What Is a Deferred Profit Sharing Plan (DPSP)? How It Works
What Is a Deferred Profit Sharing Plan (DPSP)?
A deferred profit sharing plan (DPSP) is a Canadian employer-sponsored profit sharing plan intended to help employees save for retirement. The money in an employee’s DPSP account grows on a tax-deferred basis until withdrawal.
Key Takeaways
- A deferred profit sharing plan (DPSP) is an employer-sponsored profit sharing plan in Canada that is meant to help employees save for retirement.
- Employers that offer a DPSP may elect to share their profits with all or just a select group of employees.
- DPSPs are often used in conjunction with other types of employer-based retirement plans.
- DPSPs can be funded only with employer contributions. Employees themselves cannot contribute.
- Employer contributions are tax-deductible, while employees enjoy tax-deferred growth until they withdraw the money.
Understanding Deferred Profit Sharing Plans
DPSPs are a type of pension plan registered with the Canadian Revenue Agencybasically the Canadian version of the Internal Revenue Service (IRS) in the United States.
On a periodic basis, the employer shares profits from the business with all employees—or a designated group of them—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 until they later withdraw it from the DPSP.
An employer that offers a DPSP is referred to as the sponsor of the plan. The funds are managed by a trustee.
The money in an employee’s DPSP account grows tax-deferred, which can lead to bigger investment gains over time, due to the compounding effect. Employees can withdraw part or all of their vested funds prior to retirement even if they are still working for that employer. They can also transfer the money to another registered plan and maintain its tax-deferred status. Taxes are due only upon withdrawal.
How Deferred Profit Sharing Plans Work
- Contributions may be made only by employers. Employees cannot contribute.
- Contributions are tax-deductible to the employer.
- Individuals do not pay taxes on employer contributions until they withdraw the money.
- Investment earnings are tax-deferred, as well.
- Registered Retirement Savings Plan (RRSP) contribution limits are reduced by DPSP contributions.
- DPSPs are often combined with pension plans or a Group RRSP to provide employees with retirement income later in life.
- 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 transfer their DPSP money to another registered plan or use it to purchase an annuity, while maintaining its tax-deferred status. They can also cash out, though that would trigger a tax event with a tax payment required in the year they receive the money.
Deferred Profit Sharing Plans: Advantages for Employers
For employers, a deferred profit sharing plan paired with a group retirement savings plan can be a cheaper alternative to offering a traditional pension plan. Some of the positive attributes of DPSPs from an employer perspective are:
- Tax incentives. Contributions are paid out of pre-tax business income and are therefore tax-deductible for the employer. They are also exempt from both provincial and federal payroll taxes.
- Cost. DPSPs can be less expensive to administer than other pension plans.
- Flexibility. Employers can base their contributions on their profits for the year and are not required to contribute if they didn’t make a profit.
- Employee retention. DPSPs give employers a valuable tool to incentivize their best workers to stick around, since the contributions are subject to a two-year vesting period.
What Are the Contribution Limits on Deferred Profit Sharing Plans?
In 2022, the maximum allowable contribution to a Deferred Profit Sharing Plan (DPSP) is 18% of the employee’s compensation for the year or $15,390, whichever is less.
What Is a Registered Retirement Savings Plan (RRSP)?
A Registered Retirement Savings Plan (RRSP) is a type of defined contribution retirement plan, much like a 401(k) in the U.S.
RRSPs can be either individual plans or employer-sponsored group plans. In the latter case, the employer may also make matching contributions to the employee’s account.
What Happens if an Employee With a Deferred Profit Sharing Plan Dies?
If an employee with a Deferred Profit Sharing Plan (DPSP) dies, their surviving spouse or common-law partner can roll over the vested balance into a registered retirement plan of their own, while still keeping the account’s tax-deferred status. Other types of heirs will have to take the funds in cash and pay tax on them.
The Bottom Line
Deferred profit sharing plans (DPSPs) are a type of employer-sponsored retirement savings plan offered by some employers in Canada. DPSPs can be funded only by employers and the money in them grows on a tax-deferred basis until the employee eventually withdraws it.
