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Dave Ramsey’s Baby Steps to financial peace have become a popular way to get control of finances. In case you’re not familiar with the Dave Ramsey approach to money, here are the 7 Baby Steps:

  1. $1,000 to start an Emergency Fund
  2. Pay off all debt using the Debt Snowball
  3. 3 to 6 months of expenses in savings
  4. Invest 15% of household income into Roth IRAs and pre-tax retirement
  5. College funding for children
  6. Pay off home early
  7. Build wealth and give!

While there are those who quibble with some aspects of these steps, by and large it’s a sound approach to money management. If my children when they leave home decide to follow the Dave Ramsey way of handling money, I’ll take great comfort that they are headed in the right direction.

But what about those of us who aren’t just starting out or recovering from a financial meltdown. For many of us, when we look at Dave’s Baby Steps, we realize that we have been taking on many of these steps at the same time! For example, we have a lot more than $1,000 in our emergency fund, yet we also have non-mortgage debt, we save for our children’s education (my son starts college in three years), we save for retirement, and we give money to charity.

And all of this raises the question we are going to address: Should we ‘Dave Ramsey our finances‘, and if we did, would we be better off?

To answer this question, let’s walk through the Baby Steps (particularly ##1-3) using the following assumptions:

  • Non-retirement savings: $50,000 in a mix of mutual funds and cash accounts.
  • Non-mortgage debt: $200,000 (mainly from a home renovation) on a home equity line of credit and low interest credit cards.
  • Mortgage: $400,000 on a 30-year fixed rate of 5.5%.
  • College Savings: $10,000 in a 529 Plan with kids a few years away from college.
  • Retirement Savings: $250,000 in 401(k) and IRA accounts.
  • Retirement Contributions: Currently contributing 7% to company 401(k), and company matches up to 7%.

Everybody’s specific financial conditions is different, of course, but the above assumptions will allow us to work through some of the significant issues and opportunities Dave Ramsey’s approach can present.

Dave Ramsey Baby Step #1: $1,000 Emergency Fund

Unlike those trying to save $1,000, many who chose to follow Dave Ramsey’s Baby Steps would be in the position of draining their emergency fund down to $1,000 and using the funds to pay down debt. From just a numbers perspective, using an emergency fund to pay off non-mortgage debt is usually the right choice.

Emergency funds should be kept somewhere risk-free, like in an online, high yield savings account. These accounts almost always pay less than the interest on debt. In addition, the interest a savings account does pay is taxable, while interest payments on credit cards and personal lines of credit generally are not tax deductible.

Of course, many may have debt on 0% balance transfer credit cards or on home equity lines of credit that are tax deductible. But for the most part, interest on debt will be more than interest earned on a savings account.

The big issue here for many is psychological. Having taken some comfort in an emergency fund that could pay expenses for some number of months, it will be very difficult to reduce the emergency fund to just $1,000. If that describes you, how would you answer the following question: If you had no debt and $1,000 in savings, would you borrow money to add to your emergency fund? If the answer is no, then you should ask why you are holding onto more than $1,000 while you carry non-mortgage debt.

There may be some tax considerations that come into play. If some or all of your non-retirement cash is in mutual funds or stocks, selling the investments to pay off debt could trigger tax liabilities. But putting this issue aside and returning to our example: let’s assume that we follow Dave Ramsey’s Baby Step #1 and transfer $49,000 from our non-retirement accounts to pay down our $200,000 in debt. That leaves $151,000 in debt and $1,000 in savings.

Dave Ramsey Baby Step #2: Pay Off All Non-Mortgage Debt

Baby Step #2 is to pay off all non-mortgage debt. Having reduced our emergency fund down to $1,000 as part of Baby Step #1, we now have two big questions to answer: (1) Do we use some or all of our 529 Fund to pay down debt?; and (2) Do we use some or all of our retirement investments to pay down debt?

