VoxEU Column International Finance

Financial literacy and retirement planning: How well-prepared are German households?

We live in financially compromised times – but how many people understand them? This is especially problematic when it comes to people’s own finances. This column presents findings from a study in Germany that does not make for comfortable reading.

People are increasingly put in charge of their wellbeing after retirement. Pension reforms around the world have introduced or increased the prevalence of individual retirement accounts, meaning people are often in charge of deciding not only how much to contribute to these accounts but also how to allocate their retirement wealth. Moreover, financial markets have become more complex, offering products not available in the past. In this context, consumer financial literacy plays a crucial role for a “stable and healthy economy”, as pointed out by Chairman of the US Federal Reserve Ben Bernanke.1 But are people well-equipped to face this new economic environment?

Data from Germany do not provide comforting findings. The data are collected as part of an international comparison of financial literacy based on a uniform measure of financial knowledge in as many as eight countries.2 Financial literacy is measured on the basis of responses to three simple questions (see Box 1), selected because they are applicable in all countries.3 The questions examine financial knowledge, which is at the core of many financial decisions. The first question assesses the ability to perform a simple interest-rate calculation. The second question aims to assess understanding of inflation. The third question tests whether individuals understand the concept of risk diversification.

Of over 1,000 German respondents, about 80% were able to correctly answer the interest question.4 More than three quarters gave a correct answer to the inflation question. However, only around 60% of respondents appear to understand the concept of risk diversification. Even though these are relatively simple questions, just over half of German respondents (53%) were able to correctly answer all three questions. Nearly three quarters of respondents could respond correctly to two out of three questions. About one in ten were unable to give any correct response and roughly four in ten chose “do not know/refuse to answer” at least once. While the level of financial literacy is low, German respondents have a level of financial literacy very similar to respondents in the US and the Netherlands. Given the complexity of financial decisions that individual face, these are worrisome findings.

Box 1. Financial literacy survey

1) Understanding of interest (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/ Do not know/ Refuse to answer

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, how much would you be able to buy with the money in this account?

More than today/ Exactly the same/ Less than today/ Do not know/ Refuse to answer

3) Understanding of risk diversification

Please tell me whether this statement is true or false: “Buying a single company’s stock usually provides a safer return than a stock mutual fund.”

True/ False/ Do not know/ Refuse to answer

While financial illiteracy is widespread, it is particularly severe among some demographic groups. For example, older respondents are less likely than young respondents to have given correct answers. Individuals with higher levels of education are more likely to have answered these three questions correctly. And, the self-employed were correct more frequently than those who are dependently employed or those out of the labour market.

The difference in responses between men and women is particularly striking. Among German respondents 60% of men and 47% of women were able to answer all of the questions correctly, a result which mirrors that found in most other countries studied. Women were much more likely than men to report they “do not know” the answer. This may be an indicator that women are more willing to recognise and acknowledge lack of knowledge than are men.

It is possible to also look at the differences in responses of individuals from East versus West Germany. Even 20 years after German unification, there are still fundamental differences between East and West. On average about 45% of East German compared to 58% of West German respondents were able to correctly answer all financial literacy questions. The regional disparity remains significant when demographic variables such as income, education, and wealth are taken into consideration. Moreover, there is no gender difference in financial literacy among the East German population, whereas there is a substantial difference in the number of correct responses between men and women in the West,5 a finding that raises questions on the origin of gender differences. In addition, individuals with low levels of education and low income and those out of the labour force in the East have considerably lower levels of financial literacy compared to the respective groups in the West.

Private retirement savings as a new challenge

Demographic pressure and tight public budgets have led to extensive pension reforms in many developed economies. Declining fertility, increasing life-expectancy, and the baby boomers’ transition into retirement are challenging publicly financed pension systems. In the coming years a decreasing number of labour force participants will have to finance an increasing number of pensioners. Fundamental pension reforms have been implemented to create more demographically robust retirement systems. In many countries this will lead to decreasing pension income from the public system and increased individual responsibility for financial security in old age.

In Germany, a series of retirement reforms was implemented between 1992 and 2007. As a result, private households in Germany are now required to accumulate additional funds to finance their retirement. A central question therefore is: How well are German households prepared to take on the responsibility for their retirement income? In other words, how are private retirement savings and the distribution of wealth related to the financial literacy of individuals?

