DC Design

Turning Defined Contribution Assets Into a Lifetime Paycheck: How to Evaluate Investment Choices for Retirees

Target-date and fixed income strategies designed to keep pace with the real cost of retirement, reduce the risk of significant loss and stay ahead of inflation are crucial.

A retiree’s best strategy for creating a lifetime income stream may be to keep their savings in their defined contribution (DC) plan. Doing so may maintain access to institutional investment strategies and, if the sponsor allows, a drawdown plan that can provide consistent monthly income. What’s more, for plan sponsors, retaining retiree accounts can increase assets and bolster leverage to negotiate lower fees. This would benefit all participants – and help employers attract and retain workers.

While few plan sponsors actively seek to retain retiree assets, most may desire to do so, according to PIMCO’s 2015 Defined Contribution Consulting Support and Trends Survey. To encourage plan sponsors to retain retiree assets, we offered suggestions in the paper, “Defined Contribution Plan Sponsors Ask Retirees, ‘Why Don’t You Stay?’ Seven Questions for Plan Sponsors.” Most critical to success: offering distribution flexibility and having retiree appropriate investment choices.

When it comes to retirement income, consultants said target-date strategies (at-retirement vintage) and diversified fixed income funds were the most important. To that end, we suggest ways that plan sponsors can evaluate how likely these investment strategies are to deliver retirement income.

Evaluating the DC investment lineup for retiree readiness

To generate steady and sustainable retirement income – i.e., a lifetime paycheck – retirees seek opportunity for return as well as the ability to manage specific risks. Chief among them: market, longevity and inflation risk. Each imposes unique demands on a retiree’s portfolio.

  • Managing market risk requires structuring an investment portfolio to seek retirement income with stable payouts and minimal disruption from market shocks.
  • Managing longevity risk requires assessing how long assets might last.
  • Managing inflation risk requires populating a portfolio with assets that seek to keep pace with inflation.

We propose a set of measures to evaluate portfolios on their appropriateness to retirees’ needs:

1. Correlation to retirement liability: How well does the strategy correlate to the PIMCO retirement income cost estimate (PRICE)1?

2. Information ratio relative to retirement liability: What is the information ratio relative to PRICE?

3. Downside risk: What level of Value-at-Risk2 is appropriate given a retiree’s risk capacity?

4. Asset longevity: How long are assets likely to remain during the distribution phase?

5. Inflation beta: To what extent is a retiree’s account likely to keep pace with inflation and retain purchasing power?

In the analysis that follows, we examine target-date (at-retirement vintage) and fixed income strategies. For each, we look at two strategies: for target-date funds, these include the Market Average3 and the Objective-Aligned Glide Paths (at-retirement vintage); for diversified fixed income strategies, we model the Barclays Aggregate Bond Index and a multi-sector bespoke blend of major U.S. and non-U.S. bond indexes.

The concept of the PIMCO retirement income cost estimate (PRICE) is discussed in the September 2015 DC Design, “Benchmarking Target-Date Funds to the PRICE of Retirement.” In short, the retirement cost can be defined as what an individual must pay to buy an annuity that provides lifetime income sufficient to maintain her lifestyle during retirement. Interest rates will largely determine the cost.

Figure 2 shows the correlation of the four retirement income strategies to the objective of securing retirement income as defined by PRICE. Between the target-date strategies, the Objective-Aligned approach correlates better than the Market Average Glide Path. Between the diversified fixed income strategies, the Barclays U.S. Aggregate Index has a slightly higher correlation than the multi-sector bond portfolio.

Next, we modeled how well these four strategies perform relative to PRICE, including excess return, tracking error and information ratio. Between the target-date strategies, the Objective-Aligned Glide Path (at-retirement vintage) had a higher information ratio than the Market Average Glide Path (at retirement vintage). For the diversified fixed income strategies, the multi-sector bond portfolio had a higher information ratio.

To measure potential loss, we modeled risk exposure by assessing value-at-risk (VaR) at the 95% confidence level (VaR estimates the minimum expected loss at a desired level of significance over 12 months). As Figure 4 shows, among the target-date strategies, the Objective-Aligned Glide path has lower downside risk than the Market Average Glide Path. For the diversified fixed income strategies, the multi-sector bond strategy has slightly more downside risk.

