The Beginner’s Guide to Sinking Fund Categories & Emergency Funds
As you’ve started diving into sorting out your finances, you’ve probably heard that you need a starter emergency fund of $1,000. You may have also heard some talk about building different sinking fund categories as well.
But what exactly is the difference between an emergency fund and a sinking fund? And why do you need more than one account?
Lastly, if you’re drowning in debt, isn’t everything an emergency at this point?
It’s important to not only understand the different between emergency and sinking funds, but why you need each, even this early in the debt repayment game. Especially this early in the game. Without understanding these funds and how to set them up, everything will always be an emergency. And personally, that is not how I want to live – it’s just way too stressful!
By learning about the differences between these types of accounts, where and how to set each up, you’ll be able to face any upcoming expenses – whether planned for or not – without batting an eye. Sounds amazing, right?
What an Emergency Fund Is (And Isn’t)
An emergency fund is for true emergencies. These are expenses that are unexpected and unplanned. Think of things like a job layoff, an accident, big health issues – basically anything that keeps you up at night.
Sadly, it’s not funds for when you’re too tired to cook, there’s a big sale on shoes, or when you’re forgotten that you need a haircut before a wedding.
For example, our roof was recently damaged during a storm. Since this was an unexpected expense, we took the $1,000 deductible out of our emergency fund at Capital One to pay it off, rather than putting it on our recently paid off credit card. Then we’ll use the next 2 to 3 months to build that emergency fund back up.
Emergency Fund Categories
- Emergency health bills
- Unexpected car issues
- Items that are both unexcepted and unknown
The general rule of emergency funds is that $1,000 is a good starting point while you’re still paying debt. Once all debt has been paid off, then the suggested amount is 3 to 6 months of expenses (or even more!). Note that I said expenses, not income. It’s about covering your bills if you lose your job or get hurt, not matching your missing income. There’s a big distinction between the two!
Emergency fund money is earmarked for after something happens. It’s those things in life that you can only plan so much for and generally show up at the worst times.
If you’re wondering if an expense qualifies, here are some questions to ask yourself:
- Is it an unexpected expense or was it known about it prior (like a yearly bill)?
- Is it a want or a need? If it’s a want, it’s not truly an emergency, no matter how good that sale is!
- Is it urgent, or can it be saved for?
A great example that’s come up in our house recently is the dishwasher. It’s original to the house, and is on its last leg. Sometimes it works ok, sometimes not. We can live without a dishwasher (in theory!). Replacing the dishwasher is a known expense at this point. It’s a want, not a need, and it’s not urgent. Based off these questions, replacing the dishwasher is definitely not an emergency.
What is a Sinking Fund Used For?
A sinking fund is money that you’ve saved up before something happens, so you’re thinking ahead and planning for expenses you know are going to pop up. Some examples are bills that aren’t paid monthly, car maintenance, and vacation sinking funds.
The sinking fund method is recommended by financial guru Dave Ramsey to avoid using credit cards or going further into debt. Since it’s something you know you need, you can plan ahead by saving in certain sinking fund categories, and save up to cover each expense.
Back to the dishwasher example from before – if it dies, we’ve agreed to save up to buy a new one rather than put the cost on a credit card. That is a sinking fund. Even better, we could start saving for it now before it dies. This way we’re thinking ahead about our money, rather than starting saving after it dies, which could take several months.
Essential Sinking Fund Categories
- Bills that are not monthly, like water, sewer, garbage, etc.
- Expected car costs, like tires, oil changes, tags, etc.
- Home maintenance
- New appliances/furniture
- Quarterly self employment taxes
- Property taxes
- Insurance (if not paid monthly)
- New (to you) cars
- School clothes/fees/supplies
- Copays for healthcare
Wondering How Much to Put in a Sinking Fund?
Sinking fund amounts will vary based on several factors, including how much time you have and how much money you need in total for each purchase. I use this sinking fund formula to figure out each individual monthly savings amount:
- Write down all expected expenses for the rest of the year that aren’t part of your normal budget
- Do your best to estimate how much each will cost (reference an average of last year’s cost if possible)
- Add up the total, then divide by how many paychecks you have left for the year
- Open a separate checking/savings account and keep the money there
One thing to note is that you won’t have all the sinking funds you need immediately. The best way to handle this is to prioritize the expenses you plan to cover with the sinking fund. Arrange them by due date as well as by urgency. This way, the most important sinking fund categories will be covered first, and you’ll have time to save up for the rest.
