A sinking fund sets aside money over time for specific upcoming expenses, such as vacations or annual insurance premiums. Unlike monthly bills, these expenses aren’t paid regularly but they still require planning since you know they’re coming.
Budgeting for them monthly 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 added benefits. They help you prioritize spending and plan for future expenses. Plus, many services — like insurance and streaming — offer discounts when you pay upfront rather than monthly.
This article guides you through creating and managing sinking funds, from setting your savings target to choosing the best banks and apps to keep you on track. It uses 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 like retirement investing should be part of your core financial plan and typically don’t require frequent adjustments or separate sinking funds.
Examples of irregular, recurring expenses include:
- Auto and life insurance premiums.
- Holiday gifts and celebrations.
- Back-to-school supplies and fees.
- Seasonal home maintenance (like furnace tune-ups or landscaping).
Sinking funds aren’t just for infrequent expenses. Other potential uses include:
- Replacing a vehicle.
- Making a home down payment.
- Funding home renovations or upgrades.
- Wedding expenses.
- Vacations and travel.
Steps to Set Up a Sinking Fund
To create a sinking fund, follow these steps:
- Define a clear savings target by deciding how much you need and by when.
- Set up a dedicated account — either a separate bank account or a sub-savings account — 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.
- Automate transfers to your sinking fund.
- 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 coming up in a year, you’d need to save $200 per month for 12 months to hit your goal. If you can only set aside $150 each month, it will take you 16 months to save the desired amount.
Remember, your contributions don’t have to be monthly. If it aligns better with your pay schedule, consider bi-weekly or weekly contributions. Adjust your timeline or savings amount based on what’s realistic for you.
Pro tip: 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’m a big believer in using a bank that offers sub-savings accounts to manage financial goals and sinking funds.
Instead of putting all your savings into one account, sub-savings accounts allow you to create separate “buckets” for different goals, all under one bank.
For example, I bank with Capital One and use their sub-savings accounts to manage multiple sinking funds. One important sinking fund I keep 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 it won’t get mixed in with other funds and accidentally spent, as unassigned money tends to disappear fast!
Some well-known banks that offer sub-savings accounts have no fees and high interest rates are:
- Ally Bank. Offers a “buckets” feature to create sub-accounts for different savings goals.
- Capital One 360 Performance Savings. Allows multiple savings accounts, making it easy to organize sinking funds.
- SoFi. Includes “Vaults” to separate savings into specific categories.
If you don’t want to switch banks, the budgeting app YNAB 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, you don’t have to move 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 insurance premium of $600 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 2-3 funds focused on your biggest irregular expenses from the past year, like annual insurance premiums or a vacation.
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 each deposit — a concept called reverse budgeting.
Schedule these transfers to align with your paydays so that saving becomes a priority, reducing the temptation to spend the money elsewhere.
Many banks allow you to set transfers monthly, bi-weekly or weekly, depending on what best fits your cash flow and goals. To be safe, schedule the transfer for a few days after your paycheck arrives to ensure the funds are available.
While automatic transfers are great for fixed expenses, calendar alerts work better 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 pops up, I calculate 25% of my income and transfer it to my tax fund.
Pro tip: Give your goal a fun, motivating name. Studies show that exciting names can increase the chances of achieving your goal. So, instead of just “Home Down Payment,” try “Dream Home for My Family!”
Step #4: Track Your Progress
Periodically review your automated transfer amounts, especially if your income or expenses change.
I find it helpful to do a quick check at the start of each month to see if any adjustments are needed. Sometimes, I can increase my sinking fund contributions; other times, I may need to make small reductions, though it’s best to keep adjustments minimal.
If you make changes every month, it may be time to revisit your original plan. Frequent adjustments can be a sign that you’re overextending your budget or lack the necessary cash flow to stay on track.
Final Thoughts on Sinking Funds
Sinking funds prevent going into debt for predictable expenses. While emergency funds cover unexpected costs, sinking funds help you plan for future expenses.
A personal recent example: I used a sinking fund for a $4,000 chimney repair (yes, not very exciting). This came out to setting aside $333 a month for a year. Though not urgent, it was inevitable — precisely the type of expense that often drives people to credit cards unnecessarily.
When creating a sinking fund, keep in mind to:
- Start with just 2-3 high-priority funds at first. Get used to the practice of setting aside small amounts of money each month. If you’re on a tight-budget, you might want to create more funds in the future.
- Set specific goals with real numbers; don’t save vaguely for “travel,” but rather plan a concrete vacation with a clear budget.
Like any financial habit, sinking funds take time to master. But they’re worth the effort since 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’ll wonder how you managed without them.
