A Deferred Profit Sharing Plan (DPSP) is a type of employee benefit plan in Canada. It is a way for employees to share in the profits of their employer, without having to make any investment.
A DPSP can be understood as a compensation plan in which businesses divide a portion of their profits with workers. Employees are entitled to a cut of the company’s earnings under the DPSP plan. The money, on the other hand, is not given to the beneficiary right away. It is first deposited into a deposit account where it may compound tax-free. Beneficiaries have the option of how they want to invest the funds.
What is a Deferred Profit Sharing Plan (DPSP)?
A deferred Profit Sharing Plan (DPSP) is a type of employee benefit plan in which the employer agrees to distribute a specified percentage of profits to employees but defers payment until a later date. The purpose of DPSP is to provide employees with a financial incentive to help the company achieve profitability goals.
DPSP can be an excellent way for companies to reward employees for their efforts in contributing to the business’ bottom line. It can also be used as a tool to attract and retain top talent. A Deferred Profit Sharing Plan (DPSP) is a retirement savings plan that allows employees to defer a portion of their pre-tax business income into a tax-sheltered account.
DPSP contribution limits are set by the government and are based on the employee’s salary. Employers may also make matching or discretionary contributions to their employees’ DPSPs. DPSPs offer many tax incentives, including tax-deferred growth of investments and a pension adjustment for employees. DPSPs can also help employers retain talented employees.
Understanding Deferred Profit Sharing Plans
You may understand a DPSP as a form of the pension fund. The employer periodically shares the profits generated by the business with all workers or a designated group of employees through the DPSP. Until the money from the DPSP is withdrawn, employees who received a part of the profits paid out by their employer do not have to pay federal taxes on it.
The employer, often known as the sponsor, makes all deposits to the DPSP account. Unlike other compensation plans, workers cannot put part of their salaries into the account. All payments made by the employer into the DPSP account are tax-deductible in full. It implies that they are paid out of profit before tax.
The money in the DPSP account is not taxed until the individual takes it out. Withdrawals are permitted at any time. But it is preferable to withdraw the funds after retirement because individuals’ tax rates are lower when they retire.
In Canada, such a profit-sharing plan is offered as a pension or retirement program. All firms with such plans for employees must register with the CRA or Canada Revenue Agency which is the federal agency responsible for tax collection and administration along with the delivery of tax benefit programs.
How does a Deferred Profit Sharing Plan (DPSP) work?
Under a DPSP, the employer sets aside a portion of its profits each year into a trust fund. This fund is then divided among eligible employees based on a formula that takes into account factors such as length of service and salary.
Beneficiaries do not have to pay taxes on the DPSP until they receive the payout. When they do receive the payout, they will be taxed at their marginal tax rate.
DPSPs are subject to certain rules and regulations set by the Canadian government. For example, there is a maximum contribution limit of 15% of an employee’s eligible compensation.
Legislative and Administrative Requirements for DPSP
To be lawfully registered, a DPSP plan must fulfill certain criteria. The following are the most important criteria:
- Only the employee’s portion of payments made by the firm should be allocated to him; the trustee gets none of those funds.
- The employer’s sum set aside for DPSP cannot be used to provide loans.
- Employees’ DPSP money may not be used to finance the employer’s obligations.
- With more than half of its assets in debt obligations, funds cannot be invested in the stock of a firm.
- The plan’s administrators must all be Canadian residents.
- The trustee should be a certified Canadian company or at least three individuals.
- The following individuals are not eligible to receive a DPSP award: Individuals having a financial interest in the sponsoring business; Employer relatives, Individuals connected with the sponsoring company’s shareholders; The partner of the sponsor company in case it is a partnership; The members of the partners of the sponsoring company
Ordinary Profit-Sharing Plans vs. DPSPs
An Ordinary Profit Sharing Plan (OPSP) is different from a DPSP in that OPSP payments are typically made out of after-tax profits, while DPSP contributions are made with pre-tax profits.
Some of the differences between OPSPs and DPSPs are-
- An OPSP is an agreement between an employer and employee, while a DPSP is a trust set up by an employer.
- OPSP has no government regulation, while DPSPs are regulated by the Canadian Revenue Agency.
- OPSPs are taxed as income when received, while DPSPs are not taxed until they are received.
- An OPSP can be cashed out at any time, while a DPSP cannot.
- OPSPs can be used to finance the employer’s business, while DPSPs cannot.
- An OPSP can be used to invest in the stock of the company, while a DPSP cannot.
How to set up a Deferred Profit Sharing Plan (DPSP)?
The first step is to consult with a lawyer or accountant to make sure that a DPSP is the right type of profit-sharing plan for your business.
Once you have decided to set up a DPSP, you will need to take the following steps:
- Choose a Canadian resident trustee for your DPSP. The trustee can be an individual or a corporation.
- Draft the trust agreement. This document will outline the terms and conditions of the DPSP.
- Register the Deferred Profit Sharing Plan with the CRA. You will need to complete the form and send it to your local tax services office.
- Make contributions to the DPSP trust fund. These contributions can be made each year or on a quarterly basis.
- Invest the assets in the DPSP trust fund. The investments must comply with the rules and regulations set by the Canadian government.
