Some expenses are easy to budget for because they arrive every month. Rent, utilities, groceries and other regular payments can be added to a monthly budget and accounted for relatively easily.
The challenge comes with expenses that happen less frequently. Car insurance might be paid once a year, while MOTs, birthdays, Christmas, holidays, home repairs and other costs can arrive at different points throughout the year.
A sinking fund is one way to prepare for these expenses gradually rather than trying to find the full amount when the bill arrives.
What Is a Sinking Fund?
A sinking fund is money that you set aside regularly for a known future expense.
The idea is simple. Instead of waiting until a large payment is due, you save towards it over several months. For example, if you know your annual car insurance is likely to cost £600, you could aim to put away £50 a month.
The money is not necessarily for an emergency. It is for something you expect to need in the future.
Sinking funds can therefore be useful for expenses such as:
- Car insurance and servicing
- MOTs and vehicle repairs
- Holidays
- Christmas and birthday presents
- Home maintenance
- School uniforms and other education costs
- Annual subscriptions
- Dental or optical expenses
- Vet bills
For people who are trying to make their budget more predictable, Cashfloat provides information about managing short-term financial needs and borrowing. However, for costs that can be anticipated, building savings in advance can help reduce the need to rely on credit when the payment eventually arrives.
How Does a Sinking Fund Work?
The first step is to identify the expenses you expect to have over the next 12 months.
Look through your previous bank statements and note any high costs that do not appear every month. Then add expenses you already know are coming, such as a planned holiday or an insurance renewal.
Once you have an estimated cost and a date, work out how much you need to save each month.
For example, imagine you have the following expenses coming up:
Expense Estimated costTime available Monthly savingCar insurance£60010 months£60Christmas£50010 months£50Holiday£1,00010 months£100MOT and servicing£30010 months£30
You would need to set aside £240 each month to reach all four targets.
The exact amount will depend on your circumstances, and estimates should be reviewed as prices change. The important thing is to turn large, occasional expenses into smaller regular contributions.
Sinking Funds vs Emergency Funds
A sinking fund and an emergency fund serve different purposes.
A sinking fund is for something you know is likely to happen. An emergency fund is intended for an unexpected financial problem.
For example, your annual car insurance is not an emergency if you know when the renewal is due. A sudden boiler breakdown or an unexpected loss of income would be more appropriate reasons to use an emergency fund.
Keeping the two separate can make your finances easier to manage. It also means you are less likely to use money intended for genuine emergencies to cover expenses that could have been planned for.
If you are starting from scratch with your savings, you do not necessarily need to create lots of separate pots immediately. Start with the expenses that are most important or most expensive and build from there.
How Much Should You Put Into a Sinking Fund?
There is no universal amount because it depends on your income, existing commitments and upcoming expenses.
A useful starting point is to work backwards from the amount you need.
If you expect to spend £900 on a holiday in nine months, you would need to save £100 a month to reach the target. If you only have six months, the monthly amount would increase to £150.
You can also build a small margin into your calculations. Prices can change, and some expenses may end up costing more than they did the previous year.
If the amount you need to save seems unrealistic, do not simply ignore the expense. Consider whether you can reduce the expected cost, extend the timeframe, or prioritise the most important expenses first.
What If You Need to Pay Before You Have Saved Enough?
One of the difficulties with sinking funds is that they work best when you have plenty of time to build them.
If your car insurance is due next month and you have not saved towards it, you may not have enough time to reach the full amount. Similarly, an urgent repair could arise before you have built up enough savings to cover it.
The first step should be to consider whether the expense can be delayed, reduced or covered partly through existing savings without leaving you financially vulnerable.
If borrowing becomes a consideration, it is important to understand the total cost and whether the repayments will fit comfortably alongside your existing commitments. Short-term loans can provide one form of short-term borrowing, but they come with costs and should only be considered where the repayments are affordable.
Cashfloat states that its short-term loans are subject to affordability and creditworthiness assessments, with the purpose of checking whether repayments are realistic for the borrower’s circumstances.
Where Should You Keep a Sinking Fund?
The best place will depend on how you manage your money.
Some people prefer a separate savings account, while others use savings pots provided by their banking app. Keeping the money separate from everyday spending can make it easier to see what is available for future expenses without accidentally spending it.
You could have one general pot for occasional expenses, or a small number of pots for larger priorities such as motoring, Christmas and holidays.
However, there is no need to create a separate fund for every possible expense. Too many categories can make your budget unnecessarily complicated.
The goal is to make your finances easier to manage, not to create another administrative task.
Could a Sinking Fund Make Your Budget Easier?
For many people, the main benefit is that a sinking fund makes occasional expenses feel less disruptive.
A £600 insurance bill can feel like a major expense if it has to come entirely from one month’s income. It becomes much easier to anticipate if you have been putting £50 aside every month.
The same principle applies to Christmas, holidays, car maintenance and other predictable costs. Instead of asking whether you can afford the expense when it arrives, you have already accounted for it.
A sinking fund can also give you a clearer idea of how much money is genuinely available to spend each month. Money that has been set aside for a future expense should not be treated as spare cash.
Review Your Sinking Funds Regularly
Your first estimate will not necessarily remain accurate throughout the year.
Review your sinking funds every few months and compare what you have saved with what you are likely to need. If your insurance renewal increases, adjust your target. If you spend less than expected on one category, you could leave the extra money in the fund for the following year or redirect it towards another financial goal.
It can also be useful to review your bank statements annually. This can reveal occasional expenses that you had forgotten about and help you create more accurate targets for the year ahead.
Make Irregular Expenses More Predictable
A sinking fund does not make an expense disappear, but it can change how you experience it financially.
By identifying costs in advance and spreading them across the year, you can reduce the number of occasions where a large payment arrives unexpectedly and disrupts your monthly budget.
The key is to start with the expenses you can predict, work out realistic savings targets and review them regularly. Combined with an emergency fund for genuinely unexpected costs, sinking funds can make a monthly budget more reflective of the real cost of managing your finances throughout the year.