TWO STAGE DECUMULATION STRATEGIES FOR DC PLAN INVESTORS

Peter A. Forsyth ()
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Peter A. Forsyth: David R. Cheriton School of Computer Science, University of Waterloo, Waterloo ON, Canada N2L 3G1, Canada

International Journal of Theoretical and Applied Finance (IJTAF), 2021, vol. 24, issue 01, 1-31

Abstract: Optimal stochastic control methods are used to examine decumulation strategies for a defined contribution (DC) plan retiree. An initial investment horizon of 15 years is considered, since the retiree will attain this age with high probability. The objective function reward measure is the expected sum of the withdrawals. The objective function tail risk measure is the expected linear shortfall with respect to a desired lower bound for wealth at 15 years. The lower bound wealth level is the amount which is required to fund a lifelong annuity 15 years after retirement, which generates the required minimum cash flows. This ameliorates longevity risk. The controls are the withdrawal amount each year, and the asset allocation strategy. Maximum and minimum withdrawal amounts are specified. Specifying a short initial decumulation horizon, results in the optimal strategy achieving: (i) median withdrawals at the maximum rate within 2–3 years of retirement (ii) terminal wealth larger than the desired lower bound at 15 years, with greater than 90% probability and (iii) median terminal wealth at 15 years considerably larger than the desired lower bound. The controls are computed using a parametric model of historical stock and bond returns, and then tested in bootstrap resampled simulations using historical data. At the 15 year investment horizon, the retiree has the option of (i) continuing to self-manage the decumulation policy or (ii) purchasing an annuity.

Keywords: Optimal control; DC plan decumulation; variable withdrawal; tail risk; asset allocation; resampled backtests (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1142/S0219024921500072

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