Prototype Plans
Prototype plans are pre-approved plans by the Internal Revenue
Service under the Master and Prototype program. A Master and
Prototype consists of a basic plan document and an adoption
agreement. The basic plan document contains all the non-elective
provisions. The adoption agreement contains the options which may be
selected by elective provisions and options which may be selected by
the adopting employer. A Master and Prototype may be standardized or
non-standardized.
An employer who uses a prototype plan completes an
adoption agreement to elect options which are detailed in a separate
plan document. An employer has the choice of using a “standardized”
or “nonstandardized” adoption agreement. If a standardized adoption
agreement is properly completed, further IRS approval of the plan is
usually unnecessary. A nonstandardized adoption agreement allows
additional options, but is not automatically qualified. A
nonstandardized adoption should be submitted to the IRS for
approval.
An advantage of a prototype plan is that the initial cost may be
lower since the plan is established by merely completing the
adoption agreement, as opposed to drafting specific plan provisions.
Similarly, when a plan is updated to reflect a change in tax laws,
the document will be amended by the sponsor for all employers,
eliminating the need to amend each plan separately. (However, a new
adoption agreement for each employer will be necessary.) Finally, an
employer who adopts a standardized plan usually incurs no cost in
having the plan approved by the IRS. Employers who adopt a
nonstandardized prototype plan pay a fee to the IRS, plus fees for a
plan professional to complete and submit the approval application
which may defeat one of the purposes of using a prototype plan in
the first place.
The main disadvantage of adopting a prototype plan is that the
employer is limited to the options set forth in the adoption
agreement. In most cases the adoption agreement cannot be modified
to fit unique needs or desires of the employer. Often, the initial
savings achieved by adopting a prototype plan will be quickly offset
by the cost to the employer of certain provisions included in the
prototype plan. For example, a standardized prototype plan must
provide contributions for all participants who have completed at
least 500 hours during the plan year, even if they terminate before
year end. If an employer contributes 10 percent of pay to a
standardized plan, a terminated employee who earned $40,000 while
working at least 500 hours during a plan year will receive $4,000.
If the employer adopted an individual plan, contributions would not
be required. In this situation, the prototype plan will be much more
expensive if only one or two participants terminate employment. If
an employer experiences considerable turnover, the additional
expense can be tremendous.
Another disadvantage is that a prototype plan can be difficult to
work with. The employer must review both the adoption agreement and
the separate plan document to determine the actual terms of its
plan. Both documents (and usually the summary plan description) will
include provisions not applicable to that specific employer. Other
disadvantages include: (i) the plan is often designed to protect the
interests of the sponsor rather than the employer; (ii) the
documents may be prepared and administered by individuals who are
unfamiliar with legal requirements and design options for qualified
plans; (iii) the employer may not have a local contact person to
help with questions regarding the administration of the plan; (iv)
the document is often provided at low cost to obtain the investment
business, but savings may be offset by higher management or record
keeping fees, and (v) a new plan has to be adopted each time the
employer wants to change investment companies. While a prototype
plan may be appropriate for an employer, initial cost savings must
be weighed against some significant future costs and disadvantages.
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