Last Updated on November 12, 2022 by Rebecca Lake
When you have planned expenses you need to pay for, sinking funds can help you save for them.
A sinking fund is money you set aside for a specific expense or financial goal. Sinking funds are separate from savings accounts or emergency funds, in that they’re used for a clear purpose.
That’s how sinking funds are used in personal finance. The accounting definition of a sinking fund is cash that’s reserved to pay off long-term debt, replace a wasting asset or cover future expenses.
If you’re not using sinking funds or you’re wondering how a sinking fund works, this comprehensive guide covers the most important things you need to know.
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What Is a Sinking Fund?
A sinking fund is a fund that holds the money you plan to spend at some future date.
Sinking funds are earmarked for specific expenses or purposes. You may use a sinking fund to pay for a one-time purchase or expense, or an expense that recurs irregularly.
So why is it called sinking funds?
Sinking funds are called that because the balance goes down as you withdraw money for planned expenses.
The use of sinking funds was popular with the British government in the 1700s. On the advice of Robert Walpole, a sinking fund was established by Parliament in 1717 to help reduce the millions of pounds in debt that resulted from the British-French wars of the late 1600s.
Today, corporations, governments, schools and other entities routinely use sinking funds to hold cash reserves. But sinking funds are also used by everyday people to manage personal finances.
How a Sinking Fund Works
Sinking funds work by allowing you to save money regularly toward a planned expense. Once the expense comes due, you withdraw money from the sinking fund to pay for it.
A sinking fund may be created with a specific target date in mind if you’re saving for a one-time expense. For example, you might establish a sinking fund for a vacation you plan to take six months from now.
You can also set up open-ended sinking funds to pay for expenses you pay periodically.
This type of sinking fund may work best for expenses that aren’t included in your regular monthly budget. For example, you might establish a sinking fund for biannual car insurance premiums.
What Are Sinking Funds Examples?
Sinking funds are meant to be used for planned expenses. Some of the most common sinking fund categories you might save for include:
- Home improvements or repairs
- Moving expenses if you’re planning to relocate
- Vehicle maintenance and repairs (including new tires, oil changes and other services)
- Pet care and vet bills
- Back-to-school shopping and school supplies
- Field trips or fees for extracurricular activities
- Summer camp
- Holiday shopping
- Gifts (for birthdays or special occasions other than holidays)
- Vacations or other travel
- Wedding expenses
- Insurance premiums
- New furniture
- New baby expenses
- Living expenses while you’re on maternity leave
- Self-employment taxes or other tax payments
Those are just some of the examples of a sinking fund. You can set up sinking funds to plan for virtually any expense.
Here’s a more detailed sinking fund example.
Say you plan to have a baby and you want to save $5,000 to cover new baby expenses and replace your income while on maternity leave. The baby is due in 6 months.
You could open a savings account to hold your new baby sinking fund and contribute $833 to it each month. Once the baby arrives, you’d stop adding to the account and start spending it down instead.
Pro tip: Any money that doesn’t get used in one sinking fund can be rolled over to another.
Sinking Fund vs. Savings Account
Sinking funds are different from savings accounts since there’s a specific intention behind them.
When you open a savings account, there may not be a goal attached to it. You might open the account to hold extra money you don’t plan to spend so you can earn a little interest on it.
With a sinking fund, you’re saving more methodically and intentionally.
Going back to the new baby fund example, the sinking fund has a clear goal and an end date. You also have a set amount you need to save monthly to reach your savings goal.
Sinking Fund vs. Emergency Fund
A sinking fund is for money that you save toward planned expenses. An emergency fund is designed to hold the money you save for the unplanned and unexpected.
For example, say you get laid off from work. You could draw on your emergency fund to cover your basic living expenses until you find a new job.
Or say that your cat swallows part of a shoelace and needs emergency surgery. You could tap your emergency savings to cover the vet bills.
An emergency fund is a financial safety net that’s designed for ‘what-if’ scenarios. A sinking fund is meant to help you avoid having to scramble to come up with the money for planned expenses.
Keeping sinking funds and emergency funds separate is a smart idea. When you use your emergency fund to pay sinking fund expenses, you run the risk of being low on cash when a true emergency comes along.
Who Benefits From a Sinking Fund?
Setting up sinking funds can benefit virtually anyone who wants to save toward specific expenses or goals in a disciplined, consistent way.
Here are some of the benefits of adding sinking funds to your budgeting and money management strategy;
- Save for specific goals. Sinking funds allow you to fine-tune your financial goals and break a larger savings target into smaller savings buckets.
