When you hear the term “sinking fund,” the first image that comes to mind might be a sinking pirate ship with treasure on board. That’s not what we’re talking about here.
A sinking fund is money you set aside for a specific upcoming expense. Unlike a general savings account or emergency fund, a sinking fund has a clear purpose attached to it—whether it’s to save for a vacation, down payment on a home, or a big-ticket splurge. The financial educator Haley Sacks has a sinking account just for astrologists.
If you have a big expense coming up, you might consider creating a sinking fund to take the stress out of saving for it.
Let’s talk about what a sinking fund is, how it works, and what makes it worthy of being a line item in your budget.
What Is a Sinking Fund?
A sinking fund is a safe, secure, and liquid savings account that is earmarked for a specific upcoming expense. You can use a sinking fund for most anything, but it’s helpful to have a rough amount and timeline in mind. This will help you plan your budget until you reach your goal.
“[Sinking funds] allow you to make small, manageable steps toward your ultimate goal,” explains Sophia White, CEO and founder at The Balanced Budget.
Examples of a Sinking Fund
Some common known upcoming expenses include:
- Vehicle purchases or financings
- Car repairs or maintenance
- Home repair or remodel
- Insurance premiums
- Buying new furniture
- Saving for vacation
- Holiday gifts and travel
- Paying self-employment taxes
- A big event, like attending a wedding or throwing a baby shower
- Living expenses during parental leave
These are just a few to get you started. Really, you can use a sinking fund for many other types of expenses.
Sinking funds serve their best purpose when you have an known upcoming expense, assign a timeline, and make them a part of your budget. They’re completely separate from your emergency fund and other savings accounts.
Sinking Fund Vs. Savings Account
When it comes down to a sinking fund or a savings account, it’s about intention and your desired outcome.
A savings account is a place you can safely put your money away for long-term needs and goals.
When you have an expense you know about, you don’t want to mingle the funds inside of accounts meant for bigger goals that don’t have a specific timeline.
For example, you don’t want to pay your insurance premiums out of the same account that you’re using to save extra student loan payments, because the lines can quickly blur.
It’s best practice to keep your financial goals separate from one another so you’re not tempted to use money you saved for something other than its intended purpose.
Sinking Fund Vs. Emergency Fund
An emergency fund is money set aside for a worst-case scenario, such as a sudden loss of income or a big, unexpected expense. “You have no control over when it’s going to happen. An emergency fund is your safety net to cover those types of emergency expenses,” explains White.
A sinking fund is for purchases with a defined timeline, and emergency funds are for unknown expenses that happen without warning.
You never want to keep these accounts together, in case you use your sinking funds for a goal and then get hit with an emergency right after. If that were to happen, your funds could be totally depleted, depending on how much you keep in your emergency fund, and end up derailing your progress.
How to Start a Sinking Fund
To begin, review your past expenses to get an idea of what will pop up again in the future. For example, if you pay your auto insurance every six months, you’ll have an idea of when your premium is due again.
List everything you want to save for, so that when it’s time to pay these expenses again, you can dip into your sinking fund and take care of it right away. Easy peasy.
Then, decide how many months or pay periods it’ll take to reach your goal. For example, if you need $1,000 for a vacation, you’ll need to save $83 per month. If you decide your budget allows for more, you can save $167 per month over six months instead. Adjust the timeline until the amounts feel meaningful and manageable.
Commit to your goal by transferring the amount to your sinking fund account every month or pay period. Complete the goal by paying for your expense when it’s due. Take a moment to appreciate your accomplishment. Repeat as often as necessary.
Where Should You Keep Your Sinking Fund?
Whatever you do, don’t commingle your sinking funds with your other accounts. This method works best when you have a completely separate account.
If you’re disciplined and not prone to temptation, you could open a separate savings account with your primary bank and label it accordingly. That way, you’ll see all your sinking funds neatly listed in your main account dashboard.
But if you know you’ll cave and dip into the funds for other expenses, be real with yourself and open an account somewhere else — an online-only savings account is perfect because it takes a few days to complete a transfer out of the account, so you’ll be more likely to leave it alone.
“You could choose to keep it in a separate checking account if you expect to have to use those funds quickly,” says White. If your goal is several months to over a year away, you might even opt for a high-yield savings account to earn a little interest.
You can have as many sinking funds as you need for various expenses. As long as there’s room in your budget and you make regular contributions, you can use sinking funds and rotate them out as you pay your expenses off and plan for new ones.
Other Types of Savings Accounts You Need
Ideally, before you start your sinking funds, you’ll have your other accounts in order — that means a fully-stocked emergency fund and no high-interest consumer debt, like credit cards.
If you don’t already have an emergency fund, it’s an excellent idea to have at least 6-9 months of expenses set aside in case something happens. Many experts recommend more, but how much you need depends on a variety of factors about your personal finances.
After you have an emergency fund, you can tackle debt like credit cards, personal loans, and medical bills. Once those are covered, you can turn your attention to sinking funds.
Remember to review your budget every once in a while and adjust as you make progress or as needed.