It may sound like a negative thing, but a sinking fund is money that’s saved toward a specific goal. Governments and businesses can use sinking funds to hold reserve cash to fund future expenses, but this kind of account also has a place in personal finance as you build wealth and achieve goals.
What sinking funds are is a way to earmark and stash money so you can, say, buy a new car or take an amazing vacation. Understanding how sinking funds work can help you decide if you need to include them in your budget.
What Is a Sinking Fund?
A sinking fund is money that’s earmarked to pay planned expenses that fall outside of your regular budget. In accounting, a sinking fund is used to save money to pay debt or replace an asset that is declining in value. The name, which can admittedly sound negative, may be derived from the idea of sinking, or paying off, a debt.
As mentioned, individuals, businesses, and even governments can use sinking funds to hold money in reserve for future expenses. For example, the U.S. Treasury Department maintains a sinking fund for unused appropriations.
For an individual, the meaning shifts somewhat. A sinking fund can help you be financially prepared to pay certain expenses that are on the horizon. In this way, it can help you avoid having to turn to high-interest credit cards or loans to cover expenses that don’t fit into your monthly budget. Being able to avoid debt is one of the main reasons why saving is important.
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Examples of a Sinking Fund
A sinking fund can be used to save money for a variety of expenses. Some of the most common sinking funds categories include:
• Vehicle maintenance and repairs
• Pet care
• Home maintenance and repairs
• Birthdays, holidays, and other special occasions
• Wedding expenses
• Baby expenses
Those are just a few of the things you might need a sinking fund for. The number of sinking funds you choose to establish can depend on your financial goals. You might create one for, say, a down payment on a home or a trip to Bali. It’s up to you.
You can set up separate accounts for each goal and, if you like, automate savings into each. You might add $25 per pay period to one, $100 to another. By setting up recurring transfers to occur right after your paycheck hits your checking account, you can help your savings grow with minimal effort.
Benefits of a Sinking Fund
Setting up sinking funds can offer some advantages if you have planned or recurring expenses.
• You can use them to create a structured plan for saving toward various expenses or financial goals.
• Depending on where you keep your sinking funds, you may be able to earn a decent rate of interest on your deposits.
• Sinking funds ensure that when a planned expense comes due, you have the money to pay it. You can avoid dipping into your emergency fund or using a credit card.
Drawbacks of a Sinking Fund
Sinking funds can help you to be consistent with saving, but there are some potential drawbacks.
• You have to be organized and disciplined when setting up a fund or multiple funds.
• If you’re also saving or investing in other accounts, you may have trouble keeping track of what is sinking fund money and what isn’t.
• Saving in multiple sinking funds could leave you spread thin financially if you’re not careful about budgeting.
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How to Create a Sinking Fund
Getting started with sinking funds isn’t that difficult. Here are a few simple tips for using sinking funds to save toward planned expenses.
List Your Sinking Fund Categories
The first step in creating a sinking fund is deciding what categories to include. A good way to choose sinking fund categories is to review your spending for the last six months to a year. Look for expenses that may recur periodically, like biannual or annual insurance premiums or annual home maintenance.
From there, consider what savings goals you might be working toward that are one-time expenses. That may include a wedding, a down payment on a home, a vacation, new furniture, or something else you only expect to pay for once. You can then use your recurring expenses and planned expenses to create your sinking fund categories.
Determine Your Savings Target
Next, decide how much you need to save toward each expense or goal on your sinking fund list. Assign an overall dollar amount first, then determine how much you need to save monthly, based on when you plan to spend the money.
Say you want to save $1,000 for a trip you’d like to take in a year. You’d divide the total by 12, and your savings goal would be $83.33 per month.
Decide Where to Keep Sinking Funds
Once you know what you need to save each month, you can choose where to keep your sinking funds. Again, this may be a single savings account or money market account, or a savings account with multiple subaccounts.
Certificate of deposit (CD) accounts are usually not the best place to keep sinking funds. They require you to leave money in them untouched for a set maturity term to avoid a penalty. However, you may be able to find an add-on CD account that is a work-around to this. These accounts may allow you to increase the funds on deposit; check with a financial institution that offers this product for more details.
