DPSP vs RRSP: Which Plan Should You Choose?

DPSP (Deferred Profit Sharing Plan) and Group RRSP (Group Registered Retirement Savings Plan) are two important tools for Canadian residents to engage in financial planning and retirement savings. Each plan offers unique advantages and flexibility, aimed at helping individuals achieve a better retirement life in the future. However, there are significant differences between them.

This article will delve into the differences between DPSP and Group RRSP, analyze their respective strengths and weaknesses. Whether you are a young person just starting your career or a middle-aged individual considering how to maximize your retirement income, understanding the essence of these two plans will help you make wiser investment decisions.

What is a DPSP?

The Deferred Profit Sharing Plan (DPSP) is a benefit plan established by employers for their employees, registered with the Canada Revenue Agency (CRA), which allows employers to allocate a portion of the company's profits to employees participating in the plan. Employees participating in the plan can be all company employees or a specific group of employees, but it should be noted that some major shareholders and employers and their related parties cannot participate in DPSP.

Employees cannot make direct contributions to the DPSP; all contributions come from the employer and are based on company profits and plan rules, subject to limitations under the Income Tax Act. Employers can claim tax deductions after making contributions to the DPSP.

Under the DPSP, contributions and investment earnings are tax-free, but the income is included in the employee's taxable income for the year when the funds are withdrawn. This means that the DPSP allows for tax-deferred growth of contributions and investment earnings.

For employees, it is possible to combine the DPSP with an RRSP for their retirement planning. However, it is important to note that the DPSP contributions received by an employee in the current year will reduce the RRSP contribution room for the following year.

For more official information about DPSP, please click on "Deferred Profit Sharing Plans".

Pros and cons of DPSP

The operation and use of DPSP involve both employers and employees as participants, so the evaluation of its advantages and disadvantages should also be conducted from the perspectives of both parties.

Pros for employers

Attracting and Retaining Talent: DPSP can serve as an additional benefit to help employers attract and retain high-quality employees. For employers who wish to provide a retirement plan for their staff but do not want to bear the high costs associated with Registered Retirement Savings Plans (RRSPs), this is an excellent option.

Flexibility: Unlike some other types of pension plans, employers can decide whether to make contributions to DPSP based on their profits. This offers significant financial flexibility, especially in years when business performance is poor.

Tax Benefits: Employer contributions to DPSP can be deducted as a business expense, thereby reducing taxable income.

Incentive Effect: DPSP can allocate profit shares based on employee performance or the overall company performance, serving as part of a performance reward mechanism.

Cons for employers

DPSP is limited to employee participation; company owners, their relatives, spouses, and individuals holding more than 10% of the company's shares are not eligible to join.

Additionally, DPSP is designed for employers to share profits. Therefore, only profitable companies can participate; non-profit companies cannot engage in DPSP.

Finally, it is important to note that DPSP distributions are largely influenced by the company's profits. A decrease or cancellation of DPSP distributions due to reduced profitability can cause significant psychological disappointment for employees, potentially leading to staff turnover.

Pros for employees

Additional Income: The biggest benefit of DPSP for employees is that they can not contribute to it themselves; all funds in the DPSP comes from the employer, which is like an extra income for the employees.

Supplementary Retirement Income: DPSP can serve as a supplement to traditional retirement savings tools (such as RRSPs), helping employees accumulate retirement savings. Unlike RRSPs, DPSPs can be withdrawn not only after retirement but also when employees leave the company after gaining vesting rights.

Sharing in Company Profits: DPSP allows employees to share in the company's success, and if the company is profitable, employees can also benefit from it.

Cons for employees

Liquidity Constraints: The funds within a DPSP are subject to liquidity constraints for employees. There is a two-year vesting period for the DPSP, meaning that employees must work for the company for two years before they fully own the contributions made by the employer to their account. This means that if an employee leaves the company before the vesting period is completed, they may not be able to take all of the employer's contributions with them.

Tax Implications: When withdrawing from a DPSP, the money will be considered taxable income for that year, and taking it all at once may result in a higher tax rate.

Impact on RRSP: Contributions to the DPSP will reduce the RRSP contribution limit for the following year. In other words, when an employer makes contributions to the DPSP, the employee's RRSP contribution limit for the next year will be correspondingly reduced.

What is a Group RRSP?

The Group Registered Retirement Savings Plan (Group RRSP) is a retirement savings scheme provided by employers for their employees, combining the features of individual RRSPs and company benefits. The Group RRSP is established by the employer for their employees. Employers typically choose a financial institution to manage the plan.

Both employees and employers can contribute to the Group RRSP. Employees contribute to the Group RRSP through payroll deductions. These contributions are made with pre-tax income, which can reduce the employee's taxable income for the year, providing immediate tax benefits. Additionally, employers may choose to match a portion or all of the employee's contributions, up to a certain percentage of the employee's salary. This can serve as an incentive for employees to increase their retirement savings.

Contributions to a Group RRSP can receive tax relief, and similarly, withdrawals from a Group RRSP must be declared as income for the year and taxed. This is the same as with DPSP.

