What Is a Deferred Profit Sharing Plan (DPSP)?
A deferred profit sharing plan (DPSP) is an employer-sponsored Canadian profit sharing plan that is registered with the Canadian Revenue Agency, which is basically the Canadian version of the Internal Revenue Service (IRS) in the United States.
- A deferred profit sharing plan (DPSP) is an employer-sponsored Canadian profit sharing plan used for retirement savings among employees.
- DPSPs are often used in conjunction with other retirement plan options.
- Rather than contributing their own funds, employees in a DPSP receive a pro-rata portion of the company's profits, which are then invested in a tax-free account.
- Employer contributions are tax-deductible, while employees enjoy tax-deferred growth.
Understanding Deferred Profit Sharing Plans
DPSPs are a type of pension fund. On a periodic basis, the employer shares the profits made from the business with all employees or a designated group of employees through the DPSP. Employees who receive a share of the profits paid out by the employer do not have to pay federal taxes on the money received from the DPSP until it is withdrawn.
An employer that chooses to participate in a DPSP with some or all of its employees is referred to as the sponsor of the plan. Employees who are granted a share of the profits are the trustees of the plan. Employees who participate in a deferred profit sharing plan see their contributions grow tax free, which can lead to bigger investment gains over time, due to the compounding effect. They can access the funds prior to retirement; funds may be withdrawn partly or in their entirety within the first two years of membership. Taxes are then paid upon withdrawal.
Deferred Profit Sharing Plans: Key Points
- Contributions are tax deductible to the employer; individuals do not pay taxes on contributions until money is withdrawn.
- Investment earnings are tax sheltered; individuals do not pay tax on earnings until a withdrawal.
- Registered Retirement Savings Plan (RRSP) contribution limits are reduced by DPSP contributions made the year before. The RRSP is a national retirement savings account available to Canadian citizens. They are the equivalent of the U.S. Federal Thrift Savings Plan, though that plan is only open to Federal government employees.
- DPSPs are often combined with pension plans or a Group RRSP to provide employees with retirement income.
- Most plans allow individuals to decide how their DPSP money is invested, though some companies may require employees to purchase company stock with their contributions.
- When an individual leaves an employer, they can move their DPSP money to an RRSP or a Registered Retirement Income Fund (RRIF), or use it to buy an annuity. They can also cash out, though that would trigger a tax event with a tax payment required in the year the money was received.
Deferred Profit Sharing Plans and Employers
For employers, a deferred profit sharing plan paired with a group retirement savings plan can be a cheaper alternative to a defined contribution plan. Some of the positive attributes of DPSPs include:
- Tax incentives: Contributions are paid out of pre-tax business income and are therefore tax deductible and exempt from both provincial and federal payroll taxes.
- Cost: DPSPs can be a cheaper alternative to administering a defined contribution plan.
- Employee retention: DPSPs give employers a valuable tool in helping ensure that their best talent is incentivized to stick around (such plans are tied to company profits and are subject to a two-year vesting period).