Financial planning for retirement in young adults: Interaction of professional experience, knowledge, and beliefs

Abstract

IntroductionYoung people in Slovakia are facing a very high-consequence financial decision soon after entering their first job as they must decide whether to join the 2nd pension pillar. Since 2004 the 2nd pension pillar presents a new possibility of financial planning for retirement (hereafter FPR) in Slovakia. While in the 1st pension pillar employees can count on a defined level of retirement benefits based on a computation that reflects their salary and years of service (DB pension), in the 2nd pillar employees invest their contributions in pension funds at one of the private financial institutions. The 2nd pension pillar in Slovakia represents a type of defined contribution plan (DC pension), where retirement income is calculated on the basis of the worker's level of pre-retirement contributions. Unlike the 1st state pillar, participation in the private 2nd pillar is not mandatory for Slovak employees nowadays. At the same time, only people up to 35 years can enroll in the 2nd pillar.The decision of an individual employee whether to enter the 2nd pillar has far-reaching consequences because a process of undergoing finance reform comprises the massive shift from defined benefit (DB) to defined contribution (DC) retirement plans for young adults. The changes in the retirement income system are aimed at an increase in responsibility for one's retirement income that will no longer be determined by one's employer and the state, but instead will largely depend on the saving and investment decisions of an individual employee. Yet many legal and economic changes, which accompany the 2nd pension pillar system in Slovakia from its inception until now, make this decision-making environment rather unclear and difficult to understand.In addition to enrolling in the 2nd pillar, there are many other decisions young people need to make with regard to FPR, such as investment choices in the 2nd pillar or participation in the 3rd pillar. These high consequence choices find most young people quite unprepared. Indeed, despite the importance of the financial decisions that young adults need to make, financial retirement planning decisions remain an area within which individuals receive little formal and/ or informal education.Studies on financial preparation for retirement have focused mostly on demographic indicators associated with FPR among all people of working age or they focused on older individuals approaching retirement. In the present study we examine the psychological, cognitive and motivational forces that underlie planning and saving for retirement in young people. Factual financial knowledge, financial hands-on experience, and personal beliefs on FPR are explored as important psychological variables which can broaden our understanding of the psychological forces that drive young people to prepare financially for their retirement.Financial Knowledge and FPRFactual knowledge and understanding of financial matters are arguably one of the necessary prerequisites of the ability to make personal financial decisions efficiently (Croy, Gerrans, & Speelman, 2010; Hershey, Austin, & Gutierrez, 2015; Lusardi & Mitchell, 2011a, 2011b). There is a wealth of evidence that insufficient financial knowledge in adulthood results in a range of negative outcomes. For instance, a low level of financial literacy and numeracy have been identified as the root cause of poor retirement saving and investment decisions (Lusardi & Mitchell, 2011a, 2011b). Many studies show that engagement in planning for retirement and saving rates are deeply impacted by one's level of financial and investment knowledge (Croy et al., 2010; Van Rooij, Lusardi, & Alessie, 2011). According to recent research of retirement saving across eight European countries, financial literacy positively influences retirement savings, so that individuals with a higher level of financial knowledge show a greater tendency to save for retirement (Fernandez-Lopez, Otero, Vivel, & Rodeiro, 2010). …