What is a Deferred Profit Sharing Plan (DPSP)?
A Deferred Profit Sharing Plan (DPSP) is a compensation plan wherein employers share a part of their profits with employees. Under the DPSP scheme, employees are entitled to get a share of the profits of the company. However, the amount thus received is not immediately given to the beneficiary. It is first put into a deposit account, where it is allowed to grow without being subject to taxes. Generally, beneficiaries are allowed to decide how they want the money to be invested.
- A Deferred Profit Sharing Plan (DPSP) is a compensation plan wherein employers share a part of their profits with employees.
- All contributions into the DPSP account are made by the employer, also referred to as the sponsor, and are tax-deductible.
- The amount of money in the DPSP account is not taxed until the employee withdraws it. Withdrawals can be made at any time.
Understanding Deferred Profit Sharing Plans
All contributions into the DPSP account are made by the employer, also referred to as the sponsor. Unlike other compensation schemes, employees cannot deposit part of their salaries into the account. All contributions made by the employer into the DPSP account are tax-deductible. It means that such payments are made out of profit before tax.
The amount of money in the DPSP account is not taxed until the employee withdraws it. Withdrawals can be made at any time. However, it is advisable to withdraw the funds after retirement because people are subject to lower tax rates then.
Such a kind of profit-sharing plan is offered as a pension or retirement scheme in Canada. All companies offering such schemes to employees must register themselves with the Canada Revenue Agency (CRA). The CRA is the government authority responsible for the collection and management of taxes, administration of tax policies, and delivering tax benefit programs.
Legislative and Administrative Requirements
A DPSP plan must fulfill certain conditions to be officially registered. The most important requirements are as follows:
- All payments made by the company to an employee should be allocated to the latter; the trustee does not receive any part of such payment.
- The amount set aside by the employer for DPSP cannot be used to give loans.
- Employees’ DPSP funds cannot be invested in any debt obligations of the employer.
- Funds cannot be invested in a company’s stock, with more than half of its holdings in debt obligations.
- The trustees of the plan must be Canadian residents.
- The trustee can be an authorized Canadian organization or at least three individuals.
- The following people cannot be a beneficiary of DPSP: Persons owning a stake in the sponsor company; persons related to the employer; persons related to shareholders of the sponsoring company; a partner of the sponsor company if it is a partnership; persons related to the partners of the sponsoring company.
Ordinary Profit Sharing Plans vs. DPSPs
Profit-sharing plans are common schemes of employee compensation across organizations and countries. They work on the same principle as DPSP. However, one major point of difference between the two arises out of differential tax treatment.
The money employees receive through ordinary profit-sharing is taxed at the current income tax rate, but the share of profit received through DPSP is not subject to taxation unless and until it is withdrawn from the account.
Advantages of DPSPs
1. Offers flexibility in contributions
Deferred profit sharing plans offer many benefits to employers that regular remuneration plans do not. The most important among the benefits is that employers can choose when and how often they should deposit money into the account.
If the company fails to earn profits in a certain year, then it can choose not to make any contribution to the account. The company can also decide whether it should deposit money every month, every year, or on special occasions as a bonus offer.
2. Promotes employee retention
The second benefit is that DPSP helps to retain employees, at least for some time. The scheme typically comes with a vesting period of at most two years. It means that employees cannot withdraw money from the account for the first two years of their employment, and if they wish to leave the organization within these two years, they must forfeit the money in the account. The amount thus forfeited goes back to the employer. It prevents employees from leaving the company during the vesting period.
Lastly, contributions made to DPSP accounts are tax-deductible expenses for the company.
1. No self-contribution necessary
DPSP is completely sponsored by the employer. Employees do not need to contribute anything on their own. In such a way, DPSP can be described as a free saving scheme, unlike other pension plans.
2. Offers a short vesting period and freedom of withdrawal
The vesting period is relatively short, and once it is over, the employee is free to withdraw the amount in the account (full or in part) at any time. The employee can also leave the company and take the full amount of DPSP with them.
3. Provides tax-free accumulation of savings
The biggest advantage for employees is that DPSP funds are allowed to compound tax-free as long as they are in the account. Employees can avoid large amounts of tax payments if they withdraw the amount after they’ve retired since they will fall under a lower tax bracket after retirement.
CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: