Sinking Fund

Sinking fund summary: 

• A sinking fund has you save smaller amounts of money over time to cover a big anticipated expense. 

• Sinking funds are best used to put money aside for specific goals. 

• You might want to create a sinking fund for expenses like new car tires, a vacation, or a home purchase. 

Sinking fund definition and meaning

A sinking fund is a way to split up a large expense over multiple months (or even years) so it doesn’t slam your budget in a single month. It also gives you the ability to prioritize particular savings goals by opening a special account (or designating a specific place) to save for them. 

Some online banks with savings accounts let you create different buckets or sub-accounts within the same account. That way, you can save for different expenses. 

Key concept: Creating sinking funds can help you prioritize your savings for specific goals. 

More on sinking funds

We all have big expenses that we need to take on every so often. And unlike the bills you might pay out of your emergency fund, you can plan and save for sinking fund costs. 

In short, that’s the secret to a sinking fund. You break a big goal into manageable monthly savings so you’re ready when the time comes. It can also help you plan for a big, predictable expense.

You might want to use a sinking fund to save for: 

• Holiday expenses

• Vacation

• Buying a home

Sinking funds: a comprehensive breakdown 

Here’s a step-by-step guide to how a sinking fund works to save for a specific goal. 

1. Name the expense. Figure out a large, one-time expense you can anticipate or would like to plan for: a summer vacation, a new refrigerator, or new clothes for an upcoming season. 

2. Estimate the cost. Figure out the total amount you'll need for the expense. 

3. Calculate monthly savings. Divide the total cost by the number of months you have until the expense is due to find out how much to save each month. 

4. Set up the account. Open a dedicated savings account for the fund and set aside the calculated amount from each paycheck, treating it like a necessary monthly bill. With some smaller amounts—for example, holiday tips—you could use the envelope system where you set aside cash in an envelope. 

5. Save. Continue contributing to the fund until the date of the expense, then use the money to cover the cost. 

Real-life examples of sinking funds 

Sinking funds are often used for financial hopes and dreams, like a kitchen remodel or a special trip.

Carly wants to take her family on a $2,400 vacation next summer, about 12 months away. She decides she doesn’t want to put the trip on a credit card, so she sets up a separate savings account just for their dream trip. 

Carly divides $2,400 by 12 and commits to transferring $200 every month to the vacation account. Her bank lets her give names to accounts, so it’s easy to earmark the money and transfer it to the right account. 

By the time summer arrives, she has the full amount saved and can enjoy her vacation without debt or stress. 

Sinking funds can also be used for large annual expenses. 

Kieran owns a home and knows his property taxes will be about $3,000 at the end of the year. Rather than scrambling to come up with the money all at once, he creates a sinking fund. 

Each month, Kieran sets aside $250 in a separate account. When tax season comes, he has the full $3,000 saved and can easily pay the bill, without dipping into his emergency fund or using credit.