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Sinking Funds: What They Are And How To Use Them

Lauren Nowacki6-Minute Read
February 28, 2022

Wouldn’t it feel great to buy a car with cash or purchase gifts for a loved one without swiping your credit card and worrying about how you’ll pay it off later? It is possible.

It all comes down to finding the right savings plan and being consistent with your budget. There are several tools you can use to help you reach your savings goals and one of the most effective is a sinking fund.

With a sinking fund, you can make big purchases, in full, without taking out a loan or dipping into your emergency fund.

What Is A Sinking Fund?

A sinking fund is a savings account in which the money saved is for one specific goal. It works by allowing you to save a small amount of money over a certain amount of time to take the financial burden off paying for large purchases. These are expenses you can’t or don’t want to pay in a single month’s budget. Instead, you take a small amount from your budget each week or month and put it into your sinking fund. Little by little, the fund builds until you have enough saved for the planned expense.

This isn’t just a tool for personal finance, either. Companies often use sinking funds to set aside money to pay off a future debt or bond.

What Should I Use A Sinking Fund For?

Sinking funds should be used for future, planned expenses. These can be one-time expenses or include multiple or recurring costs. They can also be for a specific item or event. Here are a few examples of what you could save money for:

  • Down payment
  • Insurance premium payments
  • Wedding costs
  • New car
  • Car repairs
  • Vacation
  • Home repairs
  • Back-to-school shopping
  • Debt repayment
  • Vet bills
  • Medical expenses, like equipment or planned procedures
  • Property taxes, if you don’t have a mortgage or escrow account
  • Holiday gifts, gatherings and events

Remember that these are just some examples of sinking fund categories. The ones you choose will depend on your lifestyle, budget, savings goals and other financial goals.

Can I Have More Than One Sinking Fund?

Yes, you can have as many sinking funds as your budget allows. And when a sinking fund is fully funded, you could even start new ones, whether you’re halfway through the year or several months in.

That said, your sinking fund contributions should never strain your monthly budget. Make sure you know how much you can set aside each month before opening a new fund.

Why Use Sinking Funds?

Whether you’re a saver or a spender, sinking funds can help you reach your goals. They help you prepare for the future and erase any guilt you may have about making large purchases. They can make the big price tag a little less intimidating because you’re saving a little at a time instead of making one huge payment. By saving up for these known expenses, you’re less likely to put a large amount of money on your credit card, dip into your other savings or emergency fund or take out a personal loan.

Sinking funds can also help you pay off a long-term debt. While you make minimum payments on the debt – or while a loan is in deferment or at 0% interest – you can save the money for one lump sum payment.

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How To Create Sinking Funds

Creating a sinking fund is pretty simple once you know your goals and have a timeline. However, there is some prep work you’ll need to take care of before you set your first one up.

You’ll need to figure out:

  • What to save for
  • How long to save
  • The total amount needed for each fund
  • How much to save each month
  • Where to store your money

Let’s take a deeper look at each step of the process.

Create Sinking Fund Categories

There are many types of sinking funds. The ones you choose to create will be personal to you and your financial goals.

If one of your goals is to purchase a home, one of your sinking funds may be a down payment sinking fund. If you want to take your family on a trip this summer, another one could be a vacation sinking fund.

It doesn’t just have to be a specific goal. You could also save for something that is inevitable, but you’re not sure exactly when it will happen like car repairs or upgrading your cell phone.

There are also expenses that happen every year, like holiday gifts and events, back-to-school shopping or birthdays. Remember, the purpose of a sinking fund is to help you save up for a specific type of expense. As long as the categories you choose will help you reach your goals, you’ll be in good shape.

Determine The Right Amount Of Money To Save

Once you have a list of sinking funds you’d like to build for the year, the next thing to do is determine how much money to save in each fund every month. To do this, you’ll first determine when you’d like to have the sinking fund fully funded – that could be by the day you’d like to make the purchase or a specific date. After specifying the date, you’ll divide the sinking fund total by the number of months you have until your target date.

For example, if you have 12 months to save $600 for Christmas, you’ll need to save $50 per month ($600/12 = $50).