How long might one’s money last? To answer this critical question, we modeled the distribution phase to evaluate the likely life of the assets. We assume participants begin retirement at age 65 with an account balance of $680,000 and withdraw 50% or 30% of a final salary of $74,500. Figures 5 and 6 illustrate the projected longevity of assets at 95% and median confidence for final salary withdrawal levels of 50% and 30%.

We find that the Objective-Aligned (at-retirement vintage) glide path has higher asset longevity under the 95% confidence level and the same asset longevity under the median confidence level than the Market-Average Glide Path (at-retirement vintage) for both 50% and 30% of final salary withdrawal rates. The multi-sector bond portfolio has the same asset longevity as the Barclays Aggregate U.S. Index under the 95% confidence level and higher asset longevity at the median confidence level, for both 50% and 30% of final salary withdrawal rates.

As to inflation responsiveness, we believe asset prices are much more sensitive to inflation surprises than actual levels of inflation. Asset classes with a positive beta to inflation surprises have historically tended to perform well, thus preserving purchasing power.

As Figure 7 shows, for the target-date (at-retirement vintage) strategies, the Objective-Aligned Glide Path had a higher inflation beta than the Market Average Glide Path. Among the diversified fixed income strategies, the multi-sector bond portfolio had a higher inflation beta.

Retirees may benefit from building a retirement income stream from their DC plan, including access to institutional investments, fiduciary oversight and attractive pricing. Plans may also benefit by leveraging the purchasing power of retiree assets to bring down the costs of the overall plan. For retirees to retain assets in plan, though, they need appropriate investment choices: strategies designed to keep pace with the real cost of retirement, reduce the risk of significant loss and stay ahead of inflation.

According to PIMCO’s 2015 Defined Contribution Consulting Support and Trends Survey, consultants rank “at retirement” target-date vintages and diversified fixed income strategies as most important. Plan fiduciaries should evaluate these strategies relative to retiree needs. Our analysis shows that an Objective-Aligned Glide Path (at-retirement vintage) is superior to the Market Average Glide Path (at-retirement vintage) across all measures analyzed in this article. Specifically, it outperforms in correlation to the cost of retirement (PRICE), risk-adjusted performance, downside risk, asset longevity in retirement and inflation beta. In addition, our analysis demonstrates that compared to the Barclays U.S. Aggregate Index, a multi-sector bond strategy may provide higher return, greater asset longevity and higher inflation protection, albeit with slightly higher downside risk.

In addition to the evaluation factors presented, we encourage plan fiduciaries to carefully consider the use of active versus passive investment management. Consultants in our survey suggested that “active management should dominate” for all asset classes except U.S. large cap equity. Retirees may benefit from increased return opportunity and reduced risk by selecting actively managed target-date and fixed income strategies. Sponsors also may consider target-date strategies that embed downside hedging intended to guard retiree assets against a sudden market downturn.

Employers also may consider making an institutionally priced annuity purchase program available to retirees. This could enable retirees to access immediate and deferred annuities. Retirees may gain greater comfort in managing longevity risk by purchasing a deferred annuity that begins paying income, for instance, when the retiree reaches age 85. A deferred annuity may allow the retiree to shorten their investment horizon and possibly increase installment payouts. Combining an objective-aligned target-date strategy or a multi-sector fixed income strategy with a deferred annuity may create a more secure life-long retirement income stream.


1 PRICE (PIMCO retirement income cost estimate) is calculated as the discounted present value of a 20-year zero-coupon TIPS ladder. Details are discussed in the September 2015 DC Design, “Benchmarking Target-Date Funds to the PRICE of Retirement.”

2 Value-at-Risk estimates the minimum expected loss at a desired level of significance over 12 months.

3 The Market Average Glide Path is constructed by NextCapital and is an average of the 45 largest target-date strategies in the market.

