What Is a Deferred Profit Sharing Plan (DPSP)?

A Deferred Profit Sharing Plan (DPSP) is an employer-sponsored retirement savings vehicle. These plans connect employee financial well-being to company performance, aiming to foster a shared interest in the business’s success. In the United States, what is commonly referred to as a DPSP falls under the broader category of a qualified profit-sharing plan, operating as a defined contribution plan. The primary goal of such a plan is to provide employees with a tax-advantaged method to save for retirement, with contributions originating solely from the employer.

Defining Deferred Profit Sharing Plans

A profit-sharing plan, often referred to as a Deferred Profit Sharing Plan (DPSP) in some contexts, is an employer-sponsored retirement plan where a portion of company profits, or other designated funds, are allocated to employee retirement accounts. This plan is established as a trust, holding assets for the exclusive benefit of participants and their beneficiaries. Profit-sharing plans incentivize employee productivity and loyalty by directly tying their financial rewards to the company’s financial performance.

These plans serve a dual purpose: they act as a valuable tool for employee retention and provide a significant component of an employee’s long-term retirement savings strategy. Participation eligibility in a profit-sharing plan typically requires an employee to be at least 21 years old and to have completed one year of service, often defined as working 1,000 hours or more during a plan year. The regulatory framework governing these plans in the United States includes the Internal Revenue Code and ERISA, which set forth requirements for plan documentation, disclosure, and fiduciary responsibilities.

Employer Contributions and Plan Management

Employers contribute to a profit-sharing plan at their discretion, meaning there is no mandatory annual contribution. Contributions are based on company profits, and employers can choose to contribute nothing in a given year, offering significant financial flexibility, particularly during periods of fluctuating business performance. The amount and frequency of contributions are determined by the employer, which can be a percentage of profits, a fixed amount, or based on a formula.

Employer contributions to a qualified profit-sharing plan are tax-deductible for the business, up to 25% of the compensation paid to all plan participants for the tax year. These contributions are allocated among eligible employees according to a predefined formula outlined in the plan document, which can be based on factors such as salary (pro-rata), age, or a combination of methods. A plan administrator is responsible for managing the plan’s investments, maintaining records, and ensuring compliance with federal regulations. This includes filing annual reports, such as Form 5500, with government agencies like the IRS and the Department of Labor.

Employee Accounts and Tax Treatment

An employee’s individual profit-sharing account receives the allocated employer contributions, and these funds grow on a tax-deferred basis. This means that employees do not pay taxes on the contributions or the investment earnings until they withdraw the money, typically in retirement. The growth of these accounts is influenced by the investment performance of the plan’s assets, which employees may have some control over, depending on the options provided by the employer.

Vesting refers to the employee’s ownership of the employer contributions. While employee contributions to any retirement plan are always 100% vested immediately, employer contributions may be subject to a vesting schedule. Common vesting schedules include “cliff vesting,” where an employee becomes 100% vested after a specific period, such as three years, or “graded vesting,” where ownership increases gradually over several years, such as 20% per year over six years. If an employee leaves before becoming fully vested, they may forfeit the unvested portion of employer contributions.

Employees can access their vested funds upon termination of employment, retirement, or in certain hardship situations, though specific rules vary by plan. Withdrawals made before age 59½ are subject to income tax and an additional 10% early withdrawal penalty, unless a specific exception applies, such as disability or certain medical expenses. Upon reaching age 73, participants are required to begin taking Required Minimum Distributions (RMDs) from their accounts, with withdrawals taxed as ordinary income.