The Beginner’s Guide to Emergency Funds & Sinking Funds
(& Why You Need Both)

The Beginner's Guide to Emergency Funds & Sinking Funds

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As you’ve started diving into sorting out your finances, you’ve probably heard that you need a starter emergency fund of $1,000. You may have also heard some talk about sinking funds. But what exactly is the difference between these? And why do you need more than one account? Lastly, if you’re drowning in debt, isn’t everything an emergency at this point?

It’s important to not only understand the different between emergency and sinking funds, but why you need each, even this early in the debt repayment game. Especially this early in the game. Without understanding these funds and how to set them up, everything will always be an emergency. And personally, that is not how I want to live. It’s way too stressful!

The Beginner's Guide to Emergency & Sinking FundsWhat an Emergency Fund Is (And isn’t)

An emergency fund is for true emergencies. These are expenses that are unexpected and unplanned. Think a job layoff, an accident, big health issues – basically anything that keeps you up at night.

Sadly, it’s not funds for when you’re too tired to cook, there’s a big sale on shoes, or when you’re forgotten that you need a haircut before a wedding.

For example, our roof was recently damaged during a storm. Since this was an unexpected expense, we took the $1,000 deductible out of our emergency fund at Capital One to pay it off, rather than putting it on our recently paid off credit card. Then we’ll use the next 2 to 3 months to build that emergency fund back up.

Examples of What to use an emergency fund for:

  • Layoffs
  • Accidents
  • Emergency health bills
  • Unexpected car issues
  • Items that are both unexcepted and unknown

The general rule of emergency funds is that $1,000 is a good starting point while you’re still paying debt. Once all debt has been paid off, then the suggested amount is 3 to 6 months of expenses (or even more!). Note that I said expenses, not income. It’s about covering your bills if you lose your job or get hurt, not matching your missing income. There’s a big distinction between the two!

Emergency fund money is earmarked for after something happens. It’s those things in life that you can only plan so much for and generally show up at the worst times.

If you’re wondering if an expense qualifies, here are some questions to ask yourself:

  • Is it an unexpected expense or was it known about it prior (like a yearly bill)?
  • Is it a want or a need? If it’s a want, it’s not truly an emergency, no matter how good that sale is!
  • Is it urgent, or can it be saved for?

A great example that’s come up in our house recently is the dishwasher. It’s original to the house, and is on its last leg. Sometimes it works ok, sometimes not. We can live without a dishwasher (in theory!). Replacing the dishwasher is a known expense at this point. It’s a want, not a need, and it’s not urgent. Based off these questions, replacing the dishwasher is definitely not an emergency.

What a Sinking Fund Is (And Isn’t)

A sinking fund is money that you’ve saved up before something happens, so you’re thinking ahead and planning for expenses you know are going to pop up. Some examples are bills that aren’t paid monthly, car maintenance, and vacations.

Back to the dishwasher example from before – if it dies, we’ve agreed to save up to buy a new one rather than put the cost on a credit card. That is a sinking fund. Even better, we could start saving for it now before it dies. This way we’re thinking ahead about our money, rather than starting saving after it dies, which could take several months.

Examples of what to use sinking funds for:

  • Bills that are not monthly, like water, sewer, garbage, etc.
  • Expected car costs, like tires, oil changes, tags, etc.
  • Christmas
  • Birthdays
  • Vacations
  • Home maintenance
  • New appliances/furniture
  • Quarterly self employment taxes
  • Property taxes
  • Insurance (if not paid monthly)
  • New (to you) cars
  • School clothes/fees/supplies
  • Weddings
  • Copays for healthcare

How to figure out your sinking fund amount

  1. Write down all expected expenses for the rest of the year that aren’t part of your normal budget
  2. Do your best to estimate how much each will cost (reference an average of last year’s cost if possible)
  3. Add up the total, then divide by how many paychecks you have left for the year
  4. Open a separate checking/savings account and keep the money there

One thing to note is that you won’t have all the sinking funds you need immediately. The best way to handle this is to prioritize the expenses you plan to cover with the sinking fund. Arrange them by due date as well as by urgency. This way, the most important sinking fund expenses will be covered first, and you’ll have time to save up for the rest.

Keep Both Emergency Fund and Sinking Fund Money Separate

I highly recommend opening an account with Capital One to set this money aside. You can open a savings account there, and then you’ll be able to create up to 25 sub-accounts with no additional paperwork. This is extremely handy when you want to earmark money for certain funds. It also links to your regular bank, so it’ll take a couple of days to move back and forth, but it’s a great way to keep that money for its original purpose.

This way you have can separate accounts for Christmas, car maintenance, vacations – whatever your heart desires, up to 25 of them!

A big mistake that I’ve made in the past is to keep my sinking funds money in my savings account (which also housed my emergency fund and quarterly tax payments, yikes!). As you can guess, I’d dip into it without realizing I was, and next thing I knew…we’d be short and struggling to replace that money come tax time.

I finally realized that the best thing we could do is that every time we get paid, I put those different chunks of money into those separate accounts. That way, we don’t spend what we don’t have, and every quarter, I can easily just transfer the tax money back to my checking account and write a check to pay it. I don’t even have to think or worry about it – easy peasy!

A Quick Review of Emergency & Sinking Funds

Emergency FundSinking Fund
Used reactively for the unexpectedUsed proactively for bills you know you’ll need to pay
Used AFTER something unexpected happensSaved BEFORE something expected happens
Examples: Job layoff, accident, big health issuesExamples: Christmas gifts, vacations, home maintenance
Recommended amount is $1000 until debt is paid off; then 3-6 months of expensesRecommended amount is variable, based on known upcoming expenses

Not everyone will have the same categories for sinking funds, or even emergencies, which is fine. What’s important is that you’ve sat down and mapped out possible expenses, and have decided to face them head on.

Burying your head in the sand and hoping extra expenses will go away if you ignore them isn’t making your money work for you. It’s making you chase your money, and work harder than you need to in order to get ahead. Creating emergency and sinking funds will only lead to making your finances a success, and will reduce your stress if (and when) something happens!

Ready to start budgeting or want to hear more about ours? Click here to learn how we’ve paid off $14,091 in debt in 12 months!

Do you have sinking funds and an emergency fund set up? What categories do you include in your sinking funds? Comment below and let me know how you’ve made these types of funds work for you and your money!

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Why you need both emergency funds and sinking funds

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7 responses on “The Beginner’s Guide to Emergency Funds & Sinking Funds
(& Why You Need Both)

  1. Leah | A Relaxed Gal

    This is a great easy to understand breakout of the diffs between sinking and emergency funds. I have an official emergency fund that I’ve used a few times when I was laid off. I guess I have a sinking fund as well, but I never really classified it as that. The money in that fund is set aside in an account that’s separate from my emergency fund and everyday accounts.

  2. Rachel

    I like the idea of calling that a ‘sinking fund’. I totally agree that it’s very helpful to keep certain funds separated from others and will be calling one of mine a sinking fund from now on.

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