What are Deferred Profit Sharing Plans?
Written by True Tamplin, BSc, CEPF®
Updated on July 10, 2021
Deferred profit sharing plans are employer-sponsored profit sharing plans in Canada that combine elements of retirement plans and pensions. They are similar to traditional profit-sharing plans and offer significant tax benefits for employers and employees. They are often used to retain senior executives by tying their performance to company profits.
DPSPs are similar to traditional profit sharing plans because they help enable companies to share profits with employees. However, regular profit sharing plan contributions made to an employee’s account are taxed as ordinary income tax.
DPSP contributions are tax-deductible for both employers and employees, meaning the amount contributed to a DPSP account is deducted before tax calculations. DPSPs are put into accounts resembling tax accounts, where they are allowed to grow in a tax-deferred manner. DPSPs have a maximum vesting period of two years in which ownership of the accounts is transferred to the employee.
A company must be registered with the Canada Revenue Agency (CRA) as a DPSP and must meet criteria related to contribution limits in order to obtain tax benefits for employers and employees.
DPSP contribution limits are the lesser of either half of the annual money purchase plan (MP) limit for that year or 18% of the employee’s annual salary for that year. The MP limit for 2020 is $13,915 and for 2021, it is $14,605.
DPSP contributions also count towards Registered Retirement Savings Plan (RRSP) and act as pension adjustments. Therefore, if an employer makes a DPSP contribution of $1,000 then the same amount is deducted from their RRSP plan.
What are the requirements to register for a DPSP?
There are two sets of requirements – legislative and administrative – for a deferred profit sharing plan. Some of the legislative requirements are as follows:
- The plan’s funds cannot be invested in the stock, bonds, debentures of the company responsible for the DPSP.
- The plan’s funds cannot be used to give loans.
- The plan’s trustees, who are responsible for administering the plan and disbursing its funds, should be Canadian organizations.
- Beneficiaries of the plan can receive annuities of 15 years or less after they turn 71.
The following people cannot be beneficiaries of the plan:
- Relatives of employers
- Relatives of shareholders of corporation
- Relatives of beneficiaries, if the employer is a trust responsible for the plan.
Some of the administrative requirements for DPSPs are as follows:
- Beneficiaries cannot be divested from the plan, if they are fired or members of unions.
- Trustees of the plan can only receive short-term loans against the trust’s funds.
- Employee contributions made before 1991 should be fully vested in their name; contributions from employees after 1991 are not allowed, except in cases of funds transfer between two DPSP accounts.
Pros and Cons of Deferred Profit Sharing Plans
The advantages of DPSPs are as follows:
- They offer tax deductions, equal to the amount put into a DPSP account, for both employers and employees.
- They are portable, meaning they can be transferred between employers or to a Registered Retirement Savings Plan.
- They tie employee performance directly to profits, thus creating an incentive for them to contribute to company success.
- They have a relatively short vesting period of a maximum of two years, making it easy for employees to benefit from them even in the short-term.
The disadvantages of Deferred Profit Sharing Plans are as follows:
- They cannot be used for emergencies since withdrawal before completion of the vesting period is not permitted, unless the employer makes exceptions.
- Contributions to DPSP are equal to pension adjustments and can potentially reduce overall pension income.
- Employer contribution in such plans depends on company profits, making DPSPs an unreliable source of funding.
- DPSPs are individual-only plans and do not allow sharing of proceeds with spouses.