Outsourcing Payroll Pros And Cons
One of the most important operational duties when managing a business is ensuring accurate payroll.
Effective payroll management requires specific expertise and technology, which is why many companies outsource it to a professional service to build trustworthiness.
Here I’ll take you through what outsourcing payroll entails and the pros and cons of this approach.
What Is Payroll Outsourcing?
Payroll outsourcing means contracting an external payroll services provider to handle payroll processing. This includes calculating wages and tax withholdings in compliance with various labor and tax laws.
The organization and its employees provide the details (compensation, hours worked, classification, etc.), and the payroll service takes care of the rest.
This allows the organization to take advantage of the provider's features such as automated reminders, wage and benefits calculation, and filing and paying taxes.
As we’ll go into, outsourcing payroll can be especially helpful for companies operating internationally or for complex processes requiring a lot of manual calculations.
Pros of Outsourcing Payroll
Starting on a positive note, the potential pros of outsourcing payroll:
Ready-made and managed payroll processing
An external payroll provider offers a ready-made, efficient payroll process so you don’t have to spend time setting one up and managing it.
For example, they handle setting up direct deposit for your employees, ensuring funds are deposited into employee accounts on payday without delay. They also automatically calculate deductions like taxes and benefits, saving you time.
Potentially lower operational costs
You don’t need to invest in payroll software or personnel to manage payroll internally. With outsourced payroll, all that is handled by a third-party provider with an expert team who can cover for each other.
For instance, a payroll provider will automatically update systems for tax code changes or new compliance requirements.
Ensured accuracy and compliance
An external payroll provider should have the expertise and resources needed to ensure accuracy and adherence to payroll compliance regulations.
For example, they will handle quarterly tax filings and end-of-year W-2 and 1099 forms on your behalf. Something to look out for here is if they’re willing to cover the costs of any errors on their part.
Easy international expansion
Hiring employees in new jurisdictions means setting up a new payroll process all over again, unless you use a global payroll service with the capability to pay workers in multiple countries and currencies.
Cons of Outsourcing Payroll
Despite the potential pros, there are also a few reasons organizations choose to process payroll in-house.
Communication delays
Relying on an external provider can sometimes lead to slower response times, especially for urgent payroll corrections.
You can mitigate this by establishing clear service level agreements (SLAs) with your payroll provider that outline response and resolution times for different types of requests. Additionally, designate a specific point of contact within both your company and the provider to streamline communication.
You should also ensure your provider offers same-day correction services for payroll errors before a critical payroll date.
Cost
In some instances, outsourcing may not necessarily be more cost-effective than performing payroll internally.
Depending on the services, cost structures, and other factors, outsourcing payroll could end up costing more in the long run. Outsourcing still requires oversight from someone internally.
“While outsourcing gets rid of direct expenses like manual processing, software, and compliance staff, you do still pay vendor fees,” says Andrew Gosselin, CPA & Senior Editor at TheCalculatorSite. “Cost savings might happen initially but expenses could rise over time, especially if changes or special requests lead to extra charges. Before deciding to outsource, do a multi-year cost analysis.”
Data privacy
Outsourcing payroll increases the risk of data breaches or unauthorized access to sensitive information.
Ensure the provider follows strong data encryption, has multi-factor authentication, and adheres to compliance standards like SOC 2 or ISO 27001. Also, consider providers that offer cybersecurity insurance to cover breaches.
Outsourcing Payroll Case Study
Conor Hughes, HR Consultant at RealHR Solutions, shares his experience outsourcing payroll:
“When we were outsourcing payroll at a mid-sized tech company, we recognized the growing complexities and pressures on our internal team.
We conducted a cost-benefit analysis comparing our internal costs, including software and personnel, with proposals from third-party providers.
For instance, internally, our costs were around $120,000 annually, whereas outsourcing quotes ranged from $60,000 to $90,000.
We also considered potential savings from reduced errors and compliance risks. The decision was financially sound, and we made sure to establish clear SLAs with the provider and kept an internal payroll expert to facilitate communication and quick problem resolution.
During the transition, we encountered some integration issues and initial discrepancies, but with proactive management, we stabilized the process quickly.
Within six months, the overall efficiency improved, freeing up our HR team to focus on strategic activities and delivering significant cost savings.”
Outsourcing Payroll Best Practices
Wendy Mankinson, HR manager at Jolanda Hydraroll, provides us with some best practices to ensure outsourcing is a success and safeguard your payroll:
- Thoroughly vet potential outsourcers. Use resources such as this site, Trustpilot, your network, and Reddit forums. Also, ask the vendor for evidence of valid insurance documentation and cyber security policies.
