Defined benefit (DB) plans can provide guaranteed income for life; however, there is no potential for wealth accumulation. Moreover, most DB plans offer little or no death benefit. On the other hand, defined contribution (DC) plans offer the potential for wealth accumulation; participants might retire quite comfortably and leave a generous bequest for their heirs. However, since the participant bears all of the investment and longevity risk in a DC plan, she also faces the possibility of outliving her accumulated wealth.
Minimizing the probability of lifetime ruin – that is, the probability of depleting one’s wealth prior to death – is an increasingly important objective in retirement planning as more individuals are responsible for managing their retirement portfolios through DC plans. But bequest goals are also an important consideration in retirement planning.
We examined hybrids of DB and DC plans. We simulated investment returns and the time of death and we measured the hybrid plans’ performance relative to both income and bequest goals. Through this analysis, we quantified the trade-offs between the income security of a DB plan and the potential for wealth accumulation in a DC plan. In other words, we addressed the questions, “How much income security will I forfeit by focusing more on wealth accumulation?” and vice versa. In addition, we suggested allocations between DB and DC that perform particularly well relative to given metrics.
Presentation from 2016 Actuarial Research Conference
Balancing Income and Bequest Goals in a DB/DC Hybrid Pension Plan
Gu, G., D. Kausch, K.S. Moore, V.R. Young. Journal of Retirement, 4 (2017), no3. 51-62.