Once you’ve prioritized your sinking fund categories, add the sinking fund budget line items to your monthly budget. This way you’ll be sure to pay them first and you’ll stay on track with your savings. If you make your sinking fund contribution first, right after getting paid, you’ll find that you are much less likely for that money to go missing by the end of the month.
For example, we are going on vacation with our family and owe my parents $500 for our lodging. Since it’s not until next summer, we’re able to divide those payments up into 12. I’ve created a separate savings account just for this sinking fund category and we’ll be able to save up for it easily in $50 monthly increments. That means it won’t sneak up on us and “surprise” us next summer – and no scrambling to scrap up our part of the bill!
How to Organize Sinking Fund Categories
One of the best accounts for organizing sinking funds is Capital One. You can open a sinking fund bank account there, and then you’ll be able to create up to 25 sub-accounts (or sinking fund categories) with no additional paperwork. This is extremely handy when you want to earmark money for certain funds. It also links to your regular bank, so it’ll take a couple of days to move back and forth, but it’s a great way to keep that money for its original purpose.
This way you have can separate accounts for Christmas, car maintenance, vacations – whatever your heart desires, up to 25 of them!
A big mistake that I’ve made in the past is to keep my sinking funds money in my savings account (which also housed my emergency fund and quarterly tax payments, yikes!). As you can guess, I’d dip into it without realizing I was, and next thing I knew…we’d be short and struggling to replace that money come tax time.
I finally realized that the best thing we could do is that every time we get paid, I put those different chunks of money into those separate accounts and keep each fund and category separate.
That way, we don’t spend what we don’t have, and every quarter, I can easily just transfer the tax money back to my checking account and write a check to pay it. I don’t even have to think or worry about it – easy peasy!
A Quick Review of Emergency & Sinking Fund Examples
|Emergency Funds||Sinking Funds|
|Used reactively for the unexpected||Used proactively for bills you know you’ll need to pay|
|Used AFTER something unexpected happens||Saved BEFORE something expected happens|
|Examples: Job layoff, accident, big health issues, emergency car repairs||Examples: Christmas gifts, vacations, home maintenance, big purchases, remodeling, extra curricular activities, anniversary or birthday presents and parties|
|Recommended amount is $1000 until debt is paid off; then 3-6 months of expenses||Recommended amount is variable, based on known upcoming expenses|
What Types of Sinking Fund Categories Do You Need?
This will vary based on each family, but we have sinking fund categories for: Christmas, vacation, anniversary, house updates, and taxes (I know – all the important stuff, right?). This way we can take a vacation without feeling guilty. And we can plan ahead of the kids’ extracircular activities without worrying how we’ll cover it, since they are insanely expensive.
Not everyone will have the same categories for sinking funds, or even emergencies, which is fine. What’s important is that you’ve sat down and mapped out possible expenses, and have decided to face them head on.
When Should I Start Creating Sinking Funds?
This really depends on what your debts are and how quickly (or desperately) you need money set aside for a sinking fund. We chose to wait until we were debt free to start our various sinking funds.
There are some instances where you know you’ll need the sinking funds before you can become debt free, like paying property taxes or your water bill.
There are some things that are just going to happen either way – like Christmas. Why not start a sinking fund category for presents, so that in January you’re not afraid to open your credit card statement?
Having a set amount to use for presents will also curb your spending and help you keep within a budget. I’ve found that it can help me to really focus on finding creative and meaningful gifts since I’m spending less.
I also start earlier in the year to look for presents, so that I’m not last minute buying whatever ugly Christmas sweater that’s on sale (though, that is a thing now, isn’t it?). By creating a sinking fund at the beginning of the year, I have some money set aside every month that I can use to buy presents as I find them without using our credit card.
Burying your head in the sand and hoping extra expenses will go away if you ignore them isn’t making your money work for you. It’s making you chase your money, and work harder than you need to in order to get ahead. Creating emergency and sinking funds will only lead to making your finances a success, and will reduce your stress if (and when) something happens!
Ready to start budgeting or want to hear more about ours? Click here to learn how we’ve paid off $26,619 in debt in 17 months!
You can also learn more about how to use sinking funds to get ahead of your finances here.
Do you have sinking funds and an emergency fund set up? What categories do you include in your sinking funds? Comment below and let me know how you’ve made these types of funds work for you and your money!
A forty-ish web designer/developer by day, a budget & financial fanatic by night. I’m a mom, wife, avid reader, and DIY enthusiast who’s tracking our journey to debt freedom. Read More