What Is a Deferred Profit Sharing Plan (DPSP) in Canada?
Understand Canadian Deferred Profit Sharing Plans (DPSPs), a strategic employer benefit for sharing success and deferred employee savings.
A Deferred Profit Sharing Plan (DPSP) in Canada is an employer-sponsored arrangement designed to share company profits with employees. These plans serve as a valuable component of an employee’s overall compensation package, fostering shared success within the organization. Employers establish a DPSP to align employee interests with business performance, encouraging motivation and retention. For employees, participation offers a way to accumulate savings for the future, with specific tax advantages.
Understanding Deferred Profit Sharing Plans
A DPSP is a formal, employer-sponsored plan registered with the Canada Revenue Agency (CRA). Its fundamental nature is rooted in profit-sharing, where an employer contributes to the plan based on the company’s financial performance. Contributions are discretionary and are typically calculated by reference to profits, such as a percentage of earnings. Only the employer can contribute to a DPSP; employees are not permitted to make contributions, with rare exceptions for direct transfers from other DPSPs.
The core concept of a DPSP involves the deferral of income. Funds contributed by the employer are held in trust and grow on a tax-deferred basis until specific conditions for withdrawal are met. This deferral allows investment earnings to compound over time, leading to substantial growth in the employee’s account.
Employers offer DPSPs to enhance employee retention by providing a long-term savings vehicle that rewards continued service. They also motivate employees by linking their financial well-being to company profitability. By sharing success, employers foster a more engaged and productive environment. Participation in a DPSP is generally open to employees, though “specified shareholders” and individuals related to the employer are typically excluded.
Key Operational Aspects of DPSPs
Employer contributions to a DPSP are typically discretionary and depend on the company’s profits. The plan document outlines how these amounts are calculated, often as a percentage of profits or employee earnings. Employers are not obligated to make contributions in years when no profits are recorded.
A significant feature of DPSPs is the vesting period, which determines when an employee gains full ownership of employer contributions. In Canada, employer contributions must vest to employees after a maximum of two years of plan membership. If an employee leaves the company before this period ends, any unvested contributions may be forfeited and returned to the employer. Plans may allow for earlier vesting periods.
Funds within a DPSP are held and managed by a trustee, who is responsible for investing the assets. Investments are similar to those permitted for Registered Retirement Savings Plans (RRSPs). Employees may have choices regarding how their funds are invested, depending on the plan’s design.
Employees can generally withdraw funds from a DPSP under specific conditions, such as termination of employment, retirement, or death. Once vested, funds can be transferred to another registered plan like an RRSP or a Registered Retirement Income Fund (RRIF) without immediate tax implications, or taken as a cash withdrawal. Employers also have administrative responsibilities, including reporting contributions to the Canada Revenue Agency (CRA).
Tax Treatment of DPSPs
From the employer’s perspective, contributions made to a DPSP are generally tax-deductible as a business expense. These contributions are paid out of pre-tax business income, providing a tax incentive for companies to offer such plans. DPSP contributions are also typically exempt from federal and provincial payroll taxes.
For the employee, contributions made by the employer to a DPSP are not considered taxable income at the time they are made. The funds accrue and grow on a tax-deferred basis within the plan, meaning investment earnings are not taxed until withdrawal. This allows for tax-sheltered growth over the accumulation period.
Withdrawals from a DPSP are fully taxable income to the employee in the year they are received. This income is taxed at the employee’s marginal tax rate at the time of withdrawal. If an employee transfers vested DPSP funds directly to an RRSP or RRIF, the tax deferral continues until funds are withdrawn from those accounts.
DPSP contributions also impact an employee’s Registered Retirement Savings Plan (RRSP) deduction limit through a “pension adjustment” (PA). The pension adjustment represents the value of benefits an employee earns in a year under a DPSP or a registered pension plan. This amount reduces the employee’s available RRSP contribution room for the following year. The PA amount is reported on the employee’s T4 slip in Box 52. For example, if an employer contributes to a DPSP on an employee’s behalf, that contribution directly reduces the amount the employee can contribute to their RRSP in the subsequent year.