Recall that retirement savings is Baby Step #4, and college saving is Baby Step #5. As a result, if we followed Dave Ramsey’s approach to the letter, it would seem that we would liquidate college savings first (since it’s further down, at step #5) and retirement savings second, until we had paid offer all of our non-mortgage debt. Let’s take a look at each option.

College Savings Fund: There are tax consequences for using a 529 Fund for something other than our children’s education. Generally, this is a 10% penalty, in addition to taxes, on your earnings. If you received any state income tax breaks on your contributions, those must also be paid back. Given the market today, however, you may not have substantial earnings, so the cost of closing out a 529 Fund may not be very significant. You can check out IRS Publication 970 for more information on 529 Plans.

In addition to the numbers, there are likely to be strong feelings among family members when it comes to a 529 Plan. Education is highly valued, as it should be, and the thought of draining a child’s education fund may not go over very well with your spouse, parents, or in-laws, not to mention your children. This is of particular concern if you are likely to rack up more credit card debt after paying it down with 529 Plan money.

In our example, however, let’s assume we close out the 529 Plan. After, say, $500 in penalties and taxes (assuming we have little by way of earnings given the current market), we are left with $9,500 to pay down our debt. That leaves us with $141,500 in non-mortgage debt.

Retirement Savings: This is the toughest decision. Unless you have Roth accounts, withdrawals from retirement accounts generally result in a 10% penalty in addition to tax liability. In our example (assuming the retirement savings is not in a Roth), we’d pay a $20,000 penalty if we withdrew the entire amount. Assuming a state and federal combined tax rate of 25%, we’d pay another $50,000 in taxes (which are calculated on the full $200,000, not the $180,000 left over after the 10% penalty).

That would leave us with $130,000 to apply to our debt. So having liquidated all of our retirement and non-retirement accounts, we have our non-mortgage debt down to $11,500. If we did this, would we be better off? To answer that question, let’s compare our balance sheet before and after:

Non-Retirement Cash and Investments$50,000$1,000
Retirement Savings$150,000*$0
529 Plan$10,000$0
Total Assets$210,000$1,000
Non-Mortgage Debt$200,000$11,500
Net Worth (Deficit)$10,000($10,500)
*Net of taxes at an assumed 25% combined state and federal tax rate


Wait… why the difference in net worth? The difference comes from the $20,000 in penalties paid for withdrawing retirement funds and the $500 in penalties and taxes for closing out the 529 plan. So, what if we stopped short of taking money out of retirement, but cashed in our emergency fund and 529 plan? Here are the numbers.

Non-Retirement Cash and Investments$50,000$1,000
Retirement Savings$150,000*$150,000*
529 Plan$10,000$0
Total Assets$210,000$151,000
Non-Mortgage Debt$200,000$141,500
Net Worth (Deficit)$10,000$9,500
*Net of taxes at an assumed 25% combined state and federal tax rate


Here, the difference in net worth is the $500 in penalties and taxes for withdrawing money from the 529 Fund. Other than this difference, there are no changes in the bottom line on our balance sheet… at least not right away.

Where the difference comes into play is with the interest savings, if any, that we receive by paying off our debt — especially interest that costs us more than the interest we were earning on our savings and investments. As a result, the higher the interest rate on debt, the more benefit one receives by using savings to pay down debts.

Dave Ramsey’s Baby Steps ##3-7

So, where do we go from here? Well, if cashing in savings and investments is enough to pay of all non-mortgage debt, Dave Ramsey would have us rebuild our emergency fund up to 3 to 6 months worth of expenses. But what if you still have non-mortgage debt even after using all reasonably available sources of cash to pay it down? Certainly we wouldn’t move on to Step #3 until the debt was paid off, but other questions still remain.

