It is both a one-time decision, with generally little scope for learning from experience, and it can have substantial implications for the financial resources available the individual for the remainder of their life. The second contribution is our specific analysis of how individuals choose to access funds held in a DC pension, which is an extremely important and understudied element in determining the effects of DC pensions. Greater understanding of the ability of older individuals to make complex financial decisions is important for many contexts, including the use of pensions and the uptake of insurance products relating to health or long-term care. The explicit focus on older individuals matters because cognitive function, a key dimension of financial literacy as defined by the existing literature, is a characteristic of people that changes with age (Salthouse, 2009). First, as noted by Lusardi and Mitchell ( 2014), relatively little is known to date about the relationship between financial literacy and the management of resources by older individuals as opposed to their younger or working age counterparts. Our contribution in this paper is twofold. The factors that are found to be significantly (positively) related to choose income drawdown are: being in full-time work immediately prior to starting to withdraw income, having children, and having at least one other form of annuity income (such as a defined benefit (DB) pension or another DC pension annuity). In contrast, we find that few factors are systematically related to choosing income drawdown rather than annuitization. These effects are evident even controlling for individuals’ education, health and employment status, other aspects of cognitive functioning (such as memory and executive functioning), the level of wealth and importance of the DC fund in the portfolio, individuals’ own survival expectations and mortality risk factors, and their parents’ survival. If one takes holdings of relatively sophisticated financial products as an indicator of financial knowledge, then we find independent roles for each of financial knowledge and numeracy, which are two of the key dimensions of financial literacy that have been identified in the recent literature. We find that the financial literacy (broadly defined) is an important factor governing individuals’ choice over whether to shop around for an annuity as opposed to taking an annuity from their original pension fund provider. We examine the role of financial literacy (and specifically, of numeracy and cognitive function) in determining whether individuals make a choice other than the ‘path of least resistance’ and, indeed, whether or not they choose to annuitize at all, while controlling carefully for other factors that may affect individuals’ desire to purchase an annuity. In the UK, the ‘default’ choice has been for a long time to buy an annuity from the provider with whom the pension was accumulated, though individuals do have the right to purchase an annuity from any provider, or to draw an income without purchasing an annuity. In this paper, we contribute to this literature by providing evidence on older adults’ decisions regarding how they start to withdraw funds from their defined contribution (DC) pensions. Broadly speaking, the conclusions of this literature are that the financial literacy and knowledge is on average rather low and very heterogeneously distributed across the population and that, particularly in a system with substantial private provision, policymakers should worry about the ability of individuals to take well-informed financial decisions that help them smooth their resources over their lifetimes and navigate more short-term economic fluctuations, such as the recent financial crisis. Lusardi and Mitchell ( 2014) provide a comprehensive summary of the current state of this literature both in terms of theoretical underpinnings and empirical evidence. In response to these trends and more general concerns that left to their own devices individuals may not save enough to fund their future retirement and health-care needs, a literature has been developed in the recent years that looks at levels of financial literacy and relates this to the nature of savings and portfolio choices that are being taken. As private saving has become increasingly important, the savings and insurance landscape has also become more complex in terms of the range and type of financial products available. The UK has been at the leading edge of these changes, particularly for pensions. Many countries around the world have been reducing the level of state provision of resources for retirement, moving towards a system that relies on an increased degree of individual or private provision.
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