What is a Deferred Profit-Sharing Plan?

With the mounting cost of living pressure, many Canadians struggle to save for retirement. A survey reveals almost 43% of Canadians are not confident they can retire when they originally planned.

Between paying the monthly rent (or mortgage installment), ensuring dedicated rainy day savings, and settling monthly credit card bills, saving for retirement often proves very difficult.

This is where a deferred profit-sharing plan (DPSP) can give you a leg up. A 100% employer-sponsored retirement plan, a DPSP can nicely supplement your other retirement savings plan, ensuring you won’t be left wanting in old age.

Additionally, a DPSP can be combined with a group retirement savings plan to offer employers a cost-effective retirement savings solution. In the event of an employee's death, surviving spouses can roll over the funds into a retirement plan without immediate tax consequences. Still, other beneficiaries must cash out the funds and pay tax on them.

Deferred Profit Sharing Plan

A Deferred Profit Sharing Plan (DPSP) offers your employer an effective way to help you build a retirement fund. Think of it as a retirement plan in which your employer shares a portion of the company’s profits. The money in your account grows tax-deferred, meaning you won’t pay taxes on the contributions made by your employer until you withdraw the funds.

Some key details about DPSPs are:

• Only your employer can contribute to your DPSP
• Annual contributions vary from one year to another and are at your employer’s discretion
• You can’t contribute to your DPSP but may have control over how the money parked in it is invested
• DPSP contributions are tax-deductible for your employer and are not regarded as income to you at the time the contributions are made; investment earnings are tax-deferred
• Contributions to your DPSP reduce your next year’s RRSP contribution room

How do Employer Contributions Work in Deferred Profit Sharing Plans?

Regarding retirement saving plans, DPSPs are pretty easy to understand.

Here’s how they work:

• Your Employer contributes every year. An employer decides whether to set up a DPSP for its employees. They can set up a DPSP for all or some employees. Since a company’s profits may vary from year to year, the amount deposited into your DPSP may differ each year. Employers have a 120-day window after the end of a financial year to make DPSP contributions. These contributions are tax-deductible for the employer.
• Employees may decide how to invest their DPSP funds. As an employee, you may have a say in how the money in your DPSP is invested. You may be able to invest in various funds, bonds, or stocks, but some plans require the participants to purchase company stock with their DPSP funds. This can limit investment control and diversification.
• There may be a vesting period. Some DPSP plans have a vesting period; others don’t. The vesting period is typically a maximum of two years. If your plan has a vesting period and you leave the company before that period ends, you may not be able to take your DPSP with you.
• You can withdraw funds after the vesting period is over, subject to the plan’s details. Once the vesting period is over, you can withdraw DPSP funds anytime. Keep in mind your employer may impose certain restrictions on early withdrawals. For example, your employer may let you withdraw only up to a certain percentage before retirement. DPSP withdrawals are subject to taxation at your current marginal rate in the year of distribution. Given this fact, it makes sense to withdraw funds after retirement because you will be subject to lower rates then.
• You can transfer the funds to your RRSP (or other registered plan). If you choose to do so, tax will be deferred until you access the money.
• Contributions to your DPSP affect your RRSP contribution room the following year. For example, if your employer deposits $2,000 to your DPSP in 2024, your contribution room for 2025 will be reduced by $2,000.

Employer Contributions and Tax Benefits

Employer contributions to a Deferred Profit Sharing Plan (DPSP) are a generous benefit for employees and a smart financial move for employers. These contributions are tax-deductible, meaning employers can reduce their taxable income and save on federal payroll taxes. In addition, the tax incentives provided by the Canada Revenue Agency (CRA) make it a cost-effective way for businesses to provide retirement benefits.

Beyond the tax advantages, offering a DPSP can be a powerful tool for attracting and retaining top talent. By demonstrating a commitment to employees’ financial well-being, employers can gain a competitive edge in the job market. This commitment can foster loyalty and long-term employment, benefiting the company and its workforce.

DPSP vs. Other Retirement Plans

When comparing a Deferred Profit Sharing Plan (DPSP) to other retirement savings options, several key differences stand out. A DPSP is an employer-sponsored plan, meaning only employers can make contributions. In contrast, a Registered Retirement Savings Plan (RRSP) allows contributions from both employers and employees, with employees enjoying tax-exempt contributions.

Another distinction lies in the tax treatment of contributions. For a DPSP, contributions are tax-deductible for the employer but not for the employee. On the other hand, RRSP contributions are tax-deductible for the employee, providing immediate tax relief.

A DPSP also differs from a Profit Sharing Plan (PSP). While both plans allow employers to share profits with employees, a PSP is not registered and does not offer tax-exempt contributions. In contrast, a DPSP is a registered plan, ensuring that employer contributions are tax-exempt, making it a more attractive option for both parties.

What are the Advantages of DPSP for employees?

The deferred sharing profit plan offers the employer and employee several benefits. 

