Dave Ramsey has lied to you.

It’s probably unintentional, and could be rooted in either his lack of fundamental training and licensing or his lack of personal financial diversity. I’m not sure which of these is true, and while it’s fun to speculate, I will not. The fact remains: Dave has lied to you. He will tell you financial peace is achieved by the accumulation of assets coupled with the eradication of debt. This is not true. No debt and no income still equal no financial peace. 

Awhile back I said this to another advisor. He said, “Mike, you just don’t understand how compounding interest works.” To which I replied, “Let’s see if we can agree. Compounding interest is when you’re making interest on your interest’s interest.” He begrudgingly agreed. I asked him how many of his clients were able to live solely on the gains and, equally as important, save some of these gains for the years where losses, not gains, were the reality. He said, “Not many.” Now, who do you think had an issue understanding compounding interest?

See this guy — and you know the type — agreed with Dave Ramsey that everyone should be invested entirely in “good growth stock mutual funds.” What he missed, though, is that the benefit of compounding interest is what justifies the risk. Remove the compounding and you greatly reduce the benefits. So, the blanket statement that everyone should be in good growth mutual funds is a lie.

Real financial peace

Still, financial peace cannot be achieved by accumulating assets alone — even at higher growth rates and even with compounding interest. I want you to imagine with me for a minute. Imagine a young couple, a model of a loving marriage and family. They’ve got nearly a million dollars in retirement savings, no debts (they don’t even mess with the three percent cash-back cards), and the wage earner makes enough for the spouse to stay home with the kids. By a show of hands how many can honestly tell me they don’t have financial peace? Amazing, I don’t see a single hand … neither literally nor figuratively.

Now, let me change one variable. I know you know people that have found themselves in this situation. What happens if the wage earner comes home one night and says, “Hun, I was fired for cause today. I don’t agree with the reason and I think we should fight this. But I was fired for cause so I won’t get a severance package; I won’t even qualify for unemployment. My last check will be on Friday.” How do you think the couple is feeling now? What fears would you have? Again, by a show of hands, how many people believe our couple still has financial peace? None, right?

But how on earth can that be? If financial peace can be achieved by following Dave Ramsey’s Baby Steps — which means it’s reached by the simple accumulation of assets and the elimination of debts — how could our couple have financial peace ripped away when all I changed was their income? What if the wage earner wasn’t fired for cause but fired during a period of economic contraction? Although they’d still be with no debt and low income, the value of their retirement assets would be greatly reduced.

The reality is that no debt and 100 percent investment into “good growth stock mutual funds” isn’t a financial plan. It’s a marketing slogan. 

I’ve been accused of being too harsh on Mr. Ramsey. I’ve gotten hate mail. I’ve received anonymous phone calls and letters. A Forbes writer even said recently that I’m trying to take away Dave Ramsey’s First Amendment rights after reading a recent column of mine wherein I said Dave would be held to a fiduciary standard once the new Department of Labor fiduciary rule is enacted.

Let me be clear. My opinion that Dave Ramsey should be regulated isn’t to “muzzle my competition,” as the Forbes piece mistakenly concluded. Dave and I don’t compete for clients. I write this column because Dave says things that those of us who are licensed and thus qualified to give advice could not say without repercussions. Dave uses bad math, and bad math leads to bad advice. Bad advice hurts people. 

Here are some more examples of Dave’s bad math.

The down payment dilemma

Brooke from Lancaster, Pa. calls into “The Dave Ramsey Show” to ask whether she and her husband should cash out a variable annuity that she feels hasn’t performed well. They’re in the middle of Baby Steps 4, 5 and 6. (If you aren’t familiar with Dave’s Baby Steps, you can read all about them here.) They purchased the annuity about ten years ago and originally deposited $13,400.

Brooke and her husband have found their “dream home” and, by cashing out the annuity, the extra amount they’ll be able to add to their down payment will bring their monthly payment to 25 percent of net income, which Dave advises.

Dave tells Brooke to cash it out. To be fair, he also tells her to seek tax advice … but then he goes right ahead with his own advice anyway. Here are Dave’s main points:

  1. The couple will owe about $2k in taxes.
  2. Although the caller said there was a penalty, Dave says that’s not possible since variable annuity surrender charge periods are only seven years.
  3. This is NOT a Retirement account; it’s an annuity account. As such, they’ll only be taxed on the gains.
  4. Retirement accounts like 401(k)s and Roth IRAs are different. These accounts would have much greater taxes and penalties.

