What is a Sinking Fund? Here’s Everything You Need to Know

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So, you know what an emergency fund is but what is a sinking fund?

Do you really need one in your budget?

Here, you will learn what you need to know about sinking funds.

Have you ever had that sinking feeling when all of a sudden you find yourself scrounging for money to come up with your kids’ back to school expenses? Or last-minute birthday gifts? What about new tires?

You knew it was coming but maybe you thought there was time or maybe you forgot. We all know the effects of “mom brain”.

So what do you do? Use your emergency fund? Put it on the credit card?

These unplanned but expected expenses can really have an impact on your budget, especially when trying to pay off debt.

It can be a vicious cycle when you feel like you are taking 1 step forward, yet 2 steps back.

One way to battle cycle is to have miniature fund accounts, called sinking funds.

Read more: How to Budget When You Are Behind on Bills

What is a Sinking Fund?

The definition of a sinking fund, according to Google is “a fund formed by periodically setting aside money for the gradual repayment of a debt or replacement of a wasting asset”.

Basically, you put money away each month to pay for a future expense. Usually, the expense is too high to be able to cash flow when it’s due so it makes sense to start putting away money now.

Let’s look into this further.

Let’s say you know that your fridge is on the brink of saying goodbye, your washer and dryer is 13 years old, and you are pretty sure that you have been having issues with your HVAC every summer.

It would be wise to create a home maintenance sinking fund and place money each month into this fund. You probably won’t use this money each month but you will continue to grow this fund until the money is needed.

I will go into how to create and decide how much money to put into sinking funds later but first, let’s understand why sinking funds are important.

Read more: How An Emergency Fund Will Help You Become Debt Free

Why Are Sinking Funds Important

Take a look at your spending for a second. You’ll begin to notice a trend. There are certain expenses that come up every year, every season, or every few months.

I’m talking about Christmas and Holidays, birthdays, back-to-school expenses, vacations, sports fees, car maintenance, home maintenance, vehicle registration, and annual dues.

Often times, these expenses are put on the back burner because “there’s still time”… until there’s not.

With a sinking fund, you’ll be able to save $2,000 for next year’s vacation AND be able to buy a new car battery for $200 AND be able to afford to send your kid to soccer camp for $500 without having to pull out the credit card and without having to feel guilty about it.

Having a sinking fund allows you to:

• Be prepared for the expected but unplanned expenses. Something is bound to break and need to be replaced eventually, it’s only a matter of time. We might not know what, we might not know when, but we do know that it’s coming. We expect it to happen. With a sinking fund in place, you can ease the stress knowing that you already have money set aside.
• Make room for fun. You know that Christmas happens every December 25th, you know your kids’ birthdays come every year, and you know you’ll always enjoy a mini-getaway each summer. Allow yourself to determine the amount of fun you want instead of your budget telling you what to do. Start saving now for that cruise you’ve been dying to go on, or your backyard makeover you’ve always wanted.
• Enjoy guilt-free spending. You’ve already saved the money for it. You’ve worked hard for it. When large expenses come up, you won’t feel guilty spending the money you saved specifically for that purpose.
• Save to your heart’s desire. With sinking funds, you make all of your decisions. You can save for whatever you want, big or small. Needs or wants. The choice is all yours.

Now your vacation will be 10 times better knowing you won’t be coming home to zero money in the bank or a maxed out credit card. The $1,000 you just put down on a new set of tires won’t hurt the budget at all.

Read more: How Tracking Your Expenses Will Give You an Edge on Creating Your Budget

Sinking Fund vs Emergency Fund

You might be asking, “So what’s the difference between an emergency fund and a sinking fund?”

The difference is this,

An emergency fund is reserved for the unexpected while a sinking fund is reserved for the expected.

Emergency funds are for emergencies. You don’t expect them to happen. You may not even use your emergency fund but having it there will give you peace of mind when the time comes.

Personally, I have 2 emergency funds. My baby emergency fund is currently $1,000 and sits in my savings account connected to my checking. My large emergency fund is 3 months worth of expenses and sits in a separate saving account at a different bank.

Sinking funds are reserved for things that you expect to happen. It’s designed and created for a specific expense. You typically know what, when, and how much.

Read More: Learn How Much You Need to Keep In Your Emergency Fund and The Best Places to Keep It

Sinking Fund vs Savings Account

What’s the difference between a saving account and a sinking fund? They are actually very similar except for one difference.

