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Payroll Outsourcing Benefits & Best Practices

How to save time and money by outsourcing payroll functions to specialized service providers.

Alina Neverova
Global Talent Acquisition Expert
Contributing Experts
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The majority (73%) of organizations outsource some aspect of payroll. Why do companies do it? You may consider this process time-consuming, expensive, and not worth the effort. However, it is increasingly accepted.

In this article, we'll look at the benefits of outsourcing payroll functions and using payroll software, what to be wary of, and how you can make this process as smooth and rewarding for your company as possible.

What Does Outsourcing Pаyroll Mean?

If you outsource a particular business process to an external company, you use their services as an outsourced provider. The pros are that you don't have to build a similar function within your company, especially if it requires resources you don't have (such as people, expertise, or time).

Payroll providers, specifically, are external service providers who manage your company’s payroll needs and related processes, such as:

  • calculating bonuses, employee rewards, еtc;
  • setting up and monitoring direct deposits;
  • deducting the correct amount of payroll taxes, tax filing, and maintaining the necessary documentation;
  • managing employee benefits such as health insurance, retirement plans, etc;
  • ensuring your process complies with аll relevant labor, pay periods, employer tax regulations, liabilities, and requirements; 
  • preparing and mailing annual tax documents such as W-2s and 1099s;

If your company does not have the expertise to manage these functions internally, it can lead to payroll errors and resulting penalties. Outsourcing is a great alternative to avoid risk and keep peace of mind.

Ways to Outsource Payroll

Outsourcing Model Control Level Flexibility Cost Efficiency Expertise Access Best For
Full Outsourcing Low Low High High Businesses looking to fully offload payroll responsibilities to focus on core operations.
Co-Sourcing Moderate High Moderate Moderate Companies that want to retain some payroll tasks in-house while outsourcing complex functions.
Hybrid Models High Very High Varies Customizable Organizations with specific needs that require a tailored mix of in-house and outsourced payroll functions.
Managed & Operate Services Low to Moderate  Moderate to High High  High Businesses seeking strategic enhancements in payroll through technology and innovation, with some level of outsourced management.

Full Outsourcing

In this form of payroll outsourcing, a third-party vendor takes care of all aspects of the payroll process. Companies that choose full outsourcing receive the maximum level of expertise and support. The payroll solution vendor manages every detail, from distributing paychecks to tax withholding and compliance monitoring for their client company.

This model brings many benefits for companies that want to redirect their internal resources to their core business fully. It also makes sense for small business owners to outsource these functions so that it is professionally handled without reducing in-house capacity. Full outsourcing also allows companies to reduce the risk of errors since they run payroll and tax payments via a dedicated specialist.

Co-Sourcing

Co-sourcing is a collaborative model in which some payroll tasks are outsourced to a payroll specialist while others remain in-house. This model is flexible and allows companies to retain control over the parts of the payroll process that they prefer to manage directly, such as payroll data entry or final approvals.

This can be an effective strategy for organizations that want to leverage outside expertise without completely relinquishing control of their payroll operations. For companies not ready to fully outsource their payroll responsibilities, this approach allows them to leverage the expertise of a payroll service provider.

Hybrid Models

You may choose a hybrid approach, combining full outsourcing and co-sourcing elements to meet their specific needs. For example, a company may fully outsource processing payroll, but retain in-house capabilities to develop payroll and employee survey strategies.

Hybrid models provide flexibility, which allows companies to customize the outsourcing agreement to meet their unique operational requirements and strategic goals. This can be particularly useful for businesses with an inconsistent number of employees, as it allows payroll solutions to scale, adapting to the size and needs of the company.

Managed Services and Operate Services

We’ve seen a growing interest in managed services and operational services. These models emphasize the strategic enhancement of payroll functions through advanced technologies and practices.

Managed services often include comprehensive payroll management, supplemented by analytics and employee data analysis, while operational services focus on outcomes and innovation in the payroll process. This form could include HR (Human Resources) processes such as hiring, onboarding, and workers' compensation management, further reducing the burden on internal teams.

Benefits of Outsourcing Payroll

Technology and Expertise

Payroll providers use the latest software and automation systems, so you get the benefits of advanced technology without the high cost of setting up your own IT infrastructure. These state-of-the-art systems ensure that your payroll is accurate, efficient, secure, and compliant with all the latest tax regulations.

Employees also benefit from a payroll solution offering an enhanced employee experience. For example, the payroll system may provide a self-service portal where employees can personally manage their bank account details and benefits administration.

Cost Effectiveness

Payroll outsourcing can help you save money on оperations and staffing. Because a payroll solution can remove various HR services from your in-house team’s daily tasks (or at least streamline them), your cost savings manifest in increased productivity and fewer errors.

