Significant expenses can’t always easily fit into a standard monthly budget. For instance, shopping for Christmas presents is probably the last thing you’re thinking about in July. In reality, you may not even think about it until December, and then you’ll have to find the funds to purchase several gifts in one go.
Sinking funds are an innovative idea that can change how you plan your budget throughout the year. Read on for a comprehensive guide, which includes an overview of the sinking fund categories that adults will need.
What is a sinking account?
A sinking fund is an account that has been built up over time to pay for the cost of a significant future cost. It helps reduce the effect of the price by spreading it over a longer time.
While I’ll be talking about sinking funds from a personal financial perspective, it’s worth mentioning that large companies (i.e., corporations and governments) also use them. For instance, when businesses typically take out bonds to borrow funds, they’ll create sinking funds to make paying back the debt less complicated as it approaches due.
The same principle applies to sinking funds in your finances. Instead of coming up with thousands or hundreds of dollars to buy Christmas presents all at once, for example, you can put aside smaller amounts each month between January and November.
A sinking account is setting up a prepayment arrangement with yourself instead of placing the costs on credit at the last minute and needing to pay monthly (with interest).
What makes sinking funds different from an emergency plan?
“But do you think,” you might be thinking? “I already have an emergency account! I don’t require a sinking fund if I do you think? ?”
The fact that you can create an investment fund to drop them implies that they can be foreseeable, and you must plan accordingly. However, in reality, you should set your emergency funds aside for the most unpredictable and extreme circumstances. Sinking fund categories are generally out of this category.
15 Sinking Fund categories you’ll probably require to include in your financial plan
To show the benefits of sinking funds to demonstrate the value of a sinking funds, let’s examine some of the most common categories that individuals use to organize their finances. After listing the classes, I’ll guide you through the steps and the best practices to follow when making your sinking fund.
1. Christmas gifts
I’ve used this scenario numerous times because it’s an ideal sinking fund type. According to a MagnifyMoney survey, about 1/3 of Americans were in debt in the festive season. In the case of Americans who took on debt, the median balance was $1,381, and 89% said they would not be in a position to pay the balance off in a month. In addition, 18 percent of Americans who had credit card holiday debt stated they were planning to pay only minimum amounts and incurred significant interest costs.
It’s possible to avoid this by setting aside a sinking fund. If we multiply $1,381 by 11 (the number of months that don’t fall in December), We get $125. This is how much you’ll need to reserve each month for a sinking fund to pay for a similar bill without taking on debt.
2. Car-related expenses
The majority of car owners have the expense of maintenance at some point through the year. The cost can be low (making sure your tires are properly maintained, having an oil change) or expensive (solving a catastrophic issue), or high (fixing a devastating failure); a sinking fund can be used to pay for them without making a fuss.
The problem lies in the fact that (unlike the other categories of sinking funds) it is challenging to determine precisely the amount you should allocate to the maintenance of your car. However, through a bit of investigation, you’ll be able to arrive at a reasonable figure. I suggest looking through the database of Edmunds to begin. It provides information on the cost of ownership for almost every car manufacturer you can think of.
Once you’ve reached an estimate, start putting money into your sinking account until you’ve enough to cover the entire year.
Many go one step further and create an investment fund to pay for their next vehicle purchase. This will allow them to make a cash payment, or at a minimum, they’ll have a sizeable down amount to pay.
3. Homeownership-related expenses
Similar to vehicles, homeowners have maintenance expenses all through the year. Professionals (such as HomeZada founder Elizabeth Dodson quoted in this article in The Balance) estimate these annual expenses to be between 1 percent and 4 percent of a house’s worth, based on the age.
You can create the sinking fund with the amount you want to replenish when you withdraw funds.
It is also possible to budget for these things in your home’s cost sinking funds:
- Property taxes
- utilities (if you pay quarterly)
- snow-removing (if the person you hire to do this)
4. Medical Expenses
Even if you’re covered by medical insurance, visits to the doctor or the hospital are likely to incur some expense (i.e., as an expense deductible). It is expected to discover a helpful sinking fund when planning the costs.
Based on the country where you have your residence, there could be accounts designed explicitly for sinking funds related to health. For instance, in the United States, you can open a reserve known as a Health Savings Account and reap tax advantages while saving for qualified medical expenses.
5. Self-employed tax
If you are self-employed (i.e., freelancer), tax is usually not taken out at the point of origin. So, you’ll have to be able to make tax payments in one lump at the end of each quarter or throughout the year.
I’m very familiar with this, employed independently for many years. My tax bill each spring was well into the five-figure mark.
When tax season came around, I tapped the budget to cover the tax cost. It would have been difficult to raise this much money at once if I had spent or put 100% of each paycheck elsewhere. Instead, I calculated the amount of each salary that my employer would withhold and then transferred the money into an account that would be a sinking fund.
If you’re engaged in a relationship that is likely to be a marriage-related affair at a yet undetermined time, setting up the wedding sinking fund could be a brilliant idea.
Weddings, after all, aren’t cheap. As per The Knot, American weddings cost on average $19,000 in 2020, despite the outbreak. In 2019 the average price for a wedding was $28,000.
