If you're looking for a way to save for retirement while also sharing in your employer's success, a Deferred Profit Sharing Plan (DPSP) may be just what you're looking for. In this blog, we will explore what DPSPs are, how they work, and the benefits they can potentially offer.
What are DPSPs?
A DPSP is a type of retirement plan established by an employer for its employees, offering a tax-sheltered savings opportunity. DPSPs only allow employers to make contributions, which are often calculated as a percentage of the employer’s profits or a percentage of the employee’s salary, subject to an annual cap. Similar to an RRSP, investment returns earned in a DPSP grow tax-deferred. After 24 consecutive months of plan membership, an employee should be fully “vested” in the plan. At this point, the employee has earned a non-forfeitable right to the benefits in the DPSP in the event of employment termination, retirement, or death. Once vested, the accumulated funds may be withdrawn or transferred to an external personal account at any time. There are, however, some cases where the funds are required to be locked in the plan until the member leaves the plan or retires.
What can you buy in a DPSP?
Qualified investments for a DPSP are like those for an RRSP. However, a DPSP cannot invest in bonds, bankers’ acceptances, or other similar debt obligations of the employer that is making contributions to the plan. On the other hand, a DPSP does not have a limit on the percentage of shares one may own in a single company, so one could heavily invest in the stock of the employer if desired.
What are the Tax Considerations?
Contributions made by your employer to a DPSP are not considered income at the time the contribution was made; hence, you do not pay a tax on the contributions. While the contributions and investment earnings accumulate in the DPSP on a tax-deferred basis, they are taxable upon withdrawal. Another important consideration is that DPSP contributions made on your behalf in a particular year will reduce your RRSP contribution room for the following year. This is an indirect effect that many may be unaware of.
An employer’s contributions appear on your tax slip as a pension adjustment (PA) on your T4 slip. The pension adjustment will include the value of your employer’s contributions as well as anything earned under other pension plans you may have. The purpose of the PA is to recognize the value of tax-deferred benefits that an employee receives from being a member of a DPSP. As mentioned above, the PA on the employee's T4 slip will reduce the employee's available RRSP contribution room for the next year.
Different ways to Utilize the DPSP
When one withdraws from the plan or retires from employment, there is a strategy referred to as the DPSP deferral election that permits a transfer of the employer shares from the DPSP to a non-registered account at book values rather than market values. This can allow the investor to report lower income on the year of withdrawal, defer the tax on the growth, and be subject to capital gains tax rates when the investments are sold. Overall, this can result in more control and tax savings but would require termination of their interest in the DPSP and filling out the CRA form T2078.
A DPSP can be an effective tool in your overall retirement planning. This blog scratches the surface of how one can use the DPSP, tax implications, and deferral elections. If you are interested in learning more about the plan or exploring your retirement options, reach out to your advisor.
The content in this article is for information purposes only and does not constitute tax or legal advice. It is imperative that you obtain professional advice from qualified tax and legal advisors before acting on any of the information in this article. This will ensure that your own circumstances are properly considered, and that action is taken based on the most current legislation.