And now for the inaccuracies:

  1. We don’t know the tax bracket and thus can’t accurately conclude the taxable liability. You have to ask questions. Licensed people ask questions. Those who don’t see claims filed against them. They are potentially fined, and eventually — either voluntarily or involuntarily — dismissed from this industry.

    Since I’m not able to ask questions in this case, I’ll make some basic assumptions about this caller. I think it’s safe to say that the caller is in the 15 percent federal tax bracket, considering this starts a little shy of $20k of taxable income (adjusted gross income with deductions and exemptions subtracted). Anything greater than about $100k gross income lands you in the $25k tax bracket. If you’re making $125k per year, you probably wouldn’t choose to cash something out at $30k. I’m also giving Dave the benefit of the doubt here. Far fewer retirees than workers find themselves in the 25 percent bracket, since much of Social Security is not taxable. If Dave thought this couple was in the 25 or 28 percent tax bracket, I would assume he’d understand the taxable implications of either situation and instruct them to wait on the annuity sale.  

    So, let’s proceed under the assumption that the couple is in the 15 percent federal tax bracket. Add Pennsylvania state tax at 3.07 percent, and we’re at just over 18 percent total. But what about other liabilities due to the IRS? Keep reading. 

  2. While, in general, I’d say it’s appropriate to conclude variable annuity surrender charges last seven years or less, it is possible for some to exceed it. Dave could have easily explained how to search a statement to see whether there’s a penalty due to the insurer, rather than foolishly concluding there was none.
  3. Dave states that this is not a retirement account; it’s an annuity. I guess Dave is unaware that many annuities are funded with qualified dollars. In fact, I’ve seen some reports that indicate that more than 50 percent of annuities are funded with qualified dollars. An annuity can be classified as a 401(k), a simple IRA, a 403(b), a Roth IRA, or a traditional IRA. (I’m sure there are more, but I think you get the point.) How could Dave have not known this? I guess you just don’t know what you don’t know.
  4. Dave tells the caller and his listeners he would NOT recommend selling the annuity if it were a 401(k) or a Roth IRA because the taxes and penalties would be much greater. Poor Dave. You know so little about the world of finance that you could be a viable candidate for Congress. Still, let’s give the man a little credit. At least he knows there are potential penalties for distributions prior to age 59 1/2. One clap for Dave. On three, everyone together and … clap.

    Alright, let’s get back to the main issue here. Dave says that if this were a retirement account he would not suggest selling it, given the taxes and penalties. But Dave, those taxes and penalties are still present even if your assumption about this not being a retirement account is correct. Variable annuities grow the interest tax deferred. And as such, even if the initial deposit was with after-tax dollars, the growth is subject to early distribution penalties for withdrawals prior to 59 1/2 if no exemption clauses are met.

What if Dave meant to only withdraw the principal? Doubtful, but it’s a fun question worth asking. Since the early 80s —I believe 1983 — all withdrawals are taxed LIFO, or “last in first out.” Meaning interest is taken out first. Therefore, we’ll still have the same tax issues. 

Sadly, this isn’t the last inaccurate tax statement Dave makes here. He also says a retirement account would be taxed differently. Nope. Wrong. Thanks for playing, but still wrong. The withdrawal will be taxed as ordinary income, which is the same way that withdrawals from a retirement account would be taxed.

A closer look at taxation

5. OK, you caught me. There wasn’t a No. 5, but let’s get back to the issue of taxation. Let’s assume that this annuity wasn’t funded with a qualified rollover (although it probably was), and that an early distribution penalty does apply. Let’s also assume that there are no surrender penalties.

Under these circumstances, here’s the tax breakdown:

Current annuity value: $29,900

Original deposit: $13,400

Gain: $16,500

Federal liability at 15%: $2,475

State liability at 3.07%: $506

10% penalty: $1,650

Total tax and penalty: $4,631

Am I really asking for Dave Ramsey’s first amendment rights to be violated when I ask him to give prudent advice? Dave clearly lacks the expertise to give tax advice, yet he does. Yes, he initially instructs Brooke to see a CPA so she won’t be surprised by a huge tax bill, but then he unfortunately goes on to answer the question of tax liability for her. Many consumers, trusting Dave as they do, will take that as a matter of fact. And many might only go to the CPA after they get the check.