- Pay out the DPSP benefits to eligible employees. The payments can be made each year or on a quarterly basis.
- File an annual return with the CRA. This return must be filed within six months of the end of the plan year.
Registered Retirement Savings Plan (RRSP) vs Deferred Profit Sharing Plan (DPSP)
RRSP is understood as a saving arrangement to which an employee and employer can contribute, in order to save for retirement.
DPSP is an arrangement where an employer can set aside a portion of the company’s profits to be distributed among employees, based on a pre-determined formula.
The main difference between RRSP and DPSP is that an RRSP is an individual retirement savings plan, while a DPSP is a company retirement savings plan. There are a few key differences between an RRSP and a DPSP-
- An RRSP is an individual retirement savings plan that is registered with the government, while a DPSP is a trust that is set up by an employer.
- Contributions to an RRSP are made with after-tax dollars, while contributions to a DPSP are made with pre-tax dollars.
- Withdrawals from an RRSP are taxed as income, while withdrawals from a DPSP are not taxed until they are received.
- An RRSP can be cashed out at any time, while a DPSP cannot.
- An RRSP can be used to finance the purchase of a home or education, while a DPSP cannot.
Employee Profit-Sharing Plan
The difference between DPSP and an Employee Profit Sharing plan is that in a DPSP, the employer contributes a portion of the company’s profits to a trust fund. The assets in the trust fund are then invested and the gains are distributed to eligible employees.
In an employee profit-sharing plan, the employer contributes a portion of the company’s profits to each eligible employee’s RRSP. The employee then decides how to invest the money in their RRSP.
There are a few key differences between DPSP and an employee profit-sharing plan-
- DPSP is a trust that is set up by the employer, while an employee profit-sharing plan is an arrangement between the employer and employee.
- Contributions to a DPSP are made with pre-tax dollars, while contributions to an employee profit-sharing plan are made with after-tax dollars.
- Withdrawals from a DPSP are not taxed until they are received, while withdrawals from an employee profit-sharing plan are taxed as income.
- An employee profit-sharing plan can be used to finance the purchase of a home or education, while a DPSP cannot.
How to make a DPSP withdrawal?
As previously said, any withdrawals may be denied to you for up to two years under your plan. Check the details of “vesting” your money in your company’s EPSP. After you’ve completed your required service time, you have the option to withdraw funds at any time.
The Canadian government, however, will charge a tax each time you withdraw money. As a result, it’s much better to use a Tax-Free Savings Account (TFSA) for emergencies instead. You will not be charged any tax if you set up a TFSA.
While retiring, you will have same sorts of options of taking out all of your RRSP funds. You can withdraw all of your money, but the tax burden will be significant. Alternatively, you may opt to convert it to an RRIF or Registered Retirement Income Fund (RRIF) or take out a retirement annuity.
How do I transfer DPSP to RRSP?
You can transfer any vested funds from your employer to your RRSP if you quit or leave your employer. If you’re retiring, these funds may be deposited into your RRIF or invested in a retirement annuity.
Advantages of DPSPs For Employers
Some of the advantages of DPSPs for employers are-
1. Offering flexibility in contributions
Employers can make contributions to a DPSP on a quarterly or annual basis.
2. Investing in the plan
Employers can invest the assets in the DPSP trust fund in a variety of investments, including stocks, bonds, and mutual funds.
3. Deferring taxes
Contributions to a DPSP are made with pre-tax dollars, which can help to reduce the amount of taxes that an employer has to pay.
4. Attracting and retaining employees
Profit-sharing plans can be a valuable tool for attracting and retaining employees.
Advantages of DPSPs For Employees
Some of the advantages of DPSPs for employees are
1. Saving for retirement
Employees can use a DPSP to save for retirement.
2. Deferring taxes
Employees can defer taxes on the contributions that they make to a DPSP.
3. Receiving employer contributions
Employees can receive employer contributions to a DPSP, which can help to boost their retirement savings.
Disadvantages of DPSPs For Employers
Some of the disadvantages of DPSPs for employers are
1. Administrative burden
Deferred profit-sharing plans can be complex to administer and require the services of a professional trustee.
Deferred profit-sharing plans can be expensive to set up and maintain.
Deferred profit-sharing plans are subject to investment risk, including the risk of losing money.
Disadvantages of DPSPs For Employees
Some of the disadvantages of DPSPs for employees are
Employees may not vest in the plan until they have been with the company for a certain period of time.
Deferred profit-sharing plans typically have clawback provisions, which means that employees may have to repay contributions if they leave the company before a certain date.
3. Investment risk
Deferred profit-sharing plans are subject to investment risk, including the risk of losing money.
On the whole, it is apparent from the preceding discussion that Deferred Profit Sharing Plans (DPSPs) provide numerous benefits to both employers and employees.
However, there are also some disadvantages that should be considered before establishing a DPSP. Overall, DPSPs can be a valuable tool for saving for retirement and providing benefits to employees.
What do you think?
Do you think Deferred Profit Sharing Plans (DPSPs) are a good way for employers to provide benefits to employees?
Do you think DPSPs are a good way for employees to save for retirement? Let us know your thoughts in the comments below.