Deferred Profit Sharing Plan: A Guide to Canadian Profit Sharing

‍What is a Deferred Profit Sharing Plan (DPSP)?

A deferred profit sharing plan (DPSP) is like a secret weapon for businesses looking to boost their team's retirement savings. It's a special kind of profit sharing plan where companies share a slice of their profits with employees. Think of it as a thank-you gesture for their hard work and contribution to the company's success.

Here's the best part: the money in an employee's DPSP account doesn't just sit there; it grows and does so without the immediate worry of taxes. This growth is on a tax-deferred basis, which means employees pay tax when they withdraw money from the account, usually at retirement.

So, to sum it up, a DPSP is a win-win: employees get a helping hand with their retirement plan and employers get a motivated workplace to which they can effectively show their appreciation.

How do deferred profit sharing plans work?

Deferred profit sharing plans operate in a straightforward yet effective way. Each year, employers contribute a portion of their profits to the plan. This isn't just any random amount; it's carefully calculated based on the contribution limits set within the plan.

These contributions are tax-deductible for the company, making it quite a financially savvy move. The real magic lies in how the money is shared with employees. It's not a free-for-all, there's a method of distribution that's typically based on factors like an employee's compensation throughout their tenure.

Employees don't need to put in their own money as the plan is entirely fueled by the employer's contributions. The funds or shares allocated to each employee grow until the employee leaves the company or hits retirement.

Is DPSP a Canadian or American thing?

Deferred profit sharing plans are uniquely Canadian and they're specifically tailored to the Canadian retirement savings landscape. They represent Canada's approach to employee retirement benefits, which is different from American systems.

Although DPSPs are exclusive to Canada, it's important to note that profit sharing in retirement plans is present in the United States. While American companies do have profit sharing plans, there are different mechanisms and regulations that they follow.

Benefits of Deferred Profit Sharing Plan

Employee benefits: Retirement savings

DPSPs are a remarkable tool for supplementing an employee's retirement savings. One of the key benefits of profit sharing, in general, is that it directly ties an employee's financial future to the success of the company. So, when the company thrives, so does the employee's retirement funds.

Another significant advantage for employees is the tax-deferred nature of a deferred profit sharing plan. The contributions made by the employer are not immediately taxable. Instead, they grow tax-deferred. This delay in taxation can lead to lots of tax savings, especially if the employee falls into a lower tax bracket during retirement.

Employees also benefit from DPSPs in the sense that they don't have to contribute their own funds. This can be very advantageous for those who might find it challenging to allocate their own funds into their retirement savings. This means that the employee's retirement readiness will be bettered and they'll be able to enjoy an extra layer of financial security.

Employer benefits: Tax deductions, flexible contributions, employee loyalty

Tax deductions

For employers, deferred profit sharing plans offer attractive tax incentives. Contributions made to DPSPs are tax deductible which reduces the taxable income of the business.

This is highly beneficial for a profit sharing partner, especially in a small business where every tax saving can affect the bottom line. Also, these contributions are exempt from both provincial and federal payroll taxes.

Flexible contributions

Employers aren't obligated to contribute a fixed amount annually. This flexibility allows businesses to base their contributions on the profit earned each year.

In years with lower profits and even losses, employers can choose not to contribute, which can alleviate financial pressure. This adaptability makes DPSPs an ideal choice for businesses with fluctuating incomes.

Employee loyalty

Beyond the financial benefits, DPSPs are a powerful tool for fostering employee loyalty. By linking a portion of the employee's retirement savings to the company's success, employees feel a lot more invested in their work and connected to the company. This sense of partnership encourages the workforce to be more engaged and motivated.

Eligibility Criteria for Deferred Profit Sharing Plan

Who can participate in a DPSP?

Participating in a deferred profit sharing plan is largely up to the employer. They have the flexibility to set specific criteria determining who can join the plan. These criteria can include factors like employment status, length of service, position or job level, and even performance metrics.

