Sinking funds: How to plan ahead and save smarter

You've learned how to budget like a boss and stick to a spending plan. That's huge if you want to get ahead financially. 

After all, it feels great to know where your hard-earned dollars go every month. You log in to your budget app and see at a glance how your expenses and income break down. 

Sinking funds can help you plan for those expenses that aren't part of your monthly budget, but still need to be paid. Let's look at how they work and when to use them. 

Also read: How to budget like a boss

What is a sinking fund?

A sinking fund is money that you set aside for planned expenses or goals. Sinking funds can help you pay for one-time expenses or purchases, or recurring expenses you pay bimonthly, quarterly, or annually. 

You might have one sinking fund or several. A sinking fund isn't the same as an emergency fund. 

Sinking funds are for money you know that you're going to eventually spend. An emergency fund is money you save for unexpected expenses or situations when you need cash. 

Why sinking funds can make managing money easier

Sinking funds help you budget and manage money more efficiently because there are no surprises. They reduce stress, and they could help you avoid debt. 

For example, say your car insurance premium is $720 every six months. You could set up a sinking fund and save $120 in it each month so that you have the cash to pay the premium once it's due. 

There's no scramble to come up with the money and no pressure to use a credit card, since you've planned for the expense. All you have to do is make your regular monthly deposit, and your sinking fund will be there for you to use when you need it. 

Here's an example of how that would work if you use the 50/30/20 budgeting rule. Let’s say your monthly take-home pay is $5,000. Half of that, or $2,500, would go to your needs. That leaves $1,500 for wants and the remaining $1,000 or 20% is what you’d have to put toward savings or debt repayment.

You could subtract the $120 for your sinking fund from the $1,000 you have to save. 

How sinking funds can keep you out of debt

Sinking funds are savings funds; essentially, you can use them to pay yourself first when your paycheck hits your bank account. 

When you have cash to pay for planned expenses, you don't need to use a high-interest credit card or get a loan. There's no debt to repay. You just have to send money to your sinking funds as scheduled each month. 

It's the same idea as an emergency fund, just a different use. The point of sinking funds is not to be caught off-guard by expenses that you know you'll need to pay. 

Using a get out of debt (GOOD) app could help you work toward your sinking fund goals. You can connect all of your financial accounts in one place so you have a complete picture of your money. 

Examples of common sinking funds

You could set up one big sinking fund to hold your savings, but you may prefer to keep different goals separate. If you need ideas on how to use these funds, here are some of the most common sinking funds examples. 

• Home. A home sinking fund could help you save for home repairs, maintenance, or upgrades you want to make. For example, you might save toward a new roof, a kitchen upgrade, or your biannual HVAC maintenance. 

• Car. A car or vehicle sinking fund can hold money for repairs, maintenance, new tires, or insurance. You could also set up a sinking fund to save for a down payment on a new vehicle. 

• Holidays/birthdays. Would you like to have a debt-free holiday season? A sinking fund for holidays or birthdays could help you save for things like gifts, decorations, wrapping paper, cards, tips, and related expenses. 

• Kids. If you have kids, you know how expensive that can be. Sinking funds for kids can cover expenses like daycare or summer camp, sports teams and other extracurricular activities, or back-to-school shopping. 

• Pets. Pet ownership can come with a high price tag. There are routine check-ups, medications, bedding, food, pet insurance—all things you can use a pet sinking fund to save for. 

These are just a few ways to put sinking funds to work in your budget. Your sinking fund categories should reflect your goals and needs. 

A good way to figure out what categories to include is to look at your expenses for the past year. Focus on those expenses you have to pay that don't come around monthly, like insurance premiums or annual home maintenance. Those are good candidates for sinking funds. 

Next, think about your goals. If you want to take a summer vacation, for example, or buy new appliances for the kitchen, you can set up sinking funds for those expenses. 

How to start a sinking fund

If you're ready to use sinking funds to budget better, it's easy to get started. These tips can help. 

• Choose your sinking funds categories, based on your needs and goals. 

• Estimate how much you need to save for each sinking fund category and how long until you'll need the money. 

• Calculate how much you'll need to save toward each sinking fund monthly to reach your goal. 

• Adjust your budget to include each sinking fund amount. 

• Establish one or more savings accounts to hold your sinking funds. 

• Automate your sinking fund contributions from checking to saving. 

Some sinking funds may be a permanent part of your budget. Car insurance, for instance, is something you'll always have to pay unless you give up driving. Others, like a new furniture fund, might be temporary.

If you eliminate any sinking fund categories for one-time expenses, go back to your budget. Look at where you can reallocate the money you were sending to that fund and decide where it can go instead. 

Do sinking funds only work if you use savings accounts? Nope, you can also use them with an envelope budgeting and saving system. Instead of putting your sinking fund money into separate bank accounts, you'd divide up your cash into individual savings envelopes. 

Tips for managing your sinking funds successfully

Sinking funds could make your financial life easier and your budget smarter. If you're ready to give them a try, use these tips to make the most of your savings efforts. 

• Use automatic transfers to move money from checking to sinking fund savings every payday. 

• Choose a savings account that offers a high interest rate with minimal fees. 

• Set calendar reminders so you know when a sinking fund expense is due and when to pull the money from your account. 

• Review your sinking funds regularly to add or remove categories and adjust your savings amounts if needed. 

• If you have multiple sinking fund accounts, link them to your budgeting app so you can see them all in one place.