Are you struggling with budgeting and trying to stay ahead? Wondering where in the world you’re going to find money for upcoming expenses outside of your budget, yet again? The best way to break out of this cycle is to create and use sinking funds.
Sinking funds are the best way to make sure that you don’t end up stealing money from your emergency fund. They’re a great way to ensure that you are planning ahead and that you’re saving for the expenses you know are eventually going to come knocking at your door.
If you’re not sure what the difference is between a sinking fund and an emergency fund, you’ll want to read this article.
In this post, we’re focusing on discuss sinking funds, including what are sinking funds, how do they work, and how do you save up for them?
What are sinking funds?
Everyone has budget items that aren’t monthly, but are items you know you’ll eventually have to pay for. Some sinking fund categories include:
- Bills that are not monthly, like water, sewer, garbage, etc.
- Expected car costs, like tires, oil changes, tags, etc.
- Home maintenance
- New appliances/furniture
- Quarterly self employment taxes
- Property taxes
- Insurance (if not paid monthly)
- New (to you) cars
- School clothes/fees/supplies
- Copays for healthcare
These are items that you need to include in your budget, but don’t happen every month. Usually they’re seasonal, quarterly, or once a year.
How does a sinking fund work?
Once you decide what budgeting items you want to create sinking funds for, you’ll figure out how much to put towards each one every month. The point is to avoid using credit cards or your emergency fund in order to cover those expenses you already know are coming.
There’s no right or wrong way to plan and budget using sinking funds. It’s really about choosing to be more aware of upcoming bills and trying to plan ahead. It’s about learning to become proactive with your budget and costs, rather than reactive all the time.
What is the purpose of a sinking fund?
The purpose of a sinking fund is to avoid either dipping into your emergency fund – or even worse – putting those expenses on a credit card.
When you’re trying to pay off debt, the last thing you want to do is dip into your emergency fund. It’s a guarantee that you’ll get caught without any backup and something big will hit.
Secondly, adding more onto credit cards is a slippery slope. It’s just too easy to keep using it, and not get ahead on your debt.
Having a sinking fund means you’re able to pay for things like oil changes, copays, and vacations without having to pay interest to a credit card company.
When to start using sinking funds
There are a couple of thoughts on when to start using sinking funds. You can start planning for and using sinking funds while you’re in debt repayment mode.
If you choose to do this, it’ll slow your debt repayment progress. However, you know you won’t end up having to put anything on a credit card.
If you wait until you are debt free, you risk having to put these expenses on a credit card, or dipping into your emergency fund. That means you’re betting against the odds that you’re able to pay it off relatively quickly from your credit card.
As much as I want to tackle our debt as quickly as possible, we’re choosing to set aside money every month for items that fall into our sinking funds. It just makes everything a lot less stressful, and it’s nice knowing we have the money to cover things like new tires and Christmas.
How to Determine How Much You Need In Your Sinking Funds
How much should be in a sinking fund? Well, there are several ways that you can choose to determine the amount you’ll need to save. Start by writing down all expected expenses for the year that aren’t part of your normal budget. Do your best to estimate costs based on previous years. Next, select how you want to determine how much to save every paycheck:
Method 1: Saving Same Amount Every Paycheck
Once you have this total, divide this amount by the number of paychecks you receive for the year. Each paycheck, put that amount into your sinking funds account.
Sinking Fund Example: When our second child was born, I knew I’d have to get a c-section, and that our deductible was $6,000. We decided to dedicate $500 each month to medical expenses so that we would have her birth paid off by the end of the year. As medical bills came in throughout the year, I pulled money from that savings account to cover them.
Pros: There are no surprises or guesswork on how much to save from each paycheck.
Cons: There were a couple of months when the medical bills exceeded what we had saved to that point. I just contacted the provider and paid the bill in chunks until I had enough in savings to finish it.
Method 2: Prioritizing Sinking Fund Categories
Pick your top 3-4 most important sinking fund categories, based on their priority. Then save money from each paycheck for those specific items.
Sinking Fund Example: Say that you know that your HOA fees are due in February, your yearly trash bill is due in March, and your spring break vacation is early April. The rest of your sinking funds are further out in the calendar year. Total the cost of these three expenses, and divide by the number of paychecks that you’ll be receiving between now and when the last item (the vacation) is due to happen (April).
Once you’ve hit the savings needed for the first sinking fund category, you can reassess and add another to your list, so that you’re still only focusing on three or so at a time.
Pros: Creating a priority to your sinking funds helps you earmark funds for specific costs, so that they don’t end up in a mixed up mess where you’re not sure what’s due when. Or worse, not having enough saved for specific bills when they come due.
Cons: Different parts of the year could be more expensive than others, making it harder to save. Unlike method #1, what you save from one paycheck to another could vary greatly depending upon what’s due when.
The Best Way to Keep Your Sinking Funds Organized
You could lump your sinking funds into your savings and call it a day, but that’s a setup for disaster. Without having them earmarked for specific costs, you’ll likely forget how much you spent and on what items.
To solve this problem, we opened a savings account with Capital One 360. It’s 100% online, and has a better interest rate than most savings accounts. The best part? It easily links to our local bank accounts, and we can create up to 25 sub-accounts without any additional paperwork!
I have one account set up for quarterly tax payments, another for Christmas, and so on. No more worrying about overspending or figuring out how much we used for one thing or another.
Now that you know how to stop the cycle of financial stress, use this info to start planning ahead. Figure out what you need to save for, and start building your separate sinking fund accounts. By knowing what you need to save for the year, you’ll avoid the last minute rush to find funds. And, you’ll be able to keep your emergency fund just for emergencies.
Looking to learn more about budgeting? Click here to see the budget we’ve used to pay off over $16,000!
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