Optimal Control of Defined-Contribution (DC) Pension Plan

Abstract

A shift from defined-benefit pension plan towards defined-contribution pension plan is currently popular around the world. Under DC plan, employers transfer the pension fund investment risk to the employees. No one knows if the DC plan will be able to provide a good pension benefit when the day of retirement arrives. Therefore, it is essential for the employees to choose optimal investment strategies during the accumulation phase so that they will have sufficient funds targeted in their retirement. In order to reduce the risk of individual DC member, we investigate the methodology of finding the optimal contribution rate and asset allocation to reach a certain target of the retirement replacement rate for different risk tolerant individual in this paper. We draw two conclusions from our investigations. First, the optimal investment strategy is very similar to the "lifestyle" investment strategy. Second, we find the influence of the transaction cost in the case of equity is very limited to the strategy of asset allocation. But, the influence of the transaction cost in the case of long-term bonds is more significant. We will switch the assets held in long-term bonds to short-term bonds.