You can extend your sinking fund date beyond a year, too – especially for big expenses. Let’s say you want to buy a home in 2 years and want to save a down payment of $10,000. You’ve already saved $5,000, so you need to save another $5,000 in 24 months. You would need to save about $209 per month.

Choose Where To Save The Money

When it comes to where to save the money in your different sinking funds, there are a few options you may choose, and they’ll depend on your goal amount.

If the amount is smaller, like a few hundred dollars, you may choose to save the money as cash in a safe place in your home instead of a bank account. This is especially helpful if you’re building this sinking fund with cash and loose change.

If the sinking fund amount is much larger, it’s safer to keep it in an account at your bank or local credit union. If your bank allows, set up separate savings accounts for each category. That way, you won’t be tempted to pull money from another sinking fund. If your bank doesn’t allow separate savings accounts, keep track of each sinking fund on your own with an excel sheet or journal to manually record each deposit and withdrawal made for each separate fund.

If the sinking fund is a large amount that you’ll continue to contribute to for more than a year, you may want to consider putting the money into a high-yield savings account. These have higher interest rates and will help that money grow faster than a regular savings account.

Just make sure you never keep the money in your checking account. The temptation to spend the money is just too high when it’s mixed into the account you use to pay for monthly expenses.

Establish A Savings Plan

Everyone’s financial situation is unique and that means you’ll need to figure out a savings plan to build your sinking fund. Look at your budget, the sinking fund category you’re saving toward and how long you want to save. You can do this for each category you’re working with. Then, create a quick chart or write out your goals on a piece of paper. This will help you keep track of your plan over the months you’re actually saving. Here’s an example of what someone’s sinking fund plan may look like.

Sinking Fund Category

Goal Amount

Months To Save

Amount To Save Per Month

Home Repairs

$600

12

$50

New Furniture

$3,000

15

$200

Holiday Gifts

$600

12

$50

Camping Trip

$700

7

$100

In this scenario, this person would pay $400 per month to four different sinking funds.

Sinking Fund Vs. Emergency Fund

It’s important not to confuse a sinking fund with an emergency fund, as the two serve different purposes. Sinking funds are for planned expenses like buying a car or saving for a vacation. An emergency fund is for unplanned or unexpected expenses, like a medical emergency, car accident or job loss. While the amount you save in a sinking fund is usually the cost of the product or service you’re buying or an estimated amount of what you’ll spend, the recommended amount to save in an emergency fund is at least 3 – 6 months’ worth of expenses.

The two types of funds do serve a common purpose. They prevent you from dipping into your regular savings, using your credit card or taking on more debt to pay for a certain expense, whether planned or not. Both tools can help you succeed in your financial goal setting and provide you peace of mind.

Sinking Fund Vs. Savings Account

While both financial tools allow you to save money each month, there is a difference between the two. A sinking fund saves money for one specific purpose and the money in there is for that purpose only.

A savings account holds money that you may just be saving for a rainy day or money that you’re saving for several different reasons. This can make setting savings goals for specific purchases harder. Since you may not have saved up an exact amount to cover something, you may end up borrowing saved money for other expenses because all of your money is in one place. A savings account may also be used to “dip into” when you need – like if you’re over budget or have a nonemergency expense you didn’t plan for.

Sinking Funds And Your Monthly Budget

While sinking funds can help you save for big expenses and help remove the guilt that can come with spending, they’re only useful tools when your other obligations are covered. Take a look at your current spending levels and your monthly income. If you have plenty of money left after paying your bills and building an emergency fund, go ahead and establish your first sinking fund. If you’re still short on money at the end of each month, look for ways to cut your expenses. You should only set up a sinking fund when you’re bringing in more money than you’re spending.

The Bottom Line: Sinking Funds Are Part Of A Comprehensive Savings Plan

Sinking funds make setting savings goals and paying for larger purchases without going into debt easier. However, they’re only one part of a strong savings plan. You’ll still need to establish a budget, build an emergency fund and identify additional ways to save money each year.

For more tips on reaching your financial goals, check out our personal finance section, which covers such topics as paying off debt, earning more, saving money and investing.

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Lauren Nowacki

Lauren Nowacki is a staff writer specializing in personal finance, homeownership and the mortgage industry. She has a B.A. in Communications and has worked as a writer and editor for various publications in Philadelphia, Chicago and Metro Detroit.