• A savings account is usually a catch-all account where a sinking fund is for a specific expense.

Here is what I mean.

A regular savings account houses funds for anything and everything. A little bit for travel, maybe some new clothes, maybe a new fridge, maybe a pool? You blindly throw money in not giving it a job.

Your sinking fund has a specific amount for a specific expense within a specific time frame.

How Do Sinking Funds Work

Now, we get to see the magic of sinking funds. Here, I will show you sinking funds in action.

Let’s say that you have $250 per paycheck that you can realistically save for sinking funds. This equals $6,500 per year.

You decide that with your $6,500 you’d like to update your kitchen. You have the money right? You’ve worked hard for it right? So you use the money to make your updates.

Then, your car battery dies on the freeway. You need a new battery and you need to cover the tow fees. When you get home, your bill finally comes in from the hospital visit 5 months ago (because technically they have up to a year to bill you), and your washing machine isn’t working and laundry is piling up.

Welp, you’ve already used all the savings you had.

Now you either have to dip into your emergency fund (if you have one) or use credit.

Dipping into your emergency fund will cover the expenses but what will happen if a real emergency occurs?

Having a sinking fund will allow you to save your emergency fund for true emergencies and will prevent you from going further into debt.

Here’s what the scenario would look like if you had sinking funds: Let’s say you had the same $250 to put into sinking funds each paycheck.

• Car maintenance fund: Save $31 each paycheck=$800 at the end of the year
• Home maintenance fund: Save $115 each paycheck=$3,000 at the end of the year
• Vacation: Save $58 each paycheck=$1,500 at the end of the year
• Medical expenses: Save $46 each paycheck=$1,200 at the end of the year

Now you can still make your kitchen upgrades, just not as many as you wanted or you might decide to wait a little while longer until you reach a higher budget. The main pro about this is that you can safely pay for a new battery and the tow fees, you can make a decent payment towards your medical bills, you have the money for your washer, AND you can still go on vacation!

See how that works?

Read more: How to Create Your First Zero-Based Budget

How Many Sinking Funds Should You Have

The choice is really yours. Just don’t get carried away with creating too many sinking funds or you won’t have any money left over for debt payment or other savings, giving, or investing goals.

When I initially decided to try out sinking funds, I made a list of all the things I wanted a sinking fund for; everything I could possibly think of. I ended up with $12,000 in sinking funds each year.

Yikes! $12,000 per year in just sinking funds! It was super intimidating and quite frankly, I was turned off from it. I put off sinking funds for a few years.

Just recently, I started back up with my Yearly Money Savings Challenge. I’m using this as my Christmas sinking fund.

I suggest starting slow with 1-3 funds. Once you get the hang of it, you can add more if you wish.

Examples of Sinking Fund Categories

If you are having a hard time deciding what you need a sinking fund for, I’m going to provide you a list of many different categories you might consider.

There are 3 main umbrella funds that will help guide you in choosing: Large expenses, Unplanned but expected expenses, Unexpected expenses

Remember, the goal of a sinking fund is to keep you out of debt and away from your emergency fund. You’ll want to reserve that one for emergencies only.

Home maintenance– HVAC, Plumbing, Roof, Appliances, Flooring Repair, Kitchen Updates, HOA dues

Car maintenance– Tires, Battery, Breaks, Windshield, Deductible, Tuning Belt, Engine, Spark Plugs, Alignments

Holidays– Christmas, Thanksgiving, Halloween, Easter, Memorial Day, Labor Day, 4th of July, Valentines Day

Travel– Large vacation, Yearly vacation, Mini-vaca

Birthdays– Kids, Kids’ friends, Parents, Siblings, Friends

Kids School– Uniforms, Supplies, Crafts, Fundraisers, Field Trips, School Summer Camps

Kids Sports/Recreation– Registration fees, Sports gear, Uniforms, Sports Camps, Tournaments, Lessons, Sports Travel

Pets– Insurance premiums, Grooming, Vet expenses

Taxes– if you consistently owe, make a fund to lessen the blow

Read More: How the Budget by Paycheck Method Is Just What You Need

Where Should You Put Your Sinking Funds

Sinking funds can go anywhere to be honest, as long as you know where it is and you can keep track of it.

The main thing to consider when choosing a place to store your sinking funds is to make sure it is liquid. This means that you can access it easily with either a quick online transfer, ATM withdraw, or by writing a check.

