What Is a Sinking Fund? How Sinking Funds Work

You set up a careful monthly budget, then the car insurance bill arrives. Or back-to-school shopping, or the holidays: costs you knew were coming that still threw the month off.

Those bills are known in advance. They come once or a few times a year, so a budget built on monthly bills has no room when they arrive.

A sinking fund closes that gap with simple arithmetic. If you already know how to budget for monthly bills, it works the same way: once you know a cost and its due date, the big bill becomes a monthly line in your budget. This guide shows how to work out that amount, which costs to save for, and what to do when money is tight or you carry credit card debt.

What are sinking funds in a budget?

A sinking fund is a pot of money you fill a little at a time for expenses you know are coming. When it’s time to pay the bill, the money is already there.

Sinking funds are built for irregular expenses: costs that come once or a few times a year, like renters insurance, income taxes, car insurance, or school supplies. They aren't unexpected, but they can be hard to pay all at once if nothing has been set aside. This means that yearly and twice-yearly bills also belong in your monthly budget. 

Why are they called sinking funds?

In government finance, a sinking fund is money set aside on a schedule to pay off debt. In 1790, the United States established a sinking fund to reduce the public debt.

Some bonds have a sinking fund too. This fund requires the bond issuer to pay off part or all of the bonds on a fixed schedule. On this page, the term "sinking funds" means the household kind: money you save on a schedule for a bill you know is coming.

Sinking fund vs. emergency fund: What's the difference?

The difference is whether you know the cost is coming. A sinking fund covers irregular expenses you can plan for, such as insurance, taxes, and school supplies. An emergency fund is a cash reserve for unplanned expenses, such as car repairs, home repairs, medical bills, or a loss of income.

This table compares the two by their purposes. If you're not sure which fund a cost belongs in, ask whether you could have put a date on it a year ago.

Keep both a sinking fund and an emergency fund, but build the emergency fund first. Once it reaches a set goal, such as $500, you can start saving for expenses you know are coming. Keep the two funds apart, so a surprise doesn't wipe out money you've saved for a planned cost.

Sinking fund vs. savings account

A savings account is one place to keep a sinking fund: you put a monthly amount into savings, so the money is ready when a large bill comes due.

A savings account holds money you set aside for later and don't expect to use often. Checking is for money you move in and out to pay bills.

How to set up a sinking fund

Start with an upcoming expense and its due date, then save a set amount each month until the bill arrives.

List the cost and its due date. Write down each bill that comes once or a few times a year, when it's due, and roughly what it costs.

Work out the monthly amount. Divide what you need by the months you have left until the bill is due.

Pick a place for the money. Use a federally insured savings account, kept apart from your checking account.

Automate the deposits. Set up a recurring transfer from checking to savings through your bank or credit union. Watch your checking balance so a transfer doesn't trigger an overdraft fee.

Check your progress. A balance alert or a running total can keep you going.

When the bill is paid, restart the fund for the next due date.

Sinking fund example

Say your car insurance bill is $1,100 and it's due in eight months. Divide the cost by the months and round up to the next dollar.

The extra $4 can go toward next year's bill. The longer you wait to put money away, the larger the monthly deposit will need to be. For example, with only five months to go, the same bill requires a $220-per-month deposit. 

Sinking fund categories

This table groups common categories by cost type. If an expense of yours isn't listed, it should still be a sinking fund if you can name how much is owed and the due date.

Repairs and medical bills can fit either fund. A cost you can see coming, such as car maintenance or a planned home repair, belongs in a sinking fund. A sudden breakdown or an unexpected medical bill belongs to the emergency fund. Track the cost of your car maintenance and repairs, so you know how much to set aside.

How many sinking funds should you have?

Your list of bills that don't come every month determines how many funds you need: one for each. You don't have to start them all at once. You're more likely to reach your goals if you focus on one or a few at a time. Start with the bill due soonest, and add the next fund once the first one's monthly amount is a regular line in your budget.

Where should you keep a sinking fund?

Keep a sinking fund somewhere safe, easy to reach, and separate from your spending money. A savings account at a bank or credit union fits the bill, with easy withdrawals and the ability to earn some interest.

Other options include a money market deposit account and a certificate of deposit (CD). A money market deposit account is a bank account that usually pays a higher rate and requires a higher minimum balance than some other accounts. A CD holds your money for a set time, from three months to five years or more. It usually pays more than a savings account, but you'll likely pay a penalty if you withdraw funds early. Choose a CD only if it matures before your bill is due.

What if you can't afford to fund everything?

Fund the costs that would hurt most to miss, and let the others wait. When money is short, weigh what happens if each cost goes unpaid, then number them in that order.

First, protect your income, your home, and your insurance: tools or licenses for your job, property taxes, and essential auto, renters, homeowners, and health coverage. A holiday or a new gadget can come later.

If the total still doesn't fit, push back the date on a cost that can wait, such as a vacation, or lower a fund's target. You can also spend less elsewhere or bring in more money. To spend less, drop memberships you don't use or compare auto insurance prices. To earn more, sell things you no longer need. If you spend a fund before it's full, plan to rebuild it.

Should you build a sinking fund if you have credit card debt?

Yes. Deciding whether to save or pay off credit cards isn't always an either-or choice: you can do both.

Save money so it’s ready when a bill comes due. Saving almost always costs less than using credit, because you avoid interest charges and late fees.

Your card's annual percentage rate (APR) is its cost of borrowing, stated as a yearly rate. Once your fund deposits are set, put extra money toward the card with the highest APR first to pay less interest.

Bills Action Plan

• List next year's irregular expenses. Go month by month and note each bill that isn't billed monthly, including the amount due and the due date.
• Add the monthly amounts to your budget. Divide each cost by the months remaining until it's due, and make the total a separate budget line.
• Automate the saving. Open a savings account with no monthly fee and schedule a transfer from checking for the day after payday.

Find more ways to plan ahead in our personal finance guides.

Key Terms

Sinking fund: Money saved a set amount at a time for a cost you know is coming.

Irregular expense: A cost that comes once or a few times a year instead of monthly, like a property tax bill.

Emergency fund: Cash set aside for costs you can't plan for, such as a sudden car repair or a loss of income.

APR (annual percentage rate): The cost of borrowing as a yearly rate.