For example, an employer might require employees to have a certain tenure with the company or to hold a specific job level before they're eligible. This means that employers can adapt the deferred profit sharing plan to the needs of their business.

Employer's role in DPSP

Employers play an important role in DPSPs. They mainly contribute to the plan and ensure adherence to legal and regulatory limits. Apart from financial input, the employer's responsibilities extend to administrative tasks. This includes setting up the plan, ensuring it meets all legal requirements, and maintaining compliance with relevant regulations.

Employers are also tasked with addressing any queries an employee may have about the plan. Managing all these aspects is important for smooth operation.

Employee’s role in DPSP

In DPSP, an employee's role is straightforward yet significant. The main requirement from an employee is to provide consistent service and stay employed with the company.

Again, unlike certain pension savings plans, DPSPs don't require direct financial contributions from employees. However, this doesn't equate to a free ride.

An employee's continued employment and work performance play a crucial role in determining the size of the profit share that they receive. In short, the longer an employee stays with a company and the better they perform, the more they stand to benefit from employer contributions to their DPSP.

Common Misconceptions about Deferred Profit Sharing Plan

Misconception 1: DPSPs are only for large corporations

It's commonly thought that DPSPs are only for big companies but in reality, they're for businesses of all sizes. The key factor isn't the size or the revenue of the company, but its strategic financial planning objectives.

Small and medium-sized enterprises can also use DPSPs to enhance the employee benefits package. If they can align the plan with their financial goals, even smaller businesses can use DPSPs to boost employee morale and retention.

Misconception 2: DPSPs are too complex to manage

Many assume that managing a DPSP is a big and complex task but this isn't necessarily true. Although understanding the various aspects of the plan is important, the administrative processes can be pretty easy to grasp once the plan sponsor becomes familiar with them.

The rules governing DPSPs are well-defined, and with the right management, the plan can run smoothly. If you want your plan to be successful, stay informed and maintain regular communication with a financial advisor.

Misconception 3: DPSPs do not offer significant tax benefits

Despite what many believe, DPSPs offer some pretty significant tax advantages. Contributions made to DPSPs are exempt from various payroll taxes, including the Employee Health Tax (EHT), Workplace Safety and Insurance Board (WSIB) premiums, and Canadian Pension Plan (CPP) contributions.

This exception can lead to substantial savings for businesses, reducing their overall tax and benefit-related liabilities. DPSPs are a useful strategic instrument in reducing a company's tax burden.

For American-Based Profit Sharing, Use This Free Profit Sharing Plan Template

For American businesses exploring profit sharing, ShareWillow offers a streamlined solution. Traditional profit sharing management can be a hassle and confusing, but ShareWillow transforms this process with a more transparent, automated, and efficient approach.

To get started, ShareWillow offers a free profit sharing plan template - a valuable resource for any business looking to implement or refine their profit sharing plan. This template simplifies the planning and execution of profit sharing.

FAQs

Is profit sharing a bonus?

Profit sharing is often seen as a bonus, but it's more than that. Unlike a standard bonus, profit sharing is directly linked to the company's profitability. Also, these payments are typically tax deductible.

What is a group retirement savings plan?

A Group Retirement Savings Plan (GRSP) is a collection of individual retirement accounts managed collectively. Employees contribute from their payroll using pre-tax dollars. It's similar to a DPSP in that both are employee-centric retirement savings plans, but the DPSP is funded by the employer.

What are the complications of profit sharing?

Profit sharing can sometimes lead to complications, like perceived inequality among employees and fluctuations in payouts due to business performance. In this sense, it requires careful management to ensure fairness and to maintain employee motivation.

What are the different types of profit sharing plans?

There are various types of profit sharing plans, including cash plans, where payouts are made directly to employees. And then there are deferred plans, where the profits are shared at a later date, often contributing to retirement funds. Each type offers its own unique set of benefits and caters to different business strategies.