Advantages for the Employer

• Cost-effective: A DPSP costs less to set up and manage than other registered plans. 
• Greater flexibility: Employers can make contributions when they can afford to. If a company is not having a good year, it may choose not to make any DPSP contributions that year. The employer also decides how much each employee will receive in their DPSP account. For example, the employer may distribute the profits equally among its employees. It may also determine that each employee will receive a specific percentage of their annual salary, up to a certain amount. 
• Contributions are tax-deductible. The employer can contribute to a DPSP without worrying about receiving a tax bill from the Canada Revenue Agency. 
• Employee retention: DPSP encourages employees to stay with the company long-term. If an employee leaves the company before the vesting period ends, he or she will have to forfeit the funds. 

Advantages for the Employee

• Funded entirely by the employer: You are not required to set aside funds for your DPSP as an employee. 
• DPSP money grows tax-deferred: This, in turn, allows you to potentially accumulate more money as it is not depleted by taxes each year.  
• Early withdrawals: Participants can withdraw money from their DPSPs after the vesting period, which is no longer than two years. 
• Transfer funds to your RRSP: You can transfer DPSP funds to an RRSP or some other registered account, and the money will continue to grow tax-deferred. 

What are the disadvantages of DPSP?

Despite being a free-of-cost retirement savings plan for employees, a DPSP has certain drawbacks. However, that doesn’t mean you shouldn’t sign up if it’s available. Instead, you shouldn’t depend solely on it to fund your retirement. Supplement your DPSP with other registered savings plans, such as an RRSP, and you’ll be fine. 

• Vesting Period: You may need to stay with the company for a certain period to access the money in your DPSP. 
• Irregular payouts: Your employer may not make a DPSP contribution every year. 
• Not available to every employee: Employees with more than a 10% stake in the company, as well as company owners, their spouses, and relatives, are ineligible for DPSP. 
• Affects Your RRSP Contribution Room: DPSP contributions create a Pension Adjustment on your T4. If your employer deposits some money into your DPSP, you will have fewer RRSP contribution rooms next year. 

Plan Administration

The administration of Deferred Profit Sharing Plans (DPSPs) involves several key roles to ensure smooth operation and compliance with regulations. A trustee is appointed to manage the plan’s assets and ensure it adheres to the Canada Revenue Agency’s (CRA) guidelines. The trustee’s responsibilities include overseeing investments, maintaining accurate records, and providing plan members with essential information about their accounts and investment options.

In addition to the trustee, a plan administrator may be designated to handle the day-to-day operations of the Deferred Profit Sharing Plan (DPSP). This role includes processing contributions, managing withdrawals, and offering customer service to plan members. The trustee and plan administrator ensure that the Deferred Profit Sharing Plan (DPSP) runs efficiently and complies with all regulatory requirements.

Contribution Limits and Rules

The Canada Revenue Agency (CRA) sets specific contribution limits for Deferred Profit Sharing Plans (DPSPs). For 2024, the maximum allowable contribution is 18% of the employee’s compensation for the year or $16,245, whichever is less. These limits apply to employer donations, as a DPSP does not permit employee contributions.

Employer donations must be made in cash and within a designated timeframe after the plan year's end. This ensures that contributions are timely and comply with CRA regulations. By adhering to these rules, employers can maximize the benefits of their DPSP contributions while ensuring compliance with tax laws.

Legislative and Administrative Requirements

To be registered with the Canada Revenue Agency (CRA), a Deferred Profit Sharing Plan (DPSP) must meet several legislative and administrative requirements. The plan must be documented in writing and signed by the employer. It must also be registered with the CRA and administered by their regulations.

The plan must provide benefits to members in line with the Income Tax Act. Additionally, a DPSP must comply with relevant laws and regulations, such as the Pension Benefits Standards Act and the Employment Insurance Act. By meeting these requirements, a DPSP ensures that it operates legally and provides the intended benefits to its members.

Conclusion

A DPSP is an employer-sponsored retirement plan that accumulates gains on a tax-deferred basis. It is 100% funded by your employer, but there’s no minimum annual contribution limit. Depending on your plan, you may be unable to choose how this money is invested. While a DPSP doesn’t cost you a thing, it does affect your RPSP contribution limit. Not all Canadian employers offer a DPSP to their employees, but if your employer does, sign up for it. 

Reach out to a Dundas Life licensed advisor today to help you find the right Deferred Profit Sharing Plan for you.

FAQs

What’s the difference between RRSP and DPSP? 

While both are retirement plans, the two have some critical differences. Firstly, RRSP contributions are based on the annual income, whereas DPSP contributions are made by your employer. Secondly, RRSPs don’t have a vesting period, but DPSPs usually do. Thirdly, you can share RRSP contributions with your spouse through a spousal plan. DPSPs, however, don’t have any such provision. 

How much money can be put into a DPSP in a year?

In 2024, the annual max for a DPSP is 18% of the employee’s annual salary or $16,245, whichever is less. 

Who’s eligible for a DPSP?

Employees are eligible for a DPSP if they (a) are not an owner or a spouse or relative of an owner and (b) do not own more than 10% of the company’s stocks.