Set Up Automatic Transfers
If you’ve opened sinking fund accounts, you can take the final step and link them to your checking account. You can then schedule recurring automatic transfers from checking to your sinking fund account each month to grow your savings automatically.
You might want to set up your automatic deductions for payday. It can be helpful to have the money whisked out of your checking account and into savings before you see it and think about spending it.
Sinking Funds vs Emergency Funds
You may be tempted to dip into your emergency fund for some expenses, like, say, buying a new mobile phone. However, a sinking fund may be a better option. While a sinking fund and an emergency fund are both designed for saving, they serve very different purposes.
With a sinking fund, you’re setting aside money regularly that you plan to spend at some point. (In the example of a new phone, maybe your current one is starting to have some glitchiness, and you know a new model will be released in six months with lots of bells and whistles.) Some sinking fund expenses may be one-time; others may be recurring.
An emergency fund, on the other hand, is designed to hold emergency cash in case you have an unexpected expense that you need to cover. Emergency funds are there for those “uh-oh” moments, when your hot water heater conks out or you get hit with a major dental bill.
Starting an emergency fund while also having sinking funds can be a good idea. When you have both, you have money set aside to pay foreseen and unforeseen expenses. And just like sinking funds, one of the benefits of having an emergency fund is that you’re less reliant on high-interest credit cards to pay for things.
Sinking Funds vs Savings Accounts
Sinking funds and savings accounts can refer to the same thing. For example, you might hold your sinking funds in a high-yield savings account at an online bank. But it’s also possible that you have other savings accounts that are not specifically used for sinking funds. Sinking funds usually have a specific goal, which can help you get motivated to save money.
Saving funds can be more general. If you have kids, you might set up savings accounts for them to teach them the value of money. Or you might have a savings account that you treat as a slush fund, where you keep money that you haven’t earmarked toward any specific goal.
If you have both sinking funds and savings accounts, it’s important to track what money goes where. That way, you can ensure that you’re saving enough in your sinking funds and not shortchanging any of your planned expenses.
Recommended: Smart Short-Term Financial Goals to Set for Yourself
Where Can You Keep a Sinking Fund?
When deciding where to keep a sinking fund, accessibility matters. You need to be able to add money to your sinking fund and withdraw it when needed. For that reason, you might open an online bank account to hold your sinking funds.
With an online savings account, you can earn interest on deposits and link your account to checking for easy transfers.
Some banks allow you to open a main savings account with multiple subaccounts. You might choose this option if you’d like to be able to add money to individual sinking funds for specific expenses. Subaccounts can allow you to see all of your sinking fund money in one place while keeping goals separate.
A money market account is another candidate for holding sinking funds. These accounts can earn interest like a savings account, but they may offer check-writing abilities or debit card access, which you typically don’t get with a savings account.
Just be sure to check if your bank limits the number of withdrawals you’re allowed to make from a money market account. For some people, this factor (if it exists) can be a deal breaker.
The Takeaway
A sinking fund can help you stay on track when saving for planned expenses. You can use sinking funds to save for a wide range of expenses, without having to dip into other savings, your emergency fund, or breaking out your plastic. It can be a helpful way to organize your finances and meet your money and lifestyle goals.
Where to keep money in a sinking fund? Someplace that bears interest but is easily accessible can work well.
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FAQ
What is a sinking fund in simple terms?
A sinking fund is a type of account that has a specific goal (such as a down payment on a house or debt repayment). Funds are typically added to it regularly.
How much should you have in a sinking fund?
If your sinking fund is an emergency fund, you should aim to have at least enough money to cover three to six months’ worth of standard living expenses. Otherwise, it’s up to you to set the purpose of a sinking fund (a Peloton bike or a trip to Yellowstone?) and how much you want to save.
What is considered a healthy sinking fund?
A healthy sinking fund has enough money to cover any planned expenses you might have on the horizon. The size of your sinking fund will depend on which expenses you’re planning for, how often you’re saving for those expenses, and how much you’re saving toward them each month.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
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