- Spend intentionally. A sinking fund makes it easier to spend money intentionally and guilt-free since you’re setting money aside for different expenses regularly.
- Avoid debt. Using sinking funds to save and plan for expenses means you don’t have to resort to using a high-interest credit card to pay for them.
- Stress less. Managing finances can be difficult enough. Sinking funds take the stress out of paying for future expenses since you’re saving for them on a defined schedule.
Saving with sinking funds means that you can enjoy the “fun” purchases or expenses you have coming up. And any recurring expenses are less likely to feel like a nuisance or a burden.
How to Start a Sinking Fund
Starting a sinking fund (or sinking funds) isn’t difficult. Here’s how to create your sinking funds, step by step.
1. Choose your sinking fund categories
The first step in creating a sinking fund is deciding what to save for.
So, again, you might start a new baby sinking fund or a home improvement sinking fund or a sinking fund for an entirely different purpose. The great thing about sinking funds is that you control how many you have and what they’re used for.
2. Set your savings goal
Once you know what your sinking fund is for, you can set a savings goal.
For instance, if you’re saving money for a Christmas fund, you might set a goal of $1,000. From there, you’d break that goal down to figure out how much you’ll need to save monthly.
If it’s 10 months until the start of the holiday shopping season, you’d need to save $100 a month. If it’s 5 months away, you’d need to save $200 a month instead.
You can do this same calculation (overall savings goal ÷ months to goal) to figure out how much to save monthly in each of your sinking funds.
3. Decide where to keep your sinking funds
There are different places where you can keep sinking funds.
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If you prefer to keep your money in the bank, you could open one or more savings accounts to hold your sinking funds. You can then link these accounts to your main checking account.
When deciding what savings account is best for sinking funds, pay attention to the fees you might pay and the interest rate and APY you could earn.
An online bank typically offers the best combination of low fees and high rates for savers. CIT Bank Savings Connect, for example, offers one of the most competitive APYs among all banks with no monthly fee.
4. Add sinking fund categories to your budget
If you’ve established your sinking funds categories, the next step is to add those amounts to your monthly budget. That way, you don’t have to worry about shortchanging any of your funds.
So here’s another example of what that might look like in your budget.
- $100/month for Christmas and holidays
- $100/month for car insurance premiums
- $100/month for home improvements and repairs
- $200/month for vacation
- $400/month for new baby expenses
That’s $900 per month you’d need to budget for sinking funds.
How much money you should keep in a sinking fund will depend on your goals. The more sinking funds you have and the higher your savings targets, the more you’ll need to save each month.
5. Automate deposits to sinking funds
Last but not least, you can automate deposits or transfers to your sinking fund bank accounts.
Automating ensures that you don’t forget to save or skip a monthly contribution. And it’s easy to automate your savings to sinking funds when you link those accounts to checking.
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How Many Sinking Funds Should I Have?
There is no exact number of sinking funds you need to have. Some people may have just one or two while others have 10 or more.
Again, some of the most common sinking fund categories include:
- Home improvement
- Car maintenance and repairs
- Insurance premiums
- Medical expenses
- Vacations and travel
The right number of sinking funds for you will depend on how many expenses you’re saving for.
You could open one general sinking fund savings account to hold all of the money you plan to save. That could be more convenient than managing multiple sinking fund accounts.
On the other hand, opening multiple savings accounts for each sinking fund means you can keep the money for each goal separate.
Do you need sinking funds and an emergency fund?
It’s a good idea to have both sinking funds and an emergency fund. Sinking funds can be used to cover expenses you anticipate, while an emergency fund is designed to help you handle life’s curve balls.
What are the best accounts for sinking funds?
The best place to keep sinking funds is a liquid savings account that offers convenient access and a high interest rate. Online banks can offer competitive APYs for savers and you can easily link them to accounts at a brick-and-mortar bank.
If you have at least $100 to open a sinking fund account, take a look at CIT Bank Savings Connect, which has one of the best APYs around with no monthly fee.
How to track sinking funds?
You could also track sinking funds online using a personal finance app like Personal Capital. With Personal Capital, you can see multiple financial accounts in one place with no monthly fee.
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How much money should be in a sinking fund?
The amount of money you keep in a sinking fund will depend on how much you need to save for that fund’s purpose or goal. You can use a sinking fund calculator to determine how much you’ll need to set aside each month for your goal.
Here are some free sinking fund calculators you can use:
Final thoughts on sinking funds
Using sinking funds can help you to get ahead financially if you’re planning ahead for expenses in advance. Starting a sinking fund isn’t complicated and you can customize your sinking funds to fit your budget and needs. It can be the best way to save so you can spend later without any money guilt.
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