What Is A Sinking Fund ― And Why Should You Have One?

Casey Bond
·5 min read

You have an emergency fund for life’s unexpected events, plus a retirement fund for your golden years. But how do you save for a big expense you know is coming (but maybe you’re not sure exactly when)?

That’s where a sinking fund comes in ― and you should definitely have one. Whether you want to save up for a big vacation, a new car or simply get better at anticipating major bills throughout the year, here’s how to do it with a sinking fund.

What is a sinking fund?

“Traditionally, the term ‘sinking fund’ refers to a fund created by a company or organization to set aside money to pay down a debt over time,” explained Cameron Huddleston, a personal finance journalist and author. Today, however, she said it’s more commonly used to describe money set aside each month for a big, planned expense. That could be an annual insurance premium payment, holiday gifts or even a vacation.

A sinking fund should be part of your overall budget ― a line item (or several) devoted to savings you squirrel away for irregular future expenses. In fact, it’s a crucial component to the paycheck budgeting method, popularized by Kumiko Love (her pen name), an accredited financial counselor, blogger and founder of The Budget Mom. “Have you ever saved up money to buy something you wanted? Then you’ve created a sinking fund,” Love said.

You might be wondering how a sinking fund is different from your emergency savings. The key difference is that a sinking fund is designed to save for a specific expense. “You know what you are saving for, how much you’ll put in it and when you will need to use it,” Love said.

An emergency fund, on the other hand, is at least three to six months’ worth of expenses set aside for the unexpected, such as a medical emergency or job loss. “Both of these savings strategies will make you feel more at ease when it comes time to needing the money, but they are created for very different reasons,” Love said.

How much should you save in your sinking fund?

Because sinking funds are for planned expenses, it’s relatively easy to figure out how much you should be setting aside each month, Huddleston noted. For example, if your annual homeowners’ insurance premium is $1,000, you would need to set aside $83.33 in a sinking fund each month to have enough saved when your payment is due.

But how do you plan for multiple irregular expenses, including one-off events and holidays? Love recommends going through your calendar month by month and writing down every major holiday you’d like to save for. You should also jot down any important birthdays you spend money on every year. Next, write down any known occasions that will be happening. For example, she said, do you have friends getting married this year, or are you throwing a baby shower? Do you want to go on a family vacation? Do you have a family member that is graduating in the new year? “Make sure to write every event down on your calendar,” Love said.

Once you’ve calendared out all your upcoming expenses, write down a specific savings goal for each one. “If you’re not sure about how much money you will spend on a particular occasion, you need to analyze your spending from last year,” Love said. For example, if you’re unsure about how much to save for Christmas expenses, “take a look at your bank statements or expense tracker from the previous year and use that amount as your savings goal.”

Where should you keep your sinking fund money?

As far as where to put the money, you have a few options. At the very least, you should save it in an interest-bearing account so that your savings grow a bit while they sit in the bank.

Many banks and credit unions today offer savings accounts with the option to create sub-savings or earmark certain funds for a specific purpose.

For example, as a self-employed writer, Huddleston has a sinking fund for quarterly estimated tax payments. “My bank – PNC – has a 3-in-1 account feature that allows me to put my money into a spend, reserve or growth account,” she said. “Whenever I get paid, I put a percentage of my check into the reserve account for taxes.” Then, when it comes time to make estimated tax payments in April, June, September and January, she doesn’t have to scramble to come up with the cash thanks to her sinking fund.

Other savings accounts with similar features include ones from Ally, which lets you set up buckets for different savings goals; Sallie Mae, which offers an online “piggy bank” for short- and long-term goals; and Alliant Credit Union, which allows you to open multiple supplemental savings accounts.

Another option is to save your money in a money market deposit account. These accounts (not to be confused with money market funds) tend to offer higher interest rates on bigger balances, plus offer debit card and check writing capabilities. They’re like a checking/savings hybrid, which you might find more convenient than a traditional savings account.

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This article originally appeared on HuffPost.