Numerical methods for optimal decumulation of a defined contribution pension plan

Abstract

The decumulation of a defined contribution (DC) pension plan is well known to be one of the hardest problems in finance. We model this decumulation challenge as an optimal stochastic control problem. The control problem is solved, at each rebalancing date, by alternatively solving a linear partial-integro differential equation (PIDE) followed by an optimization step. We solve the PIDE by using a $δ$-monotone Fourier method, which ensures that monotonicity holds to $O(δ)$. We allow for the use of leverage (i.e. borrowing to invest in stocks), as well as minimum constraints on bond holdings. We pay particular attention to minimizing wrap-around error, an issue which is endemic for Fourier methods and central to the effective use of these methods for optimal control problems. Rather unexpectedly, we find that restricting the portfolio equity fraction to a maximum of 50\% does not reduce portfolio efficiency noticeably. This may be a useful strategy for risk-averse retirees.