It will allow your team to focus on what they do best — growing your business.

Compliance

Compliance with payroll laws and regulations can be a labor-intensive process. The good news is that global payroll solutions providers are experts at navigating this field. They stay on top of all the latest regulations so you don't have to comply, reducing the risk of mistakes and hefty fines for your company.

Scalability

Do you need to expand your team quickly? A good provider can easily increase or decrease staff to accommodate changes in headcount or payroll frequency.

Data Security

Payroll service providers invest heavily in top-notch technology and security protocols to keep your employee information safe. Already, more than 81% of business owners trust their cybersecurity to such companies.

An employee holding the paycheck they received from an outsourced payroll provider.

Risks of Outsourcing Payroll

Delegating labor-intensive processes to other companies is good for the growth of your business, but there are possible risks. Below are а few of them, as well as approaches to preventing them:

Relinquishing Control

You're handing over control of a critical function to a payroll outsourcing company, which raises concerns about losing control of vital data and processes.

Find a flexible partner: Choose a company that offers customizable solutions and informs you about their processes. Regular communication and detailed payroll reports will help you maintain control and stay updated on changes, trends, and approaches.

Data Security

Any given piece of employee data is confidential. Therefore, there is a risk of losing or disclosing this data through the partner company.

Security First: When choosing a contractor, look for features such as data encryption, secure file transfers, and regular security audits.

Non-Compliance

There is a risk that the payroll provider you outsource to is not always up to date with all changes, which can lead to tax compliance issues for your business.

Local experience matters: Choose a payroll provider that is well-established in your region. They should demonstrate a thorough understanding of local laws and regulations. Ask for references and reviews from business partners, familiar business owners, or their current customers.

Customer Service

The quality of service you can expect from payroll providers varies. Choosing an incompetent provider can lead to payroll mistakes in processing, delayed payments, or a lack of proper support when you need it.

Set clear expectations: Establish clear service level agreements (SLAs) that outline the expected quality of service, turnaround time, and the expected responsiveness to your needs. Check their performance regularly, and don't forget a backup plan (in the form of an alternate payroll solution) to reduce this risk further.

Dependency

Working with a payroll outsourcing provider for long periods can lead to dependency.  Moving over to a new payroll solution or bringing payroll back in-house can negatively affect the business. Your team may not know enough about the process to take it on themselves or relay details to another provider.

Keep up to date: Don't rely entirely on аn external payroll partner; maintain a basic understanding of the process, and request regular updates. Include flexible terms in the partnership agreement, such as clear termination clauses and data recovery procedures.

Payroll Outsourcing Best Practices

Choose Your Provider Carefully

Ask the payroll provider for case studies and testimonials highlighting their commitment to service excellence before signing with them. The right payroll service provider for your company would likely be commonly used within your industry. Ask business connections who they consider to be the best payroll solution, which payroll software or service vendors they’ve moved away from, and why.

Don't hesitate to back out if a partner doesn't meet your expectations.

Establish Detailed Service Level Agreements (SLAs)

Agree on service levels during the initial phases of vendor negotiations so you don't waste time and money searching for a new provider later.

If you outsource payroll to a professional employer organization (PEO), for example, they would offer other HR services besides payroll. Be clear about what you expect the service provider to handle and what your in-house team will provide. Establish customer service expectations as well. How would your team lodge a query, how soon will it be resolved, how many hours of system support can you expect per month, who is your point person, etc?

Maintain a Backup Plan

Avoid a situation where your company is totally dependent on a payroll provider.

You can keep a “backup” plan in effect by maintaining records (with adequate security measures), keeping in-house payroll abilities up to date, and earmarking other vendors with good payroll systems in case you need to move over quickly.

Final Thoughts on Outsourcing Payroll

Outsourcing specific processes is an important strategic decision for any business. It can bring many benefits, such as time savings and cost savings. It is about freeing up valuable company resources, such as people and their expertise, as well as relying on proven experience and professionalism that can be trusted.

However, as we have already found, payroll outsourcing services are not without pitfalls. In this article, we have considered not only the possible risks but also methods of preventing them if you are discerning in your choice of payroll provider.

Alina Neverova
Global Talent Acquisition Expert
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Alina Neverova is a Global Talent Acquisition Expert with over six years of experience in recruiting. Alina has worked with top international companies from the Fortune 500 list, starting her career in a recruiting agency before moving into IT 4 years ago.

Alina has successfully built recruiting processes from scratch, hired over 120 specialists in two years for an IT startup, and built a strong recruiting team. Her areas of expertise include building hiring strategies, training recruiting teams, hiring planning, automating sourcing processes, utilizing AI in HR and recruiting analytics.

She holds a Bachelor's degree in Administrative management from the National University of Life and Environmental Sciences of Ukraine

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