The average amount of time couples spends together before getting married ranges between two to five, following Brides.com. If you and your partner-to-be are on the less-expensive end of the spectrum, you’ll need to save $14,000 for an annual sinking fund to cover the costs of an average wedding pre-pandemic. If you delay until after five years, you’ll only need to set aside $5,600 each year.
Naturally, you can lower this figure by having a less expensive wedding. Read this article for alternative options for traditional weddings.
In the past, I made the error of traveling with not much of an investment fund that was to use for this goal. Notice: I had initially had enough money set aside, but I threw it in the market in February 2020 market crash.
Although everything went well, however, I did have to perform some financial stunts at the end of the year. Take a lesson from the mistakes I made! It would have been much simpler to have an investment fund at the beginning of the year and then budget my travel budget accordingly.
8 Dining out
Dining out is a separate expense most people do not incur frequently enough to warrant it being an integral portion of the budget. Instead of putting it with “recreation” or another general category, you should create an investment fund that you can draw from when they desire to dine outcomes up.
9. Appliances and furniture that have been recently purchased
Every couple of years, you’ll require replacing at least one major furniture piece or appliance. A sinking fund with a designated sinking account is an excellent location to do this. It is easy to set it and forget it!
10. Subscriptions that renew each year
It is common to receive significant reductions on your software subscriptions when purchasing the whole year at one time. While this is great, being caught out when your subscription is due to renew isn’t. Fortunately, you can prevent this by depositing enough cash into a sinking fund each month to cover the subscription renewal.
11. Childcare expenses
When you are a parent with kids, think about the creation of a sinking account for expenses such as:
- Cost of college (look at tax-advantaged savings accounts explicitly created to meet this need)
- School supplies
- Recreation activities (i.e., organized sports, camp, etc.)
- Clothes (remember that children can get rid of clothes every day)
This is one of the essential sinking fund areas if you have young children. It’s the legal (and ethical) obligation to look after the children. Don’t let a lack of plan be why they aren’t stocked with essentials.
12. Pet care expenses
As per The Spruce the Spruce, taking care of the dog can cost (on an average) between $1,500 to $9,900 per year. This includes unexpected costs such as:
- Visits to the veterinarian
- Preventative treatments
PetCoach pegs the average annual cost for caring for the cat at $809. Although that’s less than dogs, that’s not enough to justify the creation of an investment fund.
13. Major personal discretionary purchases
If you plan to purchase something significant to mark the occasion (i.e., buying a Rolex to mark the 50th anniversary of your birthday), you should create an investment fund to sink the purchase. This will allow you to avoid exaggerating yourself (which is a no-no in the case of buying things that aren’t essential) When the time comes.
14. Charitable giving
Do you give money away at different times throughout each year (i.e., during Christmas or in memory of a loved one who has passed away at their birth)? A sinking fund associated with it will allow you to have enough money to make generous donations at the time you want.
15. Diverse recreation activities
This is one of my favorite sinking fund categories. It allows me to take advantage of unexpected opportunities (i.e., eating food with an old buddy who came into town unintentionally) without soaring my budget for the month.
If you’re saving for something particular (i.e., an excursion), One of the others might be more suitable for you. This is the category for spontaneous enjoyment.
How to establish sinking funds: A step by step guide
Now that I’ve discussed some valuable sinking fund ideas let’s go over the steps to set up your fund series.
Step 1. Determine your sinking fund category
Begin by listing the categories you’d like to establish an investment fund that sinks. I’ve listed 15 categories that provide the most common situations, but you can choose different types if they fit your particular situation better.
Step 2. Create an account that is dedicated to each sinking fund category that you’ve selected
With the abundance of no-cost online banking options today, opening multiple accounts has become very feasible. This is why I suggest creating a separate checking or savings account or a cash market bank account for each sinking fund category that you have chosen in the first step.
I’d suggest choosing the checking account for those who will be taking out funds often, savings account if you think you could but aren’t sure, and the money market account in case you know that withdrawals won’t usually be.
Step 3. Determine (or estimate) the amount of money needed to be put into every sinking fund (and by the time)
Determine next how much you will need from your sinking funds to cover expenses that arise. If, for instance, you’ve put together a sinking account for your next trip, you’ll need to have enough funds to cover the whole journey.
Its number (and the date of target) will be helpful in your next stage.
Step 4. Divide each sinking fund balance by the number of months it will take to construct it.
Then, determine how much you’ll have to put aside every month to meet your goal balance in each sinking account when you select.
For instance, If it’s May and you’re planning to make $1,381 before the beginning of November (seven months from today), you’ll need to save about $200 each month.
Step 5. Establish automatic transfers to your sinking money
Also, think about making the monthly (or biweekly) automatic transfers for your sinking fund. This is much simpler than remembering which accounts and the amounts you need to transfer every day. Read this article for some ideas on how to automate your financial affairs.
Sinking funds can be beneficial. They can make your budget more dependable and allow you to plan for unexpected costs with more ease. Once you’ve implemented these strategies, you’ll never need to think about how to get cash every time an expense that is predictable and major pops up.