Previous studies – mainly based on US households – show that low levels of financial literacy result in little retirement planning (see, eg, Lusardi and Mitchell 2008 and 2011) and the accumulation of low levels of wealth (see Lusardi 2008 and the sources cited therein for an overview of the current literature). Data from Germany show that around three quarters of survey respondents have never thought about how much wealth they should accumulate to reach a certain standard of living in retirement.6 Compared internationally, the share of planners in Germany is very low. However, given the historical design of the pension system in Germany this result is not so surprising. Nevertheless, retirement planning is particularly important for young people, who will be fully affected by the recent reforms and therefore carry a high level of responsibility for their financial security in old age.

Importantly, retirement planning is closely linked to financial literacy. Seventy percent of individuals identified as planners are able to answer all financial literacy questions correctly, whereas among those identified as non-planners, only 54% are able to do so. The relationship between retirement planning and financial literacy remains positive even after controlling for differences in sociodemographic variables; in other words, respondents with identical income levels, labour market status, educational attainment, gender and marital status, and number of children but a higher level of financial literacy have a higher probability of planning for their retirement.7

Policy implications

The findings discussed here are important in light of the recent pension reforms in Germany and increasing individual responsibility for retirement planning. If individuals with lower financial knowledge are less likely to plan for retirement, they will be less likely to be aware of and to take steps to fill the gap in retirement income that will result from the recent reforms.

This may have dramatic effects, particularly on the retirement security of individuals in East Germany, because state pensions will be lower due to interrupted employment histories.

  • Financial literacy is particularly low among East Germans with low education and low income.
  • It is also low among women.

Thus, more targeted efforts and programmes may be needed if these groups are to improve their understanding of financial matters and take appropriate steps to secure adequate retirement savings.


Börsch-Supan, Axel, Michela Coppola, Lothar Essig, Angelika Eymann, Daniel Schunk (2009), The German SAVE Study—Design and Results, 2nd edition, Mannheim Institute for the Economics of Aging (MEA).

Bucher-Koenen, T and A Lusardi (2011), “Financial Literacy and Retirement Planning in Germany”, Journal of Pension Economics and Finance, 10(4):565-584.

Lusardi, A (2008), “Financial Literacy: An Essential Tool for Informed Consumer Choice?”, Center for Financial Studies DP No. 19.

Lusardi, A and O Mitchell (2008), “Planning and Financial Literacy: How Do Women Fare?”, American Economic Review: Papers and Proceedings, 98:413-417.

Lusardi, A and O Mitchell (2011), “Financial Literacy and Planning: Implications for Retirement Wellbeing”, forthcoming in A Lusardi and O Mitchell (eds.), Financial Literacy: Implications for Retirement Security and the Financial Marketplace, Oxford University Press.


1 Chairman Ben S. Bernanke, “Statement by Chairman Bernanke on financial literacy,” April 2011, http://www.federalreserve.gov/newsevents/testimony/bernanke20110420a.htm

2 These results are taken from Bucher-Koenen and Lusardi (2011). Besides Germany the survey was conducted in the United States, the Netherlands, Italy, Sweden, Russia, Japan, and New Zealand.

3 These questions were developed for the American Health and Retirement Study.

4 The analyses are based on data from SAVE—a representative panel of German households administered by the MEA (Munich Center for the Economics of Aging) since 2001. For more information on the design of the study see Börsch-Supan et al. (2009). The results presented here are from 2009. Responses of 1,059 households are considered. Results are weighted to be representative of the German population.

5 One reason that has been put forward to explain the lower gender disparity in the East is that in East Germany women’s labor market attachment is a lot higher than in the West. However, the gender disparity in the West remains significant when controlling for income, education, and labor market status, whereas the gender difference in the East remains insignificant.

6 The following question was asked in the survey: “Did you and your partner ever think about how much you have to save today to reach a certain standard of living when you are old? Yes/No.” Only households in which at least one partner is not yet retired were asked this question (N=677).

7 In order to allow for a causal interpretation, we estimated an instrumental variable model.


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