Have you ever been hit with a big bill that you didn’t budget for? If so, it’s time to set up some sinking funds so that next time you can be prepared.
The annual premium for our disability insurance is due next month. While it’s not a surprise, it would be easy to forget that the bill was coming up, as it only comes around once a year. Finding $2,180 in our regular monthly budget to pay the bill would be tricky if we weren’t prepared.
This is where sinking funds save the day!
Because we have a sinking fund for disability insurance, we don’t have to worry about the bill at all when it comes. We pay it without a second thought!
Let’s talk about what a sinking fund is and what types of budget categories should be sinking funds. Then, we can focus on how and when to get started using sinking funds in your budget. We’ll finish up with the benefits of sinking funds. Of course I would love for you to chime in and tell us how you’ve used sinking funds too!
What is a sinking fund?
A sinking fund is simply a way to save up for a future known or unknown expense. You can save money over time in a separate account or budget category and let the allotted money accumulate until you need it. It could be a known amount and due date, such as an annual insurance premium or and unknown amount and unknown future date such as a car repair fund.
Some people choose to have separate savings accounts for each category to ensure that they don’t accidentally spend money that they have set aside for another purpose. Opening a separate savings account as a sinking fund would work well for a big, longer-term goal. The downside is that having lots of saving accounts can be cumbersome and hard to manage. You will have to remember to transfer the sum of money to pay a given bill into your regular checking account before paying the bill, which can be a lot to remember.
Personally, I like having lots of sinking funds because I don’t like my monthly budget to get surprised by big (expected or unexpected) expenses. If I know that a year from now I will need to pay $2,180, I would prefer to set aside $182 each month so that I don’t have to find $2,180 all of the sudden when next March rolls around.
Since we use lots of sinking funds, we choose to keep all of our sinking funds in our regular budget checking account. What keeps us from accidentally spending the money that we have set aside? How do we know how much is in each account? We track everything through our YNAB, our most favorite budgeting app. YNAB allows us to assign all of our dollars a job (in other words, a budget category). When we spend money, we track it in YNAB. We don’t look at our checking account balance to decide if we can afford a purchase. We look at our budget categories in YNAB. When we assign money to our sinking funds, we can trust that it will be there when we need it without needing to put each sinking fund in a separate account.
For a more in-depth explanation of the YNAB methodology and how to get set up your budget this way, check out this post.
What budget categories should be sinking funds?
Since I don’t set up a separate savings account for each sinking fund, there really is no limit to the number of sinking funds I can have! You can make any budget category into a sinking fund, but there are some types of budget categories that really lend themselves to being a sinking fund.
I recommend setting up a sinking fund for three types of budget expenses, with multiple sinking funds of each type.
- Large Annual Expenses- What is considered “large” will vary depending on each family’s situation. If having the expense pop up by surprise would throw off your monthly budget, then consider this a large expense. The nice thing about this type of sinking fund is that you know exactly how much you will need and when the due date is. Here are a few examples:
- Life insurance premiums
- Disability insurance premium
- Annual subscriptions
- Unexpected Expenses– Any categories that might have big, unexpected spending. Car repair, for example, never comes at a time when it is convenient, yet it is inevitable. Here are some examples:
- Car repair
- Medical
- Dental
- Specific Savings Goals– It’s natural for a savings goal to be a sinking fund. Any specific savings goal that will take multiple months or years to save for is a perfect candidate for its own sinking fun. For example:
- Vacation fund
- Large purchase
- Christmas
Of course you can sink funds in any other budget category, even if it’s small.
How to get started with sinking funds
Thankfully getting started with sinking funds is easy. It’s just a matter of setting up your categories and deciding how much you would like to set aside each month.
For annual bills (category 1 above), take the total amount that will come due and divide the total by the number of months left before the due date. For example, our life insurance premium of $1,250 is due in November. If I were starting a sinking fund for our insurance premium right now (so starting in March), I would have 9 months to save. $1,250 divided by 9 is $139.
In subsequent years, I would take the total and divide it by 12. So after paying our life insurance premium in November, I would start over in December by setting aside $104 each month.
For unexpected expenses (category 2 above), we can’t calculate precisely how much we will need since we can’t see the future. We can get a pretty good idea, though, by looking at the past. Look back at the past couple of years to see how much you have spent in that category. What does your average spending look like for car maintenance? Take that amount and divide it by 12. If there are expenses that you can foresee (i.e. We will need new tires in the next 6 months), be sure to take those expenses into consideration.
For a medical sinking fund, consider your total deductible and out of pocket medical expenses. We are generally healthy and don’t often meet our health insurance deductible for the year, so we usually have the goal amount for our medical sinking fund be the amount of our total deductible and divide the amount by 12.
For specific savings goals (category 3 above), we start by figuring out the total that we want to save. For vacations or home improvement projects, this requires some research to come up with a reasonable goal amount. From there, we set a time frame for our goal. With those two numbers, it’s just a matter of dividing the goal dollar amount by the number of months to reach the goal.
When we planned our trip to Guatemala with our three older kids, I made a thorough trip budget so we knew we would know how much to save. I did the same thing to plan our upcoming family cruise.
When should you start using sinking funds?
You can start using sinking funds in your budget right now, even if it’s only with a little bit of money. If you can’t manage to set aside the ideal amount of each of your sinking funds, don’t worry. Having something set aside is always better than nothing. Little by little, as you improve your budgeting, you can increase the amount you put into your sinking funds.
In order to make setting up each month’s budget smooth and easy, I like to put the ideal monthly amount right in the name of the budget category (i.e. “Disability Insurance ($190)”). That way I don’t have to look at past months or repeat calculations to remember how much money to assign to that category. It’s easy to edit the category name if we decide to change the monthly amount we aim to save.
Some months when our finances are tighter due to earning less or having higher than normal expenses, we don’t fund all of our sinking funds. We prioritize the funds where an exact amount is calculated (type #1 above), because we would have to make up the shortcoming in the future otherwise. For a fund like Christmas savings (type #3 above), it would just mean that we will have less to spend when the time comes.
If you don’t have sinking funds set up yet, don’t hesitate. Get started now so you can start reaping the wonderful benefits!
Benefits of Sinking Funds
Using sinking funds in your budgeting has so many great benefits. Here are some of my favorites:
- Better budgeting
When you’ve thought through all of the annual expense, potential unexpected expenses, and specific savings goals, your budget is a more accurate reflection of your true expenses. While no two months are ever alike, your regular budget categories become much more predictable when you’re actively using sinking funds.
- Reaching financial goals
Sinking funds help us keep on track to reach our financial goals because they prevent us from getting derailed by surprises. By faithfully using sinking funds we very rarely need to touch our emergency fund, so we can focus on our big goals. Often our financial goal is a sinking fund, like a family vacation!
- Peace of Mind
Knowing that we are prepared for almost anything that comes our way gives me an amazing sense of peace. Having lived with six figures of debt, I’m very familiar with what it’s like to not feel financial peace, so I can really appreciate the beauty of not being completely stressed about money.
Setting aside money aside in sinking funds for future needs takes discipline and consistency, but the joy that you feel when the money you need is readily available is totally worth it! I hope you’ll love sinking funds as much as I do!
How about you?
I would love to hear how you use (or would like to use) sinking funds in your budgeting.
Do you use separate accounts for each sinking fund or keep the money all in the same account and use a budgeting tool like YNAB to keep everything straight?
What is the biggest benefit of sinking funds for you?
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