For example, do you stop contributing to retirement (Baby Step #4) until the debt is repaid? And do you stop saving for your children’s education (Baby Step # 5) until the debt is paid? While there’s no one-size-fits-all answer to these questions, here’s one approach to consider:

  • Retirement Savings: Continue to contribute to retirement savings, at least to get 100% of any company match. In the long run, this approach should increase net worth more than leaving the company match on the table. This is the approach we are taking.
  • 529 Fund: Stop funding your child’s education until all non-mortgage debts are paid, you have a reasonable emergency fund, and you are saving for retirement. In the worst case scenario, our children can pay for their own college and/or we can help them out of our then-current income. It just doesn’t make sense to save for future college expenses while paying interest on current debt.

Related: How and Why to Track Your Net Worth

Conclusion and Warning

From all of this, here are the key points for those trying to apply the Dave Ramsey Baby Steps:

  1. Cash accounts earning low interest rates should generally be used to pay higher interest debt.
  2. Tax consequences should be considered before liquidating non-retirement investment accounts to pay off debt.
  3. Using 529 funds to pay of debt should be considered, factoring in any penalties and taxes you’d have to pay (and just how angry your in-laws would be).
  4. Retirement savings, because of the 10% penalty on withdrawals, will often not be a good source of funds to pay off debt.
  5. Continuing to fund a 529 account while paying interest on non-mortgage debt could cost more in the long run.
  6. Contributions to retirement accounts, at least to take advantage of an employer’s match, is a sound choice.

In the final analysis, we are following a modified version of the Dave Ramsey approach to money management. We are using most of our cash and any non-retirement investments with few gains to trigger a tax liability to tackle our non-mortgage debt. We’ll continue to fund our 401(k) up to the company match, but direct all other funds toward our debt. Once the debt is paid, we’ll beef up our cash accounts and education savings.

Finally, there are two big warnings to heed. First, every situation is different. The tax consequences of the decisions you make vary from person to person, tolerance for risk varies, and the need for liquidity can vary. The point is that the above perspective, while generally the approach we are taking, may not be right for you. If you are looking for advice before you make any financial decisions, seek the advice of a professional.

Second, it is important to understand your own tendencies. If you believe that you’ll likely accrue more debt once the credit cards are paid off, it may not make sense to cash in your savings account to pay them down. The one “advantage” to a maxed out credit card is that you can’t borrow any more on it.

All of which is to say, “To thine own self be true.”

Author Bio

Total Articles: 1083
Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Article comments

Linda says:

Dave doesn’t ask you to cash in what you’ve already started. He asks you to start from where you are. Why would you cash all that stuff in? If you listen to his show or read his books you’ll learn that he doesn’t ask you to cash everything in. He does ask that you quit contributing to them for the time being until you take care of the other stuff and then resume funding them!

DR says:

Linda, you’re absolutely right about Dave’s advice. But I wanted to explore more than just repeat what he says. For example, it makes absolutely no sense to stop contributing to a 401k if you have a very good match from your employer. And for many, it may be a good choice to cash in the 529 fund. So on these points, at least under some circumstances, I’d disagree with Dave Ramsey.

Tim says:

It makes a lot of sense to stop contributing for those families making $50k a year. I agree that it doesn’t make a lot of sense for higher income families but for those barely making ends meet, it is sound advice since they need money to work with if they are ever going to be out of debt. I follow the baby step community on facebook and read comments from people all the time who are having trouble just saving the $1000 for bs1. Sometimes it takes them 3-6 months to do it. If they were contributing to 401k, they’d never get there. Dave’s advice is geared a lot towards helping those who need the most help. From your example, someone with a $400k home would be much more likely to have the income to tackle 401k and debt simultaneously versus someone just trying to pay the rent and feed the kids while paying off student loans and high interest credit cards.

WAP says:

Actually it does make sense to stop the 401K contribution IF you executre Dave’s plan the way he teaches it and get manical about paying down the debt. As he says this is not about math – if you could be motivated by the math then you wouldn’t be in debt in the first place. It IS about behaviour modification. Get really rserious about paying off the debt and knock it out quickly. Dave doesn’t call to incur tax penalties to cash out tax advantaged acocunts, unless that is the only way to eat. Stopping the 401K for a year or two to kill the debt won’t matter that much. Never paying off the debt and paying a lifetime of interest will negate the advantage of a match quickly.

