What is a deferred profit sharing plan (DPSP)?
A deferred profit sharing plan (DPSP) is a Canadian employer-sponsored profit sharing plan that is registered with the Canada Revenue Agency, which is essentially the Canadian version of the Internal Revenue Service (IRS ) in the USA.
Key points to remember
- A Deferred Profit Sharing Plan (DPSP) is a Canadian employer-sponsored profit sharing plan used for employee retirement savings.
- DPSPs are often used in conjunction with other pension plan options.
- Rather than contributing to their own funds, employees of a DPSP receive a proportionate share of the company’s profits, which are then invested in a tax-free account.
- Employer contributions are tax deductible, while employees benefit from 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 by the business with all employees or a designated group of employees through the DPSP. Employees who receive a share of the benefits paid by the employer do not have to pay federal tax on the money received from the DPSP until it is withdrawn.
An employer who chooses to participate in a DPSP with some or all of their employees is called a plan sponsor. The employees who receive a share of the benefits are the plan trustees. Employees who participate in a deferred profit sharing plan see their contributions increase tax free, which can lead to greater investment gains over time, due to the cumulative effect. They can access funds before retirement; funds may be withdrawn in whole or in part during the first two years of membership. Taxes are then paid upon withdrawal.
Deferred profit sharing plans: key points
- Contributions are tax deductible for the employer; individuals do not pay tax on contributions until the money is withdrawn.
- Investment income is tax sheltered; individuals do not pay income tax before a withdrawal.
Contribution limits to a registered retirement savings plan (RRSP) are reduced by contributions to the DPSP paid the previous year. The RRSP is a national retirement savings account accessible to Canadian citizens. They are the equivalent of the United States Federal Thrift Savings Plan, although this plan is only open to employees of the federal government.
- DPSPPs 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, although some companies may require employees to purchase shares of the company with their contributions.
- When an individual leaves an employer, they can transfer their money from the DPSP to an RRSP or a registered retirement income fund (RRIF), or use it to buy an annuity. They can also withdraw money, even if it 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 combined with a group retirement savings plan may be a cheaper alternative to a defined contribution plan. Some of the positive attributes of DPSP include:
- Tax incentives: contributions are paid on business income before tax and are therefore tax deductible and exempt from provincial and federal payroll taxes.
- Cost: DPSPs can be a cheaper alternative to administering a defined contribution plan.
- Employee retention: DPSPs offer employers a valuable tool to ensure that their best talents are encouraged to stay (these plans are linked to company profits and are subject to a two-year vesting period).