You have several retirement savings options in Canada.
As an employee, you may have the option of creating a Deferred Profit-Sharing Plan (DPSP) with your employer.
A DPSP is often used by employees alongside other plans to prepare for retirement.
But unlike an RRSP, employees don’t need to make contributions.
DPSPs are quite different from other retirement plans, starting with the way they are funded.
In this article, we will go over how they work.
How Does a Deferred Profit-Sharing Plan Work?
A DPSP is a pension fund.
The fund is contributed to on a periodic basis, using shares of profits produced by the company.
Your employer shares in some of the profits the business makes through the DPSP.
As an employee, you do not pay taxes on the funds you receive through your DPSP.
You pay income taxes when you finally withdraw from the pension plan during retirement.
As an employee who takes part in a DPSP, you, along with any other participating employees, are “sponsors” of the plan.
A DPSP also has a trustee that manages the plan.
You and all participants (sponsors) of the DPSP have contributions grow tax-free.
Because of compounding interest, your investment can gain more and more over time.
It should be noted that while you can withdraw funds ahead of retirement, you will have to pay taxes on your withdrawals.
You also lose some of the compounding effects of DPSP investments.
Lastly, you can only withdraw funds during the first two years of your sponsorship of a DPSP.
However, you can withdraw any portion and even opt to withdraw all the contributions to date.
How Are DPSPs Started?
To start a new DPSP, an employer must set it up for all or a specific group of employees.
The DPSP must meet the conditions for registration, which are laid out in the Income Tax Act.
If the plan meets the requirements, the CRA will register the plan for the business.
The Income Tax Act lays out annual contribution limits for a DPSP.
Contributions are made to a trustee, for the benefit of the company’s employees.
Employers are incentivized to participate in a DPSP through tax deductions.
Employees don’t worry about taxes at all until they withdraw during their retirements.
Is a Deferred Profit-Sharing Plan Right for Me?
For employers, DPSPs can be an answer when cash flow is an issue.
That’s because they often change how much is contributed every year.
At the same time, the tax deductions further benefit the business.
They offer flexibility and can weather changes.
Employees also have a lot to gain, and little to lose, by sponsoring a DPSP.
Employees don’t typically rely entirely on a DPSP.
However, they can make a great addition to any retirement portfolio.
While employed, an employee doesn’t have anything to worry about regarding contributions and taxes.
Advantages of a Deferred Profit-Sharing Plan
- Tax Benefits. Both employers and employees can benefit from contributions to a DPSP.
- Transferable. DPSP contributions can be transferred between employees, or to an RRSP.
- Incentivization. Employers are incentivized through tax benefits. Employees are also incentivized to work better, as their benefits in a DPSP are directly tied to the company’s performance.
Disadvantages of a Deferred Profit-Sharing Plan
- Not Mobile. DPSPs are not easy to access early. They are not good for emergencies.
- Potentially Poor Contributions. If the company you work for starts to perform very poorly, so will your DPSP. In this way, they can be a bit unreliable.
- Individual. DPSPs are only for individuals. You cannot share the proceeds with your spouse.
DPSP vs RRSP
DPSPs and RRSPs are different, but serve the same purpose.
Both provide you with retirement savings.
However, you may prefer to simply focus on an RRSP in some cases.
First of all, you can only sponsor a DPSP as an employee.
Self-employed individuals cannot consider a DPSP.
The main benefit an RRSP has over a DPSP is greater flexibility.
For example, contributions to your RRSP are vested immediately and automatically.
If you leave your employer, you take your RRSP with you.
A DPSP also has a two-year vesting period, and while there are exceptions, you cannot just take your funds until that period is over.
A DPSP also has a significant edge over an RRSP – a DPSP is essentially free money (from the employee’s point of view).
So, the vesting period is less of an issue, unless you’re in a rush to move to a better job you found.
If you later decide that you don’t want your DPSP, you can transfer the funds to an RRSP.
That way, you can still just move your retirement income into a different account that also enables tax-advantaged growth.
Frequently Asked Questions
- Can a DPSP be transferred to an RRSP?
Yes, you can transfer a DPSP to an RRSP. You can also cash it out when you quit your job, however, that would trigger a taxable event.
To transfer funds from a DPSP to an RRSP, you don’t have to pay taxes. The Income Tax Act (Subsection 147(19)) allows a single tax-free, direct lump-sum transfer. You can transfer the funds to an RRSP or pension plan.
- Can I withdraw from my DPSP?
Yes, you can withdraw from a DPSP before retirement. However, you’ll be taxed at your current income tax rate. When you’re taxed for this income on top of your regular salary, you can expect a higher tax rate than you would face in retirement. If this pushes you into an even higher tax bracket, it represents a fairly high cost. That’s why many experts suggest against withdrawing the funds before retirement.