DR says:

WAP, this is where Dave Ramsey drives me crazy. Stopping a 401k with a dollar for dollar match for two years in your 30s will have a huge impact in your total balance at retirement. In fact, if it’s not about the math, why not cash in the retirement account? Although you’d pay a 10% penalty, depending on your balance, it wouldn’t be worse than leaving a good company match on the table. That said, I do agree that’s it’s not just about the math.

Bryan Hadlock says:

The main thing about Daves plan is to focus on one thing at a time. If you are spreading yourself over many payments, you won’t see the progress and quit. If you follow Daves plan you will have a lot more money after steps 1-3 to put towards your retirement, and you won’t miss the dollar for dollar matching. If you quit because you didn’t get through step 2 you’re screwed anyway. If you don’t follow his plan closely, don’t quit the 401k.

“This is where Dave Ramsey drives me crazy. Stopping a 401k with a dollar for dollar match for two years in your 30s will have a huge impact in your total balance at retirement.”

Amen to that.

Michelle says:

double Oblivious’s amen – 1) stopping 401k contributions that trigger a match is (to my mind at least) turning down part of your salary. You wouldn’t say “No, thanks” to a 3% raise? Then why would you not (at least) contribute the amount that will be matched (which in my case is that 3%)? 2) I use 401K contributions to help manage my tax bracket, and i’m sure other do so as well. Not to get into too much detail, but if I were to suspend contributions, that would LESSEN the amount from my net paycheck that is available to snowball debt and increase my liabilities at tax filing season…

dave in STL says:

I’m on Dave’s plan, but I didn’t stop my 401K contributions. In fact, when i got a raise last October, I started adding an additional 2% since the market has been “on sale.”

The only reason I would stop 401K (because the match is basically a 100% return) is to pay IRS debt or to pay off a payday lender. Luckily, I’ve never had to deal with either of those.

Jeff in MD says:

Great Post: We are on Baby Step 3 saving 3-6 months of expenses. We cashed in 80% of a 529 for our young children, due to the market we paid no penalty.

Now we have NO DEBT (non-mortgage), no credit cards, no loans, never turning back. We are keeping our 401k contributions with the match through the process. However, if we had debt I would consider stopping 401k to be more intense on paying off the debt.

Marie says:

Let me start by saying that I really do appreciate the message that Dave sends to the folks who really need it. I know that his advice has definitely been instrumental in getting many Americans off the spending/debt carousel, and many families will be better off for it.

However, I fully agree that the “baby steps” really are not sensible for the average professional. I’m 34 and an attorney. Like many young professionals who attended law, med or other grad school, I do have over $80,000 in student loan debt. I’ve actually knocked out about $30,000 of student loan debt from undergrad, law and grad school in the past few years, including all of my higher-interest private loans, while contributing to retirement. The $80,000 still remaining is direct federal loan debt at 3.13%.

If I followed Dave’s advice, I’d be neglecting retirement and the benefit of compounding interest UNTIL I got the rest of this student loan debt taken care of. Which makes NO sense given the difference between the low interest rate on this debt versus the interest I’d make on my 401K (also consider the tax consequences of NO 401k contributions for a high income person like myself, making over $100K).

I also shudder at his idea of only having a $1,000 emergency fund in the bank while paying off debt. That’s scary to me – I keep much more in an emergency fund. Especially for the families with multiple kids, who is often the target Dave audience. As someone is paying off debt on the first baby step, what if they encounter a setback (car repair, medical bill, property repair) that costs over $1,000. I can think of many. That person would certainly end up charging the credit card further putting them in the hole.

I do think that Dave does serve a purpose for many but his advice is certainly not one size fits all.