Plan Ahead: The Power of Sinking Funds

There’s nothing like needing to spend money and having the money already there to be spent! What peace that brings. One way to do this is with an emergency fund. But I’m here to share about saving for other expenses you CAN foresee. Emergency funds are meant for unexpected, urgent, and necessary events. To build your emergency fund, you calculate one month of necessities, multiply by 6, and stash that away in a dedicated account. That’s the best way to deal with Murphy’s law! But what about expenses you know are coming? Nope, those aren’t emergencies, and you can plan for these with a Sinking Fund.

Sinking Fund Uses

There are a myriad of events that recur at roughly the same time every year: taxes, auto registration, birthdays, school fees, and car insurance, just to name a few. Last time I checked, Christmas comes on December 25th year after year. Yep, you can plan ahead for that!

How about those extra things you want that aren’t required to make your household run (sometimes they feel like they are): lawn care, youth sports (that’s our big one), upgrading to the latest iPhone with Apple Intelligence, and vacations?

Then there are those expenses you know will happen, maybe not every month or year, but they are coming. Examples are oil changes, tire replacement, car detailing, duct cleaning, garage door tune-up, electric mower battery replacement, and doctor and dental copays. The list could go on.

The benefit is that if you include a sinking fund in your budget (you have a budget, right? 😉), you are TOTALLY FREE to spend! What an amazing feeling. No stress, no muss, no fuss. The money’s there so that you can use it. So, spend away! Here are three examples to illustrate the benefits of planning ahead with a sinking fund.

Who doesn’t like to pour out gifts on their kids or grandkids? And who doesn’t also reach January saying, “Yeah, I spent a little more than I thought.” So, fun gets mixed with regret and leaves a less-than-desirable taste. If you start in January, stashing money away, you can have guilt-free, generous spending in December. I highly recommend it.

Who pays for their car insurance monthly? You may have noticed that when your agent sends your bill, it shows a significant discount if you pay in full. Sometimes, it amounts to several hundred dollars. What if you had the money to pay the bill in full and could pocket the difference for something a whole lot more fun than insurance?

Some business owners struggle to keep up with income and self-employment taxes. The last thing we want is to take that big, beautiful check from a job and pay taxes. But that’s part of operating a business. I’ve seen too many instances where owners get behind during the year, have a mountainous bill, and face an “Oh crap” moment. With a sinking fund, you can make the whole thing less painful by socking away a portion every month. Then, when it’s time for quarterly payments, you can, less reluctantly, pull the trigger on paying the government. Way less stressful.

How to Create a Sinking Fund

It’s really a simple process. The hardest part is getting into the habit and sticking to it. Before I give you the steps, here are common mistakes I’ve observed.

Mistakes to Avoid

• Commingling too many expense goals in the same account. Keep the account’s use clear.

• Raiding an account to fund emergencies or wants. Spend the money on its original intent and have a dedicated emergency fund.

• Overcomplicating and having too many accounts. You want enough for differentiation but not too many that your financial advisor can’t keep track. Ha!

Steps

Here are three easy steps to get your dedicated sinking fund(s) up and running.

1. Open a dedicated account for the goal. Keep your accounts at the same institution whenever possible. Don’t forget to make your spouse a joint owner and set beneficiaries.

2. Calculate the amount needed to fund the goal and divide it by the number of periods until the money will be used.

3. Set up an automatic transfer from the account that receives your paycheck to the sinking fund account.

That’s it—easy peasy. Over the years, I've found other insider tips to make sinking fund spending a success, so now I’ll share our family’s strategy to liven up the simple sinking fund steps.

Our Sinking Fund Plan

We have five main sinking fund accounts: Taxes, House Maintenance, Insurance, Giving, and Auto. We have other lesser funds (medical, family gifts, etc.) that don’t have their own dedicated account because we use some of the money most months, so it just sits in our checking account. We’re trying to strike a balance between order and complexity. You might ask, “What about the travel fund?” We don’t have a dedicated one of those yet, but that is on the horizon. For now, we budget for that out of regular income or take funds from an inherited IRA.

Tax Fund

Our tax sinking fund account holds two funding goals: property taxes and my wife's self-employment taxes. Right after I pay the property tax bill for the current year, I increase the total by an amount that aligns with the historical increase, divide it by 12, and set up my autopay for that amount on the last day of each month. When June and September roll around, boom, I make the payment. Tanya’s self-employment income isn’t automated because it’s irregular. For this, we simply take 25% of the amount she receives in any month and move it manually to the tax account. Then, quarterly, I take the amount set aside (I know how much that is because of the budget) and make our quarterly estimated payment. That’s worked out well because we are usually within a few hundred dollars of our tax liability and what we paid during the year.

House Maintenance Fund

This one’s way simpler. We don’t really know how much we will spend on house maintenance, but it sure is great to have money there when the inevitable comes up. For now, we automate $100/mo. into this account so when some honey-do item hits the husband to-do list, I can hit up The Depot with cheer. I’d love to get our savings into this maintenance fund closer to the rule of thumb widely recommended in the finance world: 1 – 4% of your home’s value. For example, if your home is worth $300k, you’d sock away $3k-$12k each year. That way, this fund can take care of bigger items like roof, furnace, and hot water heater replacements. For now, the emergency fund would handle those larger expenses for us.

Insurance Fund

I love saving money on things that cost way too much, and I find paying annually for auto and home insurance to be one way to do that. So, we take a similar approach to this as we do to property taxes. Right after we pay the bill in November, I increase it by 10-20%, divide it by 12, and set up my autopay for that amount on the 15th of each month. And yes, we pay auto, home, and umbrella all at the same time. Keeps life simpler. You may have noticed that the timing differs from the property tax autopay. That’s to spread out the transfers, so we make sure to maintain a buffer in our checking account. I highly recommend this. When next November rolls around, I’m ready to cut the very painful but absolutely necessary check to the insurance company to transfer the liability risks to them. Well worth it!

Giving Fund

Generosity is in our family’s DNA, so we portion some of our income to various individuals and charitable organizations. Some of these gifts are monthly, and others are irregular. That means part of what we set aside for giving isn’t spent each month and builds up. We clear that out of our checking account into the giving sinking fund to make it clear that we’ve chosen to give it away. No touchy touchy. We built up a decent chunk at the end of last year and gave in a more tax-optimized way by gifting appreciated mutual funds. I love the flexibility and ability to be spontaneously generous with that pool of money.

Auto Fund

The last fund is for the dreaded automobiles. Only this fund makes regular vehicle maintenance fun. Just today, I showed up to our scheduled oil change and freely slapped down the $80+ dollars for the full synthetic oil change and a tire rotation. It feels good to take care of seemingly small things that can save us big bucks later. Any time we have a big repair, we have that covered too, because this fund has grown to where we can pay for most repairs I’ve ever encountered. Eventually, I want this sinking fund to be where we grab cash for a vehicle replacement. For now, $125/mo. heads automatically on the 15th of the month to its dedicated home.

Need a Plan?

Hopefully, all this jabber about saving inspires you to plan ahead, sink some money into a dedicated account, and spend freely. Or maybe you were about to vomit and broke out into a cold sweat. That’s understandable. But don’t knock it before you try it. If you find yourself struggling in some of the ways I described, sinking funds can be a powerful tool to give you freedom. We’d love to partner with you to devise a plan for your money. Click here to contact us.