True or false? If you adopted a 401(k) plan offered by a U.S. prototype vendor, you can leave compliance entirely up to the vendor. You may be surprised to know that the answer is “false”.

An easy way to quickly adopt a U.S. tax-qualified savings plan, “prototype 401(k) plans” are marketed by mutual fund families, financial institutions and insurers and have become a popular way for U.S. employers to adopt 401(k) plans without being responsible for satisfying complicated and changing legal requirements. Or so the employers who adopted these plans assumed based on marketing material from the vendors.

However, there is no such thing as a tax-qualified retirement or savings plan that runs itself correctly without employer involvement. Even if the vendor promises to create required reports and filings for the plan, you are still responsible for compliance with some plan documentation requirements and for correct plan operations.

  • Periodic amendments to prototype plans are required to maintain their tax benefits, typically even if the marketing vendor has reserved the right to make unilateral plan compliance amendments. For example, “good faith” amendments to reflect the Pension Protection Act of 2006 were required for calendar year plans by December 31, 2009. Did you or your vendor adopt them? If not, you are a “non-amending” employer and are subject to penalties. In fact, another important amendment deadline is looming on April 30, 2010 for employers that adopted prototype 401(k) plans, and your failure to act by that date will jeopardize the plan’s tax qualified status. Failure to timely sign new amendments may lead to costly audit problems or require a special correction filing with the IRS if you are lucky enough to catch the problem before the IRS does. Failure to file for IRS approval of these amendments by April 30 could also limit your reliance on the vendor’s IRS approval letter for your plan.
  • Some employers become late in depositing employee contributions (the safe harbor for small plans requires deposit within seven business days). Delinquent deposits are a particular target of U.S. Department of Labor audits, but may be corrected under an official correction program if self-discovered.
  • Prototype 401 (k) plans may still require annual testing for discriminatory coverage or benefits. Any testing done by the vendor is only as good as the data you send over. If you do not understand the testing rules, you might not provide all of the required employment data, and your prototype vendor will not be responsible for resulting testing errors.

This is a good time for employers to check to see whether all prototype requirements have been satisfied by taking the plan off “auto-pilot” and conducting a prototype plan check-up. Most important of all, to steer clear of potentially costly qualification problems in the future, employers need to disabuse themselves of the myth of the “hands off” prototype plan.