Many Canadian employers have set up group RRSPs for their employees. The Deferred Profit Sharing Plan (DPSP) is a less well-known retirement savings plan that can be a good option for companies wanting to help their staff save for retirement.
If you’re an employer, we’ll explain in this post the key advantages and disadvantages of the two plans. If you’re an employee, we’ll discuss the differences and how these may have an impact on your retirement saving options.
What is a Deferred Profit Sharing Plan (DPSP) in Canada?
This is an employee profit sharing plan to help them save for retirement. As the name suggests, employers contribute a share of profits to the plan. In a good year, they may contribute a sizable amount. However, if there are no profits, or minimal profits, the employer may decide not to give any money.
What is a Registered Retirement Savings Plan (RRSP)?
Most people know how an RRSP works. A Group RRSP set up by an employer is similar but several rules apply. It is established and administered on a group basis by the employer, with contributions being deducted from employee pay.
Sometimes employers match contributions made by employees. There is often a limit to how much an employer will contribute, such as 5 percent of an employee’s earnings. For example, if a team member earns $50,000 per year, the limit would be $2,500. In a Group RRSP, contributions by employers are taxable for employees.
If you are really lucky, your employer will set up both a DPSP and Group RRSP for you.
How does a DPSP work?
The plan must be registered with the Canada Revenue Agency. Only the employer can set up a plan. It has the option of establishing it for all employees or just certain ones.
Each DPSP has trustees (who must be residents of Canada) who are responsible for overseeing the plan.
Every employee can select his or her investment vehicles. So if you are a low-risk investor, you can choose conservative investments. Sometimes a company may require that you invest part of the funds in company shares.
Whatever investment choices you make, your earnings are tax sheltered. You will not pay any tax on investment growth until you make a withdrawal. This is one of the key advantages of a DPSP.
The Canada Revenue Agency has a lot of rules that must be followed when establishing and running a DPSP. So, if you are considering opening one be sure to visit their website for details.
What are the advantages of a DPSP?
For the employer:
- Can claim a tax deduction for contributions
- Can require that employees remain with the company for up to two years in order to receive their contributions. If an employee leaves the firm before then, the contributions are returned to the company. This helps with employee retention.
- Can halt contributions if there are no profits or reduced profits.
For the employee:
- Do not contribute to the plan. The DPSP is only made up of funds from the employer
- Contributions are tax-deferred. Employees only pay tax when they make a withdrawal
Disadvantages of a DPSP
For an employee, the DPSP may require that you be “vested” (be with the company for up to two years) in order to keep the money.
For employers, there can be challenges:
- Company owners or those who own more than 10 percent of the shares cannot participate in DPSPs
- There are a lot of government rules that must be followed
Does a DPSP affect an RRSP?
Not directly. However, if you have both a DPSP and a personal RRSP there may be an impact on how much you can contribute to your RRSP. The contributions to your DPSP are counted as part of your RRSP room. This is known as “pension adjustment” and will reduce the amount that you can put in your RRSP. This is another disadvantage of a DPSP.
How do I make a DPSP withdrawal?
As mentioned, your plan may restrict you from making any withdrawals for up to two years. Check on the exact rules for “vesting” your money in your particular employee profit sharing plan.
Once your funds are vested, you can withdraw funds if desired. However, the Canadian government will impose a withholding tax every time you make a withdrawal. So, it’s much better to have a Tax Free Savings Account (TFSA) that you can use for emergencies. With a TFSA, you will not face any tax withholding.
When you retire, you have similar options to making withdrawals from your RRSP. You can take out all the money – although the tax hit will be very large. Instead, you may wish to convert it to a Registered Retirement Income Fund (RRIF) or purchase a retirement annuity.
Employee profit sharing plan
What’s the difference between a DPSP and an employee profit sharing plan? Basically, it’s the tax treatment. If your company has an employee profit sharing plan and pays out at the end of the year based on how much money was made during the year, this income will be taxable immediately. Your employer will deduct tax from this payment, just as it would for your regular salary. On the other hand, a DPSP allows you to defer taxes on the payout.
It's more work to set up a DPSP than to simply pay out a share of profits. Therefore, your employer may prefer to simply cut a cheque for profit sharing.
How do I transfer DPSP to RRSP?
If you leave your employer, you can transfer any vested funds to your RRSP. If you are retiring, these can go straight into your RRIF or be used to purchase a retirement annuity.
