Employer contributions and tax savings can really add up
Employers often use group benefits as a way to attract and retain their best employees. The most popular group benefits typically offer the most flexibility for employees and the lowest costs for employers. That’s why employers are increasingly turning to the flexibility and low costs characterized by Deferred Profit Sharing Plans (DPSPs) and Group Registered Retirement Savings Plans (RRSPs).
Essentially, a DPSP is a type of registered pension plan (it must be registered with the Canada Revenue Agency) that is funded solely by the employer, based on the profitability of the business. The employer will make contributions on any schedule they choose and only if there are profits to share. Employees can generally decide how the DPSP funds are invested, and those participating in the plan do not pay tax on the contributions made to their DPSP until the money is withdrawn from the plan. For the employer, a DPSP has definite tax advantages in that contributions are made from pre-tax income, are tax-deductible for the employer, and are not subject to either federal or provincial payroll withholding tax or EI and CPP/QPP deductions.
A drawback to this plan, however, is that employer contributions can be unpredictable, may be cancelled at any time, and the benefit is not guaranteed. In addition, RRSP contribution room is cut by the amount of the previous year’s DPSP contribution. DPSPs also allow for vesting up to two years – if an employee leaves the firm before the vesting period, the employer keeps the money.
An employer can contribute a maximum of one half of the money purchase limit for the year (that is, one half of $26,500 in 2018, or $13,250) or 18% of the employee’s compensation in the year (based on the year’s maximum pensionable earnings – $55,900 in 2018), whichever is less.
DPSPs are often used in conjunction with a Group Registered Retirement Savings Plan. These basically has the same structure as an individual RRSP, except that they are administered by the employer, and individual investment choices are typically limited.
Both employer and employee contribute to the plan. Contributions are tax deductible, and like individual RRSPs, tax on any investment growth inside the plan is deferred until you collapse the plan. Contributions are made by regular payroll deduction. Because this is an RRSP contribution, it results in a tax deduction, which can be applied to reduce the employee’s source withholding, in effect giving the employee an instant tax refund. Employer contributions are not mandatory but are usually made as an additional employee benefit.
Group RRSPs are administered by the employer and are typically contracted out to institutional pension fund managers. Depending on the terms of the Group RRSP, there may be some choice in the type of investments or portfolios to choose, but generally employees won’t be able to trade individual stocks.
A key advantage is that administrative costs of Group RRSPs are negligible and often non-existent for the employee. Also, minimum deposits are generally low, and the administrator will take care of all the tax reporting paperwork.
If an employee leaves the company, their proceeds from the Group RRSP can be transferred to their individual plan or to a Registered Retirement Income Fund or annuity if at or close to retirement age. Taking the proceeds in cash will be considered taxable income in the year received and will be taxed at the employee’s marginal rate for the year.
A drawback to Group RRSPs is that employees may have only limited rights to withdraw funds from the plan while remaining with the employer. In addition, the employer may cancel the plan at any time, transferring the proceeds to the employee as cash or transferring to an individual RRSP, a RRIF, or annuity. The same tax rules apply as if you had left the employer.
Then, too, there’s the question of investment management. While the management of Group RRSPs is typically contracted to institutional managers, this may not always be the case. If you have doubts, check with an independent financial advisor about the calibre, qualifications, and performance history of the money manager before signing up.
© 2018 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.