Financial literacy and private old-age provision

Private old-age provision is growing increasingly important in times of demographic change and mounting strains on the public pension system. For many individuals in Germany the “need” to save for old-age in addition to the state pension is new and households seem to face difficulties saving for old age due to the high complexity and the large variety of old-age savings contracts. Therefore, it is important to evaluate who saves and who does not and whether this decision is related to financial knowledge of individuals.

How much do individuals know?

Financial literacy is measured on the basis of three simple questions:

1. Understanding of Interest Rate (Numeracy)
“Suppose you had 100€ in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow: more than 102€, exactly 102€, less than 102€?”
2. Understanding of Inflation
“Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?”
3. Understanding of Risk and Diversification
“Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”

About 85% of the households know the correct answer to the interest question, and more than 86% answer the inflation question correctly. Taken together around 82 % of the individuals comprehend both, the functioning of interest and inflation. And 60 % of the individuals understand the relationship of risk and diversification. Overall around 52 % of the individuals give correct answers to all three considered questions of financial literacy.

Who knows a lot and who knows little?

The next question is: who is able to give three correct answers and who is not? Financial literacy relates to higher levels of wealth, higher income and higher education. Moreover, men are more likely to know all the answers than women and individuals older than 55 are less literate than younger individuals. Individuals in East and West are equally literate, when controlling for differences in income, wealth and education.

How is financial literacy related to retirement savings?

A positive correlation of financial literacy and financial decision making is identified: more literate households are more likely to save privately for their old-age and at the same time households saving privately for their old-age acquire financial knowledge to improve their investment decisions. Interestingly, the possession of a state subsidised Riester contract is related to lower levels of financial literacy than the possession of other non-subsidised forms of private old-age provision. On the one hand this indicates that Riester subsidies to some extent successfully encourage individuals with lower financial knowledge to save privately for old-age. Nevertheless, individuals in the lowest income quintile still have low levels of private coverage despite the high subsidies. At the same time they show the lowest levels of financial literacy. On the other hand, if the causal relationship runs in the opposite direction, individuals signing a Riester seem to acquire some financial knowledge in the course of this process. However, they acquire less financial knowledge than individuals with non-subsidised old-age savings contracts.

Thus, the analysis above suggests that the subsidies provided by Riester successfully encourage certain groups in the middle of the income distribution and with moderate levels of financial literacy. However, the poorest 20% of the households still do not respond to the policy measures. Thus, more effort is needed here. It would probably be efficient to target specific groups at risk with financial information.


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