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Sinking Funds: Plan for Bills That Come Once a Year

4 min read

Summary: Some costs do not arrive every month. A sinking fund is a simple way to spread them out, so a yearly bill does not feel like a shock.

What is a sinking fund?

A sinking fund is money you set aside in small amounts for a cost you know is coming. It is different from an emergency fund, which is for surprises. A sinking fund is for things you can predict, even if you do not know the exact price. (Our guide on starting an emergency fund covers the other kind.)

The term is common in personal finance writing, but it is not an official one. The idea behind it is simple, and it matches advice from the US Consumer Financial Protection Bureau (CFPB): decide how much to set aside for special occasions, so you can enjoy life without overspending.

Why it helps

A monthly budget can look fine until a large bill lands in one month. If you save a little each month for a known cost, the bill is already covered when it arrives.

Steps

1. List the irregular costs. Think about the past year. Look at your bank or card history for things that were not monthly. Common ones are insurance, a car test or service, a yearly subscription, gifts, holidays, school costs and travel.
2. Write down an amount and a date for each. Use last year's figure if you have it. If you are unsure, use a cautious guess and update it later.
3. Divide each amount by the number of months left. This is the monthly amount for that cost.
4. Add the amounts up. This is your monthly sinking fund total.
5. Check it fits your budget. If it is too much, push back a goal, or drop a want. Our guide on needs and wants can help.
6. Put the money aside each pay day. Keep it separate from everyday money if you can. Some people use one account and a simple list of how much belongs to each cost.
7. Spend it when the bill arrives. Then start again for next year.

Watch your direct debits

Many yearly and monthly bills are paid by direct debit. Your Europe, the EU's official guide for citizens, says that if a direct debit is wrong or taken by mistake, you have the right to a refund within 8 weeks. This applies to domestic and cross-border direct debits in the EU. So when the bill arrives, compare the amount taken with what you expected. Outside the EU, the rules can differ, so check with your bank.

Keep it up to date

The CFPB suggests comparing your actual spending with your budget, monthly or more often, and making changes if it is regularly out of line. The same goes for your sinking funds. If a cost rises, raise the monthly amount. If you cancel something, free the money.

An example

This is an example with made-up amounts.

Lena looks back over a year and finds three costs that are not monthly: an insurance bill of 240, a car service of 180, and gifts of 120. Together they are 540. It is now the start of the year, so there are 12 months to go. 540 divided by 12 is 45. Lena sets aside 45 a month.

In month five the car service comes in at 200, not 180. Lena has saved 225 so far, which covers it, and the extra 20 comes out of the pot. Lena checks the amounts, then raises the monthly figure by a small amount to cover next year.

Limits

A sinking fund does not remove risk. Prices change, and life brings surprises. If you can only save a little, a little is still useful. If a bill is hard to pay, a consumer advice body in your country may be able to help.