Background: Taking into account our rapidly ageing population, older people are of particular interest in studying health inequalities. The aim of the present study is to examine the relation between socio-economic status and health-related functioning in older people and to find out how material factors (e.g. the lack of basic goods) and psychosocial factors (e.g. low self-efficacy) compare regarding the explanation of these socio-economic differences. Methods: Data came from 5061 Dutch men and women aged epsilon 55 years who participated in the longitudinal Study on Medical Information and Lifestyles Eindhoven (SMILE) study. Baseline data were collected between November 2002 and May 2004 and respondents were followed until May 2009 (follow-up range: 0-5 years). Multilevel analyses were used to study the association between educational level and longitudinal changes in physical and mental functioning (i.e. two subscales of the SF-36) and to study the relative contribution of material and psychosocial factors to this relation. Results: Low educational level was associated with poor initial physical and mental functioning. However, no further widening of these gradients was found during follow-up. Material factors reduced the initial educational differences by an average of 29%, whereas psychosocial factors, mastery and self-efficacy in particular, reduced these differences by an average of 60%. Conclusion: More than material factors, psychosocial factors, mastery and self-efficacy in particular, explained a large part of the educational differences in physical and mental functioning in older people. Further research is recommended to explore the amenability to change of characteristics that hamper people from taking control over their lives.