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Complete guide to sinking funds for beginners 

Heard the term sinking fund and wondering what on earth people are on about?

This guide to sinking funds for beginners will set out exactly what a sinking fund is and why you definitely need to start one. You may realise you already have a sinking fund! 

We all have expenses that come up every single year like clockwork. It might be the car service, your family holiday or the growing list of family birthdays you need to remember. 

Budgeting for sinking funds

A sinking fund ensures you are prepared for these situations. 

It’s different from an emergency fund, which is there to cover unexpected costs such as your boiler breaking down. 

Studies show us that many Brits struggle to set aside money each month. A survey by the Money Advice Service found four in 10 adults do not have £500 or more in savings.

A survey by ING bank found 28% of UK adults have nothing in the bank.

So let’s dive in and see what a sinking fund actually is. 

What is a sinking fund?

A sinking fund is where you put regular savings for expenses you know are going to happen. 

You set aside money every month for planned expenses. 

Your sinking fund takes the stress out of budgeting for the year ahead and means that when you get to annual events, like renewing your car insurance, the money is there to pay for it. 

Where you put the money is up to you, but as you will be using this cash throughout the year for your sinking fund expenses, you’ll want it somewhere there’s no fee for accessing your money. 

You calculate how much you need to save for your sinking fund by figuring out all your upcoming expenses for the year. 

Say for example you know you want to take a holiday this year and it will cost around £1,000 for the family. You divide that by the number of months you have until the trip and that tells you how much money you need to set aside each month to have the cash ready to pay for your trip. 

Why is it called a sinking fund?

The word “sinking” makes you think of something negative, right? 

It used to be reserved for corporate funds that were set aside to help pay off long-term debts. 

However the term has multiple meanings and for the purposes of what we’re talking about, it means the money you set aside for upcoming expenses you know about. 

What’s the difference between a sinking fund and savings?

You already save money every month so why do you need a specific sinking fund?

Because your savings are there to increase your wealth – whether you need that for retirement or to invest in a house. 

Sinking funds are set aside so that you have money readily available for known expenses coming up in a given year. 

They are there for a specific purpose that you need to spend money on. Also when you calculate what to put into your sinking fund you split the money into different pots, so you know exactly where that money will be going. 

Savings may be put in accounts that you can’t access readily or investment accounts that need to be left untouched so they can gain value. 

Sinking funds are also different to your emergency savings. 

Your emergency savings are there for unexpected issues, including for example where your car breaks down and needs repairing or a window gets smashed and you need to replace it. 

A sinking fund is something you will probably dip into regularly throughout the course of a year. We all hope we don’t have to touch our emergency savings! 

Benefits of a sinking fund 

There are a lot of benefits to having a sinking fund to cover your upcoming expenses: 

A balanced budget 

You can plan ahead for what your known expenses will be and get prepared right now. 

Being prepared means you are less likely to go overdrawn or have to place those expenses on a credit card that ultimately leads to debt if you can’t pay it off right away. 

Planning ahead means you can put the money you need to one side and spend with confidence when you want to treat yourself. 

Your emergency fund stays intact 

Your emergency fund needs to be your back-up in case of emergencies. It is your safety net. 

By putting money aside for those expenses you know are coming up, you keep your emergency fund for those things that you just couldn’t see coming. 

Peace of mind 

You can spend money on little treats for yourself knowing you won’t be left short in a month’s time when your car needs an MOT. 

You know the big expenses have been budgeted for, so that money is right there ready to be used when you need it. 

Clearly defined spending limits 

You will be aware of exactly how much money you have leftover at the end of each month and over the course of a year. 

What can you use sinking funds for?

Sinking funds can be used for anything! Every household will have slightly different things they have to spend money on each year and the amount you need for those things will also vary. 

For example you may have a large family meaning birthday expenses take up a large proportion of your sinking fund. 

If you have pets then this will need to be a part of your sinking fund so you can pay for annual treatments like vaccinations and check-ups. 

If you own your own home then you will need to set money aside for repairs you know are coming up, for example if you know the boiler needs replacing by the end of the year. However if you rent your landlord will be responsible for things like that. 

So as you can see, what you will need sinking funds for will vary massively. However this list should give you an idea of what you can use sinking funds for. 

Whatever you use it for, your sinking fund is where you set aside money each month towards a big financial expense. 

Sinking fund categories 

Here are a few categories that you may need sinking funds for: 

  • Birthdays 
  • Holidays 
  • Christmas 
  • Car insurance 
  • Car service
  • Car MOT 
  • Home insurance 
  • Hair cuts
  • School uniform (including shoes)
  • Pets 
  • Furniture 
  • Household expenses – this includes expenses you know are unavoidable so for example if your boiler will need replacing or servings this year as opposed to last-minute emergency costs. 
  • Wedding 
  • Tax – if you are self-employed or earn money working freelance on the side of your full-time job you will need to self-assess and pay tax every year

Sinking fund example

Here’s an example of what your contribution to your sinking fund might look like. 

Let’s say you need to set aside £500 a month to cover the following costs: 

  • Holiday – £100
  • Christmas and birthdays – £150
  • Car costs – £50
  • School uniforms and shoes – £10
  • Household expenses and furniture – £150
  • Pet – £10
  • Days out and activities with kids – £25

This is just one example of how your sinking fund may be divided up. 

How much should I put in a sinking fund?

So your sinking fund can cover a whole lot of expenses throughout the year. 

How much you need to put into your sinking fund depends on your individual circumstances. 

For example the maintenance and repairs on your house that happen each year may cost a lot more if your home is very old compared to a new build property. 

A hamster will cost a lot less in vet bills than a larger animal like a dog who needs regular vaccinations and treatments. 

To work out how big your sinking fund should be, go through this process: 

  • Write down all of the expenses you foresee (include any household repairs you think are coming up, as this means you won’t have to dip into the emergency fund)
  • Calculate how much each will cost
  • Work out how many months you have to save this money 
  • Divide the total amount by the number of months you have to save the cash 
  • This is how much you need to put away each month 

Where should I keep my sinking funds?

You can start a new savings account and have that established as your sinking fund or simply place the money in an existing savings account. 

Keep track of how much is specifically for your sinking fund by keeping a record either on paper or on your computer.

You may find it easier to ring-fence your sinking fund if you have a separate bank account specifically for this purpose.  

What if I cannot afford to save enough in my sinking fund?

Balancing a budget can be a big challenge. 

This is especially true if you are freelance and the amount you earn each month fluctuates or you’re currently on maternity leave and your pay is significantly down on what it would normally be. 

So figure out what the difference is between what you need to save and what you can afford to save into your sinking fund each month. 

Then look at your overall budget and see where you can make some savings. 

When we take a step back and look at our finances there are often obvious areas where we can make savings. 

For example are there any subscriptions you can ditch? If you have both Netflix and Prime can you live with just one of those?

Can you switch supermarkets and start being strict on meal planning to bring your weekly grocery budget down? Shopping smart for food can save you a lot of money each month. 

There are lots of tips for frugal living over on this post. 

Related posts: Tips to save money on groceries

Guide to sinking funds