Cash: You can carry your sinking funds in an envelope dedicated to a specific expense. I found some really cute cash envelopes on Amazon that are totally worthy of holding your sinking funds.

One Account: Having one account for all of your sinking funds is doable as long as you can differentiate the money when it comes time to spend it. I recommend keeping a ledger, tracker, or spreadsheet to track how much money is in each fund at any given time. You can also use apps like Mint and EveryDollar to help you keep track.

Multiple Accounts: Another way to use sinking funds is to open multiple savings accounts at your bank or credit union. If your bank offers this to you, it can be helpful especially if you like to do all of your transactions online. Just make sure that you meet minimum balances if there is one.

Read more: Where to Keep Your Emergency Fund and How Much to Save

How to Set Up and Organize Sinking Funds: A Step by Step Guide

Setting up sinking funds can be tricky. You might be tempted to want to make a category for everything, like I did. Realistically, start with 1-3, then determine if you need more.

Here’s how to get started:

Step 1. List out all the things you need or want to save for and how much money you need.

Make a list of everything and anything you want and/or need to save for. Don’t hold back here. The list should be long.

Step 2. Prioritize your sinking funds

Now, out of that list, choose the most important ones for you and your family.

For this example, we are going to choose 3 sinking funds. Christmas, Washer/Dryer, and Vacation.

Step 3. Determine when you need the money and how much you need- be realistic here

Christmas: Need $1000 in 7 months

Washer/Dryer: Need $1500 in 1 year

Vacation: Need $3,000 in 1 year

Step 4. Divide the amount of money you need by the number of paychecks (or months) you need it.

Since I budget by paycheck, this is how I will organize the sinking funds. You can choose to do this monthly if you’d like.

Christmas sinking fund: $1,000/15 paychecks= $67 per paycheck

Washer/dryer sinking fund: $1,500/26 paychecks= $58 per paycheck

Vacation sinking fund: $3,000/26 paychecks= $116 per paycheck

In this example, you will be putting away $241 towards your sinking funds. You are free to use the extra $9 to pad these accounts or start another sinking fund if you’d like.

Step 5: Deposit this amount into each sinking fund every paycheck

Open a separate bank account if necessary to house your sinking fund.

I highly encourage you to set up automatic payments so that you aren’t tempted to spend the money. It will help you stay on track with your savings goals.

If you cannot automate, mark your calendar every paycheck to transfer or withdraw the money into it’s own fund.

Step 6: Use the money out of your sinking fund then start the process all over again

When the time comes, you’ll be able to easily pay for Christmas, enjoy your much needed vacation, and have money in the bank when your washer and dryer finally decide to kick the bucket.

Once your funds are used, start the process all over again. You might not use washer/dryer again for another 10 years or so but perhaps name your sinking fund Home Maintenance or Appliances. Lord knows your refrigerator is starting to make some awful sounds.

Read more: 14 Frugal Habits of Debt-Free Families

How to Keep Track of Sinking Funds

It’s very important to keep track of your sinking funds. As a mother, it is very easy to become distracted.

You don’t want to put money into savings for your car but then forget and use it for your vacation. Then, wonder where the money went when your car needs a new battery.

You can keep a log if you prefer to use pen and paper. You can also use a spreadsheet if you like spreadsheets. Or you can use an app like EveryDollar. If your bank allows multiple savings accounts, you can keep track with your bank’s app.

There are multiple ways that you can keep track of your funds. Try the one that will work best for you.

Should You Build Sinking Funds While Paying Off Debt

This a question that comes up time and time again. The answer, it depends.

I know, I know… not what you wanted to hear. Truth is, it’s not black and white.

Personally, I chose to opt out of using sinking funds until I was debt free. I was able to cash flow all of my expenses at the time.

I was also fortunate that I did not have to use my emergency fund. My refrigerator did break but I bought a used one for $200 instead of buying a new one for $1,500. I was able to use the regular cash in my budget without using my emergency fund.

For the larger expenses like Christmas and our yearly vacation, I was able to save up as much as I could a few months before.

I made the choice to use my emergency fund if my tires needed to be replaced, if my HVAC needed fixing, or if my washer/dryer gave out. I got lucky and I didn’t need to use it.

If you believe that you can cash flow most expenses, then it would be okay to opt out of sinking funds until you are debt free. If you cannot pull off $550 vehicle registration on the fly, then you need a sinking fund for it.

Again, the goal of a sinking fund is to stay out of debt and to save your emergency fund for true emergencies.

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