Pros and cons of Group RRSP

Pros for employers

Tax Relief: Employer contributions can be deducted as business expenses, reducing taxable income.

Attracting and Retaining Talent: By offering a Group RRSP, employers can attract new talent and retain existing employees, especially if they provide matching contributions.

Flexibility: Employers can define the level of contributions and choose to increase or discontinue employer matching at any time.

Cons for employers

No Vesting Period: Group RRSPs do not have a vesting period, meaning employees do not need to remain with the company for a certain period to fully receive these funds, which could potentially lead to a relative decrease in employee retention rates for employers.

Tax Liability: Employer contributions are subject to payroll taxes, including Employment Insurance and Canada Pension Plan premiums.

Pros for employees

Tax Benefits: Contributions can reduce taxable income, providing immediate tax advantages.

Disciplined Saving: Automatic payroll deductions help employees develop a habit of disciplined saving.

Additional Contributions: If employer matching contributions are in place, employees have the opportunity to receive additional funds.

No Vesting Period: Contributions made to a Group RRSP, whether they are employee contributions or employer matching contributions, immediately belong to the employee.

Cons for employees

Tax Implications: Withdrawals are considered income for the year and are subject to taxation, unless they are made under the Home Buyers' Plan or the Lifelong Learning Plan.

Liquidity Restrictions: In some plans, employers may set restrictions that limit employees' ability to access funds during their period of employment.

DPSP vs RRSP: How to choose the right option?

Choosing between a Deferred Profit Sharing Plan (DPSP) and a Group Registered Retirement Savings Plan (Group RRSP) depends on several factors, and it requires a comprehensive consideration of the characteristics and differences of these two plans, clarifying the special needs for setting up a welfare plan for employees, and making a choice based on that.

The biggest difference between the two plans lies in the source of contributions and the vesting period issue.

Sources of Contributions:

• DPSP: Contributions come solely from the employer. Employers make contributions to the DPSP based on company profits and plan rules; employees do not directly contribute to the DPSP.

• Group RRSP: Contributions can come from both employees and employers. Employees contribute to the Group RRSP through payroll deductions, and employers can choose to match employees' contributions or provide additional contributions.

Vesting Period:

• DPSP: There is usually a vesting period, meaning that employees need to work for the company for a certain number of years before they can gain full ownership of the employer's contributions. This period is typically two years.

• Group RRSP: There is no vesting period. Once contributions are made to an employee's Group RRSP account, the funds belong to the employee.

Based on this, if employers have certain needs that can differentiate between these two plans, then they can easily make a choice. For example:

• Whether employees need to contribute: If employees need to contribute, then choose the Group RRSP.

• Whether the company only contributes when profitable: If contributions are made only when the company is profitable, choose the DPSP.

• Whether the company's contributions need to vest immediately with employees: If not, choose the DPSP.

Each plan has its unique advantages and limitations, and the choice of which plan to select depends on specific needs. Please make a careful choice after considering all aspects.

How to transfer a DPSP to an RRSP?

After leaving their employment, employees can transfer funds from their DPSP to other registered plans or choose to withdraw the funds. As long as the vesting period requirements are met, employees can withdraw the full amount; however, this may lead to a higher income tax rate for that year. Therefore, it is recommended to transfer these funds into an RRSP to defer taxation and avoid the potential high tax rates associated with a full withdrawal.

When transferring DPSP funds to an RRSP, please pay attention to the following points:

Determine Eligibility for Transfer: You must be 71 years old or younger by the end of the year in which you are transferring the funds to be eligible to transfer DPSP to an RRSP.

Confirm RRSP Account: Ensure that you have an RRSP account; if not, you will need to open one in advance. (moomoo Canada supports the opening of RRSP accounts; for more details, please click on "Registered Retirement Savings Plan".)

Contact DPSP Provider: Reach out to your DPSP provider to understand the process of transferring funds to your RRSP account.

Tax Treatment: If you transfer the amount directly, do not report this amount on your income tax and benefit return, nor claim a deduction for the transferred amount. However, if you receive a lump-sum payment in cash or by cheque before making the transfer, you cannot defer the tax. You need to report this amount on your income tax and benefit return for the year in which the payment is received.

How to open an RRSP in Canada?

To open an RRSP account in Canada, you can follow these steps:

1. Determine Eligibility: To open an RRSP, you must be a resident of Canada, have a Social Insurance Number (SIN), and have contribution room available. You also need to have filed a Canadian tax return.

2. Choose a Provider: You can select financial institutions such as banks, credit unions, or online brokerage firms (such as moomoo Canada) to open your RRSP account. Different providers may offer varying investment options and management fees.

3. Prepare Necessary Documents: You will need to provide valid government-issued identification, such as a driver's license, passport, or provincial ID, as well as your SIN. Some financial institutions may also require proof of income and employment, such as pay stubs or employer letters.

4. Complete the Application: Provide personal information such as your name, address, date of birth, and contact details. You may also need to provide information about your income, employment status, and investment experience to help the financial institution determine your risk tolerance and investment objectives. Submit the application and wait for approval.