plans they offer. You can’t unilaterally switch carriers mid-contract if your employees are unhappy with the network. For some businesses, that flexibility matters a lot. For others, offloading that decision is actually a relief.
Operational friction during transition: Migrating your workforce to a PEO isn’t frictionless. Employees re-enroll in benefits, payroll systems change, and there’s typically a period of confusion and questions that your internal team has to absorb. For a business in a stable phase, this is manageable. For a business in the middle of rapid growth or a leadership transition, the timing may not be right regardless of what the numbers say.
Dependence on the PEO’s service quality: Your employees’ payroll accuracy, benefits administration, and HR support are now partially dependent on a third party. If the PEO’s service quality is poor, your employees experience it directly. Vet the PEO’s client retention rates and service reviews, not just their pricing.
The risk of PEO failure: This is the scenario nobody likes to think about, but it’s real. If a PEO loses its license, becomes insolvent, or exits your market, your workers’ comp coverage and benefits administration can snap back to you with very little notice. A thorough PEO termination clause risk analysis should be part of your due diligence before signing any agreement. You’d need to re-establish a standalone workers’ comp policy mid-year, which is both difficult and expensive. Understanding the PEO’s financial stability and whether they carry the appropriate surety bonds is part of due diligence, not paranoia.
Sometimes the cost model shows clear savings, but the operational cost of switching, the timing, or the risk profile makes the PEO the wrong call for your specific situation right now. That’s a valid conclusion. The model’s job is to give you clarity, not to push you toward a particular answer.
Putting It All Together: Your Checklist and Next Steps
Here’s a quick-reference summary of each step as a single action item:
1. Pull 12 months of payroll reports, insurance invoices, and benefit statements. List every non-wage labor cost by employee classification.
2. Calculate your burden rate at the individual employee level and company-wide average using: (Total Non-Wage Labor Costs ÷ Total Gross Wages) × 100.
3. Review each cost line and categorize it: shifts to PEO, stays with you, gets replaced by admin fee, or disappears entirely.
4. Build a two-column spreadsheet using your actual numbers and the PEO’s actual quoted costs. Calculate the burden rate in both columns using the same formula.
5. Run at least three stress tests: headcount change, workers’ comp claim scenario, and health premium escalation. Identify your breakeven threshold.
6. Document the non-financial tradeoffs specific to your business situation and weigh them against the financial delta.
This model should be rebuilt annually, not treated as a one-time exercise. Labor burden shifts constantly. SUTA rates change. Workers’ comp experience ratings move. Health plan renewals alter your cost structure. A model you built two years ago doesn’t reflect what you’re spending today.
The real leverage comes when you run this comparison against multiple PEO proposals simultaneously. Different PEOs price workers’ comp, benefits, and admin fees very differently, and those differences aren’t always visible in a single proposal. Having your baseline model already built means you can drop any new proposal into the comparison framework immediately, without starting from scratch each time.
And if the numbers don’t clearly favor the PEO after you’ve run this exercise honestly, that’s not a failure of the process. That’s the process working exactly as it should.
Before you sign that PEO renewal, make sure you’re not leaving money on the table. Many businesses unknowingly overpay because of bundled fees, hidden administrative markups, and contracts designed to limit flexibility. Don’t auto-renew. Make an informed, confident decision.
