A Deferred Profit Sharing Plan (DPSP) is a Canadian employer-sponsored profit-sharing plan designed to help employees accumulate retirement savings. Contributions from the employer grow on a tax-deferred basis until they are withdrawn by the employee.
Key Takeaways:
- A Deferred Profit Sharing Plan (DPSP) is aimed at assisting Canadian employees in saving for retirement through employer contributions.
- Employers may choose to share their profits with all or only select employees through this plan.
- These plans can work in conjunction with other employer-based retirement plans without overlapping contributions from employees.
- Only employers fund DPSPs. Employee contributions are not permitted.
- Employer contributions to DPSPs are tax deductible, while employees benefit from tax-deferred growth until withdrawal.
Understanding Deferred Profit Sharing Plans (DPSPs)
DPSPs serve as a specialized pension plan enrolled with the Canada Revenue Agency (CRA), similar to the IRS in the U.S. Periodically, employers distribute a portion of their profits to their employees via the DPSP. Employees do not pay federal taxes on these contributions until they withdraw the funds from the DPSP.
An employer offering a DPSP is referred to as the sponsor of the plan, and these funds are managed by a trustee. Tax-deferred growth in an employee’s DPSP account potentially offers substantial investment gains over time thanks to compounding. Employees can withdraw their vested funds prior to retirement or transfer the money to another registered plan to retain its tax-deferred status. Taxes are applicable only upon withdrawal.
How Deferred Profit Sharing Plans (DPSPs) Work
- Contributions are exclusive to employers; employees are not allowed to contribute.
- Employer contributions are tax-deductible.
- Employees experience tax-deferred growth on employer contributions until withdrawal.
- Investment earnings within the DPSP account are tax deferred.
- Contributions to Registered Retirement Savings Plan (RRSP) limits are adjusted based on DPSP contributions.
- DPSPs are often paired with pension plans or Group RRSPs to aid employees in ensuring adequate retirement income.
- Employees typically have autonomy over investment decisions within their DPSP accounts, although some employers might require investments in company stock.
- Upon leaving an employer, employees can either transfer their DPSP funds to another registered plan, purchase an annuity, or cash out—bearing in mind that cashing out will result in a taxable event and tax payments for that year.
Deferred Profit Sharing Plans (DPSPs): Advantages for Employers
For employers, combining a DPSP with a group retirement savings plan can be a cost-effective alternative to traditional pension plans. Some advantages include:
- Tax incentives: Employers benefit from tax deductions on contributions and are exempt from provincial and federal payroll taxes.
- Cost: Administering a DPSP is generally less costly compared to other pension plans.
- Flexibility: Employer contributions are tied to profitability and are not mandatory unless profits exist.
- Employee retention: Two-year vesting periods in DPSPs incentivize employees to remain with the company, improving retention of top talent.
Contribution Limits for Deferred Profit Sharing Plans (DPSPs)
As of 2022, the contribution limit for a DPSP is the lesser of 18% of the employee’s compensation for the year or $15,390.
What Is a Registered Retirement Savings Plan (RRSP)?
RRSPs, similar to 401(k) plans in the U.S., are another form of designed contribution retirement plan in Canada. These can be individual plans or employer-sponsored group plans, with possible employer matching contributions.
Handling the Death of an Employee with a Deferred Profit Sharing Plan (DPSP)
If an employee with a DPSP passes away, the surviving spouse or common-law partner can roll over the vested balance into their own registered retirement plan, maintaining the tax-deferred status. Other heirs will need to take the funds in cash and pay tax upon receipt.
The Bottom Line
Deferred Profit Sharing Plans (DPSPs) offer Canadian employees a valuable, employer-funded retirement savings plan. These contributions grow tax-deferred, providing substantial financial growth opportunities until they are eventually withdrawn.
Related Terms: Registered Retirement Savings Plan (RRSP), defined contribution plan, vesting, annuity.
References
- Government of Canada. “Register a Deferred Profit Sharing Plan—Overview”.
- Government of Canada. “Payments from a Deferred Profit Sharing Plan”.
- Government of Canada. “Pension Adjustment Guide”.
- Government of Canada. “Contributing to a Deferred Profit Sharing Plan”.
- Government of Canada. “What’s New”.
- RBC Wealth Management. “Pensions Part 3—Deferred Profit Sharing Plans”.