4 Multi-sector bond consists of: 20% Barclays U.S. Aggregate Index

20% Barclays Global Aggregate ex-USD (USD Hedged) Index
20% Barclays Capital Global Credit Hedged USD Index

20% BofA Merill Lynch Global High Yield BB-B Rated
Constrained Index

20% JPMorgan EMBI Global Index

5 We employed a block bootstrap methodology to calculate asset longevity. We start by computing historical factor returns that underlie each asset class proxy from January 1997 through the present. We then draw a set of 12 monthly returns within the dataset to derive an annual return number. This process is repeated 25,000 times to have a return series with 25,000 annualized returns. The standard deviation of these annual returns is used to model the volatility for each factor. We then use the same return series for each factor to compute covariances between factors. Next, the volatility and distribution of each asset class proxy is calculated as a function of variances and covariances of risk factors that underlie that particular proxy. We assume participants begin retirement at age 65 with an account balance of $680,000 and withdraw 50% or 30% of a final salary of $74,500. Finally, the asset longevity for each strategy is estimated using the following return assumptions combined with the above described block bootstrap simulation methodology and DC assumptions.

The Author

Stacy Schaus

Head of Defined Contribution Practice

Ying Gao



Past performance is not a guarantee or a reliable indicator of future results. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower’s obligation, or that such collateral could be liquidated. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Investors should consult their investment professional prior to making an investment decision.

The correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility. Information ratio is a ratio of portfolio returns above the returns of a benchmark to the volatility of those returns. Tracking error measures the dispersion or volatility of excess returns relative to a benchmark.

Glide Path is the asset allocation within a Target Date Strategy (also known as a Lifecycle or Target Maturity strategy) that adjusts over time as the participant’s age increases and their time horizon to retirement shortens. The basis of the Glide Path is to reduce the portfolio risk as the participant’s time horizon decreases. Typically, younger participants with a longer time horizon to retirement have sufficient time to recover from market losses, their investment risk level is higher, and they are able to make larger contributions (depending on various factors such as salary, savings, account balance, etc.). Generally, older participants and eligible retirees have shorter time horizons to retirement and their investment risk level declines as preserving income wealth becomes more important.

No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown. Hypothetical or simulated performance results have several inherent limitations. Unlike an actual performance record, simulated results do not represent actual performance and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated performance results and the actual results subsequently achieved by any particular account, product or strategy. In addition, since trades have not actually been executed, simulated results cannot account for the impact of certain market risks such as lack of liquidity. There are numerous other factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results.

The portfolio analysis is based on index blends and no representation is being made that the structure of the average portfolio or any account will remain the same or that similar returns will be achieved. Results shown may not be attained and should not be construed as the only possibilities that exist. Different weightings in the asset allocation illustration will produce different results. Actual results will vary and are subject to change with market conditions. There is no guarantee that results will be achieved. No fees or expenses were included in the estimated results and distribution. The scenarios assume a set of assumptions that may, individually or collectively, not develop over time. The analysis reflected in this information is based upon data at time of analysis. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.

PIMCO routinely reviews, modifies, and adds risk factors to its proprietary models. Due to the dynamic nature of factors affecting markets, there is no guarantee that simulations will capture all relevant risk factors or that the implementation of any resulting solutions will protect against loss. All investments contain risk and may lose value. Simulated risk analysis contains inherent limitations and is generally prepared with the benefit of hindsight. Realized losses may be larger than predicted by a given model due to additional factors that cannot be accurately forecasted or incorporated into a model based on historical or assumed data.

Value at Risk (VaR) estimates the risk of loss of an investment or portfolio over a given time period under normal market conditions in terms of a specific percentile threshold of loss (i.e., for a given threshold of X%, under the specific modeling assumptions used, the portfolio will incur a loss in excess of the VAR X percent of the time. Different VAR calculation methodologies may be used. VAR models can help understand what future return or loss profiles might be. However, the effectiveness of a VAR calculation is in fact constrained by its limited assumptions (for example, assumptions may involve,
among other things, probability distributions, historical return modeling, factor selection, risk factor correlation, simulation methodologies). It is important that investors understand the nature of these limitations when relying upon VAR analyses.

It is not possible to invest directly in an unmanaged index.

This material contains the opinions of the authors but not necessarily those of PIMCO and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or
a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.