Performance of a newly developed decadal climate prediction system is examined using the low-resolution Community Earth System Model (CESM). To identify key sources of predictability and determine the role of upper and deeper ocean data assimilation, we first conduct a series of perfect model experiments. These experiments reveal the importance of upper ocean temperature and salinity assimilation in reducing sea surface temperature biases. However, to reduce biases in the sea surface height, data assimilation below 300 m in the ocean is necessary, in particular for high-latitude regions. The perfect model experiments clearly emphasize the key role of combined three-dimensional ocean temperature and salinity assimilation in reproducing mean state and model trajectories. Applying this knowledge to the realistic decadal climate prediction system, we conducted an ensemble of ocean assimilation simulations with the fully coupled CESM covering the period 1960–2014. In this system, we assimilate three-dimensional ocean temperature and salinity data into the ocean component of CESM. Instead of assimilating direct observations, we assimilate temperature and salinity anomalies obtained from the ECMWF Ocean Reanalysis version 4 (ORA-S4). Anomalies are calculated relative to the sum of the ORA-S4 climatology and an estimate of the externally forced signal. As a result of applying the balanced ocean conditions to the model, our hindcasts show only very little drift and initialization shocks. This new prediction system exhibits multiyear predictive skills for decadal climate variations of the Atlantic meridional overturning circulation (AMOC) and North Pacific decadal variability.