Saving for retirement is a challenge for most Canadians. Between paying a mortgage, paying off credit card bills, and saving for a rainy day, saving for retirement sometimes has to take a backseat.
That’s where employer-sponsored retirement plans come in. They can fill in the gaps between your own contributions and what you actually you need for your golden years.
If you start a new job and your company says they offer a DPSP, you might be wondering how to take advantage of that. Learn the ins and outs of DPSPs below.
What Is a Deferred Profit Sharing Plan (DPSP)?
A Deferred Profit Sharing Plan (DPSP) is a combination of a pension and retirement plan sponsored by employers to help workers save for retirement. A DPSP is created when a company distributes part of their profit into their employees’ DPSP account.
Only employers can make contributions to a DPSP. Employees don’t have to pay taxes on contributions until they withdraw money from their DPSP.
Companies create DPSPs to entice employees (and to entice current employees to stay) and to reduce their tax burden—all of the company’s contributions are tax-deductible.
How Does a DPSP Work?
Here’s how a DPSP works. The company goes over their accounting for the year and reports a profit. This can happen on a regular or irregular basis.
They decide to share part of the profit with their employees in the form of distributions to their Deferred Profit Sharing Plans. The money they distribute is tax-deductible for them and tax-deferred for the employees. Companies have 120 days after the end of the fiscal year to make contributions.
The employees receive these proceeds, which they can use to invest in various funds, stocks, or bonds. They can also buy company stock with the money. Employees don’t have to pay taxes on these contributions unless they withdraw and claim the income on their taxes.
When the employee signs up for the DPSP, they’ll designate someone as their beneficiary, most often a spouse or long-term partner.
DPSP vs. Profit Sharing Plan
A DPSP and a profit sharing plan both operate on the same basic principle. When a company has profit, it can share that profit with its employees as a major benefit. When there’s no profit, the company doesn’t have to make any contributions. A company can set its own limits on how much profit it needs to have before distributing it to the workers.
The most important difference between a DPSP and a general profit sharing plan is that employees have to record profit sharing contributions on their taxes unless they have a DPSP. If a company distributes profits without a DPSP, then the money is taxable.
“A deferred profit sharing plan is a registered plan, and any contributions to it reduce the clients’ RRSP room, as the contributions create a pension adjustment,” said Wealthsimple financial advisor Damir Alnsour.
This is why a DPSP is preferable to a regular profit sharing plan. If your company doesn’t use a DPSP to distribute profits, talk to someone and see if they might consider creating a DPSP system.
DPSP vs. RRSP
An employee who has both a DPSP and RRSP will have the DPSP contributions subtracted from their RRSP limit. If the person’s company adds $1,000 to their DPSP, that’s $1,000 less they can contribute to their RRSP.
Employer contributions to an RRSP are automatically vested. If the company adds $1,000 to the employee’s account and they quit the next day, that money is theirs.
Differences between a DPSP and RRSP
Employer contributions to an RRSP are automatically vested so an employee can leave and take the RRSP with them. A DPSP may have a vesting period up to two years. This can be a sticking point, but since a DPSP is essentially free money from the company, it doesn’t matter as much unless you receive a much better job offer elsewhere.
DPSPs and RRSPs have different contribution limits. In 2019, the annual max for a DPSP was $13,615. The 2019 limit for an RRSP was 18% of your income, up to $26,500. Employees should also be aware that any DPSP contributions will affect how much they can contribute to their RRSP.
Advantages and Disadvantages of DPSP
Advantages for the Employer
The employer has the right to only make contributions when they want to. If a company’s having a bad year, they don’t have to put any money into a DPSP. They can create their own contribution schedule, on a monthly or sporadic basis. They can put DPSP contributions into each pay period or save it for annual bonuses.
A DPSP can have a maximum vesting period of two years, which can prevent turnover within a company. An employee who leaves before the vesting period has to forfeit the DPSP.
A company can decide which formula to use when distributing money into a DPSP. They can pick a basic formula, like “everyone receives an equal share" of the profits" or “employees receive a percentage of their salary up to a certain amount.”
Contributions are tax-deductible for the employer, which make them preferable to a regular profit sharing plan.
Disadvantages for the Employer
Because a DPSP is an employee-only plan, owners, their relatives and spouses and anyone with more than a 10% stake in the company are prohibited from having a DPSP. This can be a drawback for the senior executives, especially if there’s a lot of extra profit. This can also affect how companies reward their top leaders with extra incentives.
Distributions to DPSPs depend on the employer having profits so in a bad year, the employer may not make any contributions. This can be disappointing to employees and affect turnover. When setting up a DPSP, the company should consider how likely it is they’ll have enough profit every year to contribute to a DPSP.
Advantages for the Employee
The biggest advantage of a DPSP is that it’s entirely funded by employer contributions. The employee doesn’t have to put any money into a DPSP to receive the full employer contribution. This makes it free money for the employee.
A DPSP has a maximum vesting period of two years. Employees only have to stay at a company for two years to receive full access to their DPSP. This is a relatively short vesting period. Your company may have an even shorter vesting period or make employees automatically 100% vested.
You have immediate access to funds once you’re vested. Funds in a DPSP may be withdrawn before retirement, but they’ll be taxed at the employee’s current tax rate. If the tax rate is 26%, the employee will pay 26% taxes on those DPSP withdrawals. That’s why experts suggest not touching the money until you’re retired because you’ll likely be in a lower tax bracket.
Disadvantages for the Employee
A possible disadvantage for the employees is that the employer can require the employee to purchase company stock with their DPSP funds. This isn’t true for all DPSPs, but can be a possibility. Employees who don’t have full control of their DPSP investments should make sure they’re diversified in their RRSP or other retirement accounts.
If the employee purchases company stock and the value drops significantly, their DPSP could be rendered worthless. This is why a DPSP that has little control for the employee isn’t as valuable as a DPSP without excess oversight.
Employers aren’t required to contribute to a DPSP if they didn’t produce enough revenue or have lower profit margins. This can make retirement planning more volatile for employees who are solely relying on their DPSP. If the DPSP is your main source of investing income, consider what you’ll do if your company can’t afford contributions in a given year.
The DPSP is an employee-only plan, so you can’t split the funds with your spouse. This is a major difference between a DPSP and an RRSP.
How to Transfer a DPSP to an RRSP
When an employee leaves a company, they can take their DPSP with them to transfer to an annuity, RRIF, or an RRSP. Employees can also cash out the amount. If they receive the amount as a check or cash, they have to report it on their taxes and pay income tax on it.
It’s always best to transfer a DPSP directly to an RRSP to avoid taxes, especially if you have a significant amount of money in your DPSP.
Contact the DPSP provider to ask how to transfer the money into your RRSP account. If you don’t have an RRSP account yet, set one up beforehand. It’s crucial to do a direct rollover from your DPSP to your RRSP in order to avoid a huge tax burden.You must be 71 or younger to transfer your DPSP to an RRSP. This is also the oldest you can be to contribute to an RRSP.
If your spouse or partner died and you receive ownership of his or her DPSP, you may transfer it to your RRSP account. If you and your spouse get divorced and the divorce agreement gives you some or total ownership of your former spouse’s DPSP, you may transfer it to your RRSP.
