What is a Sinking Fund? A Complete Guide [+ How I Use Them]

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A sinking fund sets aside money over time for specific future expenses, such as vacations or annual insurance premiums. Unlike monthly bills, these expenses are not paid regularly, but they still require planning since you know they are coming.

Making a monthly budget for them with a sinking fund helps you avoid relying on credit cards or dipping into your emergency fund.

Beyond reducing debt and protecting your savings, sinking funds have additional benefits. They help you prioritize expenses and plan for future expenses. Additionally, many services, such as insurance and streaming, offer discounts when you pay up front instead of paying monthly.

This article will guide you through creating and managing sinking funds, from setting your savings goal to choosing the best banks and apps to stay on track. Use examples from my personal finances.

Types of Expenses Suitable for Sinking Funds

Sinking funds work best for two types of expenses: irregular but recurring costs and short- to medium-term goals.

Long-term goals, such as investing for retirement, should be part of your main financial plan and generally do not require frequent adjustments or separate sinking funds.

Examples of irregular and recurring expenses include:

• Life and automobile insurance premiums.
• Christmas gifts and celebrations.
• Supplies and fees for back to school.
• Seasonal home maintenance (such as boiler adjustments or gardening).

Sinking funds aren’t just for infrequent expenses. Other potential uses include:

• Replacement of a vehicle.
• Make the initial payment for a home.
• Finance home renovations or improvements.
• Wedding expenses.
• Vacations and trips.

Steps to establish a sinking fund

To create a sinking fund, follow these steps:

1. Define a clear savings goal by deciding how much you need and by when.
2. Set up a dedicated account, either a separate bank account or a savings subaccount, to keep your sinking funds organized and easy to manage. Alternatively, you can use a budgeting app that allows you to allocate money specifically for sinking funds.
3. Automate transfers to your sinking fund.
4. Track your progress and adjust if necessary.

Step #1: Determine your savings goal and contribution schedule

Start by identifying the specific expense you’re saving for, such as a vacation, home repair, or vehicle purchase.

Calculate the total amount needed and set a realistic deadline based on how much you can comfortably save within your current budget.

For example, if you have a $2,400 vacation in one year, you will need to save $200 per month for 12 months to reach your goal. If you can only save $150 each month, it will take you 16 months to save the desired amount.

Remember, your contributions do not have to be monthly. If it aligns better with your payment schedule, consider biweekly or weekly contributions. Adjust your savings schedule or amount based on what is realistic for you.

For advice: If you’re not already using one, try a budgeting app to see all your income and expenses in one place. Check out our list of recommended budgeting apps.

Step #2: Choose the Right Savings Account

I am a big believer in using a bank that offers savings subaccounts to manage financial goals and sinking funds.

Instead of putting all your savings in one account, savings subaccounts allow you to create separate “deposits” for different purposes, all under one bank.

For example, I bank with Capital One and use their savings subaccounts to manage multiple sinking funds. A major sinking fund I maintain is for taxes. Since I’m self-employed, I set aside a portion of each withdrawal specifically for taxes.

Keeping this money separate helps ensure that it isn’t mixed with other funds and accidentally spent, as unallocated money tends to disappear quickly.

Some well-known banks that offer savings subaccounts without fees and with high interest rates are:

1. Allied bank. Offers a “bucket” feature to create subaccounts for different savings goals.
2. Capital One 360 ​​Performance Savings. Allows for multiple savings accounts, making it easy to organize sinking funds.
3. SoFi. Includes “Vaults” to separate savings into specific categories.

If you don’t want to switch banks, the YNAB budget app makes it easy to set up and track multiple sinking funds, so you don’t have to create multiple sub-savings accounts.

With the app, there is no need to transfer money to a separate account. Instead, you allocate portions of your available cash to specific categories so you always know how much is reserved for each goal or expense. For example, if your $600 insurance premium is due every six months, YNAB helps you allocate $100 each month to a designated category.

If you spend less than you earn each month, keep your sinking funds simple, especially when starting out. I recommend 2 or 3 funds focused on your biggest irregular expenses from the past year, such as annual insurance premiums or vacations.

Step #3: Automate your savings

Setting up automatic transfers from your checking account to each sinking fund is a smart way to ensure consistent contributions without remembering every deposit, a concept called reverse budgeting.

Schedule these transfers to align with your paydays, so saving becomes a priority and reduces the temptation to spend the money elsewhere.

Many banks allow you to set up monthly, biweekly, or weekly transfers, depending on what best suits your cash flow and goals. To be safe, schedule the transfer a few days after your paycheck arrives to ensure the funds are available.

While automatic transfers are great for fixed expenses, calendar alerts work best for funds that need monthly adjustments.

Since my income varies monthly, I use calendar alerts. For example, I get an alert sent to Gmail for my tax sinking fund. Each month when the alert appears, I calculate 25% of my income and transfer it to my tax fund.

for a tip: Give your goal a fun and motivating name. Studies show that interesting names can increase your chances of achieving your goal. So instead of just “Home Down Payment,” try “My Family’s Dream Home!”

Step #4: Track your progress

Periodically review your automatic transfer amounts, especially if your income or expenses change.

I find it helpful to do a quick check at the beginning of each month to see if any adjustments need to be made. Sometimes I can increase my contributions to the sinking fund; Other times, you may need to make small reductions, although it’s best to keep adjustments to a minimum.

If you make changes every month, it may be time to review your original plan. Frequent adjustments can be a sign that you’re stretching your budget too far or that you’re lacking the cash flow needed to stay on track.

Final Thoughts on Sinking Funds

Sinking funds avoid going into debt for predictable expenses. While emergency funds cover unexpected costs, sinking funds help you plan for future expenses.

A recent personal example: I used a sinking fund for a $4,000 chimney repair (yeah, not very exciting). This was equivalent to setting aside $333 a month for a year. Although it wasn’t urgent, it was unavoidable—precisely the kind of expense that often leads people to turn to credit cards unnecessarily.

When creating a sinking fund, keep the following in mind:

1. At first, start with just 2 or 3 high-priority funds. Get into the practice of setting aside small amounts of money each month. If you’re on a tight budget, you may want to create more funds in the future.
2. Set specific goals with real numbers; Don’t save vaguely for “travel”, but plan a concrete vacation with a clear budget.

Like any financial habit, take time to master sinking funds. But they are worth the effort as they keep you focused on specific goals while avoiding unnecessary debt. Once you start seeing the funds grow and start using them for their intended purpose, you will wonder how you ever managed without them.

RJ Weiss, founder of The Ways To Wealth, has been a CERTIFIED FINANCIAL PLANNER™ since 2010. With a bachelor’s degree in finance and having completed the CFP® certification curriculum at The American College, RJ combines formal education with a deep commitment to provide impartial financial services. perspectives. Recognized as a trusted authority in the financial field, his expertise is highlighted in major publications such as Business Insider, the New York Times, and Forbes.