Sinking Funds: How to Pay Yearly Bills Without the Panic

The car insurance renewal arrives, and it's the same bill you paid last year. You knew it was coming, and it still feels like a surprise. Does that happen to you too?

A sinking fund is how I'd take the sting out of that moment. It's money you put aside a little at a time, every month, for one bill you know is coming. I'll show you what a sinking fund is, work through one small sum with you, and help you start your first one this week.

What is a sinking fund?

A sinking fund is savings you keep for one bill only. You choose a bill you can see coming, like car insurance, a birthday or the holidays, and you put a small amount aside for it every month. When the bill arrives, the money is already sitting there.

It's a funny name, isn't it? It comes from business, where a company puts money aside bit by bit to pay back a big loan by the day it's due. At home it works the same way, just with smaller bills (and nobody has to call a board meeting about it!).

People often mix it up with an emergency fund, so here's how I tell the two apart.

I'd keep the two apart, so paying the car insurance never empties the money you were keeping for a breakdown. If you'd like an emergency fund as well, I wrote about how to build an emergency fund in small steps.

Why a bill you know about still feels like a surprise

We plan one pay at a time. Rent, groceries, gas and the phone bill come out of each pay, and we live on whatever is left until the next one. A bill that comes once a year doesn't fit into that picture, because it only turns up in one month out of twelve.

So when it arrives, the whole bill has to come out of one pay. Often that means the credit card, and then you're still paying it off next month.

A sinking fund is that little bit, set aside from every pay. It might be for car insurance, the dentist, back-to-school costs or the holidays. Which bill is it for you?

How much to put aside each month

Here's the sum, with one bill. Say your car insurance is $600, and it's due once a year. There are twelve months in a year, so you split the $600 into twelve equal amounts.

Put $50 aside each month, and after twelve months you have the full $600, ready before the renewal arrives.

What if the bill is only six months away? Then you split it into six instead, and $600 split into six is $100 a month. It's more each month for now, and you'll still have the full amount by the due date. Next year you can go back to $50, because you'll have all twelve months.

The best part is the day the renewal turns up. The money is already there, so you pay it and there's no drop in your stomach this time. I love that part!

How to start your first sinking fund

I'd start with one bill, the one that caught you out most recently. Here's how I'd set it up in one sitting.

1. Pick one billChoose the yearly bill that stings the most, like car insurance, the dentist or holiday gifts. Write down its name and the month it's due.
2. Find last year's amountSearch your bank statements for that bill's name and write down what you paid. Divide that amount by the number of months until it's due.
3. Give it its own accountOpen a savings account, or rename one you already have, and name it after the bill. Then set a transfer for your monthly amount on the day after payday.

I like to name the account after the bill (a boring name like "Car insurance" is ideal). When you see that balance, you know exactly what it's for, so it's much harder to spend it by accident on a busy weekend.

Where does the $50 come from, if your pay already feels spoken for? A simple budget you'll actually use shows you what's left each pay. And if one month is too tight, skip that transfer and start again next payday. The money you've already put aside stays where it is, and you'll need a little more in the months that are left.

Once a month, I'd check the balance to see how much has built up. A monthly money date is a good time to check it. When the first fund feels normal, you can start a second one, for birthdays or the holidays.

Beth x

This is general education, not legal, tax or financial advice.