Let’s walk through the potential outcome of this advice together. Brooke sends in the liquidation paperwork to the insurer. She and her husband then meet with a CPA, thinking, “No rush; we just won’t use it all.” The CPA shows them how much they owe. They’d prefer to not pay nearly $5,000 to effect this transaction, especially since the value has more than doubled in the last ten years. That’s an annualized growth rate north of 7 percent. So, they decide to undo the transaction. No problem, right?

Big problem. If Dave is right and the funds are not retirement funds, as he calls them, then once the check has been cashed, it’s irrevocable and the penalties and taxes are unavoidable. Wow. He never mentioned that. Why not? I’ll leave you to speculate on the answer. Although I find this quote interesting:

“That stupid saying ‘What you don’t know can’t hurt you’ is ridiculous. What you don’t know can kill you. If you don’t know that tractor trailer trucks hurt when hitting you, then you can play in the middle of the interstate with no fear — but that doesn’t mean you won’t get killed.”

— Dave Ramsey, Financial Peace Revisited

Bad advice on student loans

Surely this type of bad advice isn’t commonplace from the Dave Ramsey, is it? I’m glad you asked. 

Kate from Washington, D.C. called into Dave’s show to ask if she should roll her student loan balance into her mortgage. Dave says never to do this unless it’s to avoid foreclosure or bankruptcy.

Wait a minute. How can someone’s delinquent student loan lead to foreclosure? Has Sallie Mae started giving mortgages? Doubtful. Furthermore, I’ve also heard Dave tell people never to use retirement accounts to pay off debts unless to avoid foreclosure or bankruptcy.

Jeff Mapes, a bankruptcy attorney, noted the following in his blog titled, “Dave Ramsey’s Worst Advice Ever:”

“Why on earth does Dave think you should [use retirement account funds] to avoid bankruptcy? I wish I knew; there is no good reason. Let’s look at what a bankruptcy could do in a situation like this:

Chapter 13 could stop a foreclosure and allow you to cure the arrears over time, AND let you keep your retirement savings.

Chapter 13 could allow you to repay most or all of your debts in one payment, AND let you keep your retirement savings.

Chapter 7 could eliminate most if not all of your debts, AND let you keep your retirement savings.

Either Chapter 7 or Chapter 13 would allow you to continue saving for retirement and free up more money to do so.”

Dave should know better than to give such advice. He himself went through bankruptcy. Although I understand the importance of paying one’s financial obligations, I also know that sometimes good, honest people make a series of seemingly inconsequential bad choices. Sometimes enough bad choices stacked upon each other create an insurmountable mound.

Here’s a story of one such client. Bob and Mary (I always call clients Bob and Mary) were retired. They were doing the honest, noble thing and withdrawing $40k gross ($30k net) per year from their retirement accounts to pay off credit card debt that accumulated when Bob was laid off from work prior to his Social Security eligibility. I’m sure there were some poor spending choices sprinkled in. When I met them, they were down to about $60k. The credit card debt tallied a staggering $65k.

The path Bob and Mary were headed down meant they’d be broke within two years. They’d still have credit card debt, as well as other debts, but they’d be unable to meet the minimum obligations. I can remember Mary crying as I mentioned bankruptcy, and Bob staring at me like I called his firstborn child ugly. I insisted that they needed to seek legal counsel. They did and, along with a few other changes, today they have a retirement.

One more equation

Dave Ramsey will tell you that financial peace is essentially achieved by this simple formula: Eliminate debt and accumulate assets and you’ll be fine. It’s not true. He’s either lying to you or he is unknowingly incompetent.

There’s an equally simple equation. No debt and no income equals still BROKE. I wish there was a nicer way of saying it, but sometimes you have to fight fire with fire. I won’t stop fighting for the regulation of someone who does what I do, who claims to have the qualifications that I have, but who isn’t held accountable like I am. I’m not encroaching on anyone’s amendment rights in doing so. After all, I thought we were all created equal.