- Negotiate robust service-level agreements with inbuilt penalties
- Map out a detailed implementation and transition plan
- Maintain internal expertise to oversee your outsourcing provider
- Understand the outsourcer's limitations on issues such as global payrolls
- Insist on secure data transfer protocols.
- Have a contingency plan to bring the payroll back in-house should it be needed.
Attending payroll seminars can help you stay updated on key strategies that these for effective payroll management that grow and change with current industry challenges.
How Does Payroll Outsourcing Work?
Follow these steps to help you outsource the payroll function:
1. Assessing needs and selecting a provider
- Identify your specific payroll needs e.g. on-demand pay, international payroll processing
- Research and select a payroll outsourcing provider (e.g., ADP, Paychex, Gusto). Evaluate their services, pricing, and experience with U.S. payroll compliance.
2. Contract negotiation
- Draft and negotiate a contract outlining services provided, data protection, compliance with federal and state tax laws, service level agreements (SLAs), and pricing structures.
3. Setup and data migration
- Work with the provider to set up your payroll system. This includes migrating employee data, tax details, benefits information, and payment schedules.
- Ensure that data is securely transferred, and all necessary tax forms (e.g., W-2s, 1099s) are properly managed.
4. Compliance and legal requirements
- The payroll provider should handle federal, state, and local tax withholdings, file taxes on your behalf, and ensure compliance with changing payroll laws.
- Confirm they can manage benefits deductions, overtime, and any state-specific regulations (e.g., California labor laws).
5. Training and integration
- Your team may need to be trained on how to interact with the outsourced payroll system, including how to input data, review reports, and communicate issues.
6. Ongoing payroll processing
- The provider will process payroll according to your set schedule (weekly, bi-weekly payroll, etc.), ensuring employees are paid accurately and on time.
- You will receive regular reports and updates, which can be integrated with your financial systems.
7. Support and issue resolution
- Ensure there's a clear process for resolving any payroll discrepancies or employee queries. SLAs typically outline response times for addressing issues.
Typical Services Offered By Payroll Companies
Payroll companies typically offer a range of services that cater to the diverse needs of businesses. Here are some common services provided:
1. Payroll processing
This is the core function of any payroll company, handling the calculation and distribution of employee wages based on hours worked, salaries, and other compensation factors.
Includes:
- Calculating gross wages, deductions, and net pay.
- Processing payments through direct deposit or checks.
- Handling pay schedules (e.g., weekly, bi-weekly, monthly).
2. Tax filing and compliance
Payroll providers ensure compliance with federal, state, and local tax regulations, including accurate withholding, reporting, and filing.
Includes:
- Withholding and remitting payroll taxes (federal, state, and local).
- Preparing and submitting quarterly and annual tax filings (e.g., 941, 940).
- Generating year-end tax forms (W-2 for employees, 1099 for contractors).
- Ensuring compliance with wage and hour laws.
3. Direct deposit and payment options
Automates the distribution of employee wages, making payments faster and more secure. This covers:
- Setting up direct deposit transfers for employees.
- Offering alternative payment methods like paycards or printed checks.
- Handling multiple bank accounts or splitting payments.
4. Employee self-service portals
Digital platforms where employees can access their payroll information, reducing administrative work for HR. This includes:
- Viewing pay stubs, tax forms (W-2s), and benefits information.
- Updating personal information such as addresses or banking details.
- Requesting time off and viewing time-off balances.
5. Time and attendance tracking
Time tracking tools that integrate with payroll systems to track employee work hours, overtime, and time-off balances.
- Time clock systems (physical or digital) for employee check-ins.
- Tracking overtime, holidays, paid time off (PTO), and sick leave.
- Syncing time and attendance data with payroll for accurate wage calculations.
6. Benefits administration
Some payroll companies offer benefits management services, integrating them into payroll to streamline deductions and reporting. This includes
- Managing employee benefits (e.g., health insurance, retirement plans, 401(k) contributions).
- Handling benefits deductions and employer contributions.
- Enrolling employees in benefit programs and managing annual open enrollment.
7. Garnishment and deductions management
Handling court-ordered wage garnishments or voluntary deductions like retirement plan contributions or health insurance premiums.
Includes:
- Calculating and withholding garnishments (e.g., child support, tax levies).
- Administering voluntary deductions (e.g., charity donations, health premiums).
- Ensuring legal compliance with garnishment limits and processes.
8. HR support and compliance
Some payroll providers offer additional HR services, helping companies manage compliance with labor laws and regulations. These can include
- Assistance with onboarding new employees and preparing documentation.
- Providing guidance on labor law compliance (e.g., Fair Labor Standards Act, OSHA regulations).
- Offering HR resources like employee handbooks or compliance audits.
9. Workers’ compensation and unemployment insurance management
Some payroll companies can help administer and file workers' compensation claims and manage unemployment insurance.
This includes calculating and paying workers’ compensation premiums, filing state unemployment insurance taxes, and managing claims and resolving disputes with state agencies.
10. Customizable reporting
Payroll providers often offer reporting features that provide insights into payroll, taxes, and overall HR data. This can be:
- Generating payroll reports (e.g., total labor costs, benefits summaries).
- Tax liability and compliance reporting.
- Custom reports for budgeting, audit preparation, and financial planning.
11. Onboarding and offboarding services
Some payroll providers will handle the process of adding new hires to payroll or removing former employees. For example:
- Handling new hire paperwork, setting up payroll, and ensuring tax compliance.
- Processing final paychecks, managing exit paperwork, and reporting to government agencies (e.g., COBRA compliance).
Payroll Service Vetting Checklist
1. Data security
☐ Encryption: Ensure the provider uses end-to-end encryption for sensitive payroll data.
☐ Compliance: Verify that the provider complies with data protection regulations (e.g., SOC 2, ISO 27001, GDPR if applicable).
☐ Access controls: Confirm they use multi-factor authentication (MFA) and role-based access to limit who can access payroll data.
☐ Data backup: Ask about data backup procedures and disaster recovery plans.
☐ Cybersecurity measures: Inquire if they have cybersecurity insurance or processes in place to manage breaches.
2. System reliability
☐ Uptime guarantee: Check if the provider guarantees a certain percentage of uptime (e.g., 99.9%) and what measures they have in place to prevent downtime.
☐ Mobile & desktop access: Ensure the system works seamlessly on both mobile devices and desktops for easy access to payroll data.
☐ Integration capabilities: Confirm the payroll system integrates with your existing software (e.g., HR, time-tracking, accounting systems).
☐ Scalability: Make sure the system can scale with your business as you grow or expand into new markets.
3. Customer service quality
☐ Response time: Ask about their average response time for payroll issues (e.g., same-day, next-day).
☐ Dedicated support: Check if they provide a dedicated account manager or point of contact for your company.
☐ Service hours: Confirm if support is available during your business hours, especially if you operate across multiple time zones.
☐ Training & resources: Inquire if they offer training for your team or provide self-service resources like FAQs, tutorials, or help desks.
☐ Client reviews: Look for client testimonials or reviews that highlight their customer service quality.
4. Compliance & tax expertise
☐ Tax filing accuracy: Verify if the provider handles federal, state, and local tax filings and guarantees accuracy.
☐ Legal compliance: Ensure they stay updated with payroll laws, wage regulations, and benefits requirements (e.g., multi-state payroll, international compliance).
☐ Liability coverage: Ask if they cover penalties and interest in case of tax filing errors caused by their team.
☐ Audit support: Confirm if they offer assistance during payroll tax audits or in the event of compliance investigations.
5. Cost transparency
☐ Clear pricing: Ask for a detailed breakdown of all fees, including setup costs, ongoing fees, and fees for additional services (e.g., filing taxes, issuing W-2s).
☐ Add-on costs: Check for any extra charges for services like multi-state payroll, benefits management, or handling garnishments.
☐ Contract flexibility: Ensure there is flexibility in the contract to add or remove services as your business needs change.
6. Ease of use
☐ User Interface: Test the software to make sure it’s user-friendly for both employees and administrators.
☐ Employee Self-Service: Confirm if employees can access pay stubs, W-2s, and update personal information through an online portal.
☐ Automation Features: Look for automation in tasks such as tax calculations, direct deposits, and time-tracking software integration.
7. Reporting and analytics
☐ Custom reports: Verify if the provider offers customizable reports (e.g., payroll summary, tax liabilities, labor costs).
☐ Real-time insights: Ensure you can access payroll data and analytics in real-time to support financial decision-making.
☐ Compliance reports: Ask if they provide reports that support compliance audits and tax filings.
Bonus: Other considerations
☐ Client retention: Ask about the provider’s client retention rate, which can indicate long-term customer satisfaction.
☐ References: Request references from other clients in your industry or of a similar size to understand their experience.
☐ Trial period: See if the provider offers a trial period or demo account so you can evaluate the service before committing.
To Outsource Or Not To Outsource
Ultimately, the decision to outsource payroll is based on your organizations’ unique needs and some due diligence around these.
Your payroll service provider of choice should be knowledgeable and well-versed in payroll compliance and have secure systems in place to properly store and manage employee data.
A good starting point is our pick of the best payroll companies.
It’s also beneficial to have frequent communication between the company and the payroll provider to ensure that the payroll is being processed as accurately and efficiently as possible.
