How To Use Sinking Funds To Finally Beat The Debt Cycle And Live Debt Free
Do you feel trapped in a recurring cycle of debt? It is hard to get out of debt when life keeps getting in the way. As soon as you finally pay off a credit card, a $600 bill to renew your car insurance shows up and you are back to square one. Or your emergency fund finally has a $1,000 balance when your mechanic calls to say that it is time for new tires.
They key is to start planning ahead for the irregular bills. Most of our financial surprises are not actually all that surprising. We know that they are coming, and if we can just take a few minutes to set up a system to prepare for them, we can finally move on to making progress with paying off debt and creating financial freedom.
Open a Sinking Funds Account
The first thing you need to do is open a savings account, separate from your emergency fund and your big goals fund. Establish an automatic transfer to this account. Start small if your budget is tight. Setting aside something is better than nothing, and you can always increase this amount as you adjust your spending plan.
Determine What Your Sinking Fund Needs To Cover
Make a list of all of the things that you know you will have to pay for in the next year or two. These are the bills that tend to catch you off guard. The ones that don’t come every month, so it is easy to forget all about them. They seem to just pop out of nowhere, completely throwing off your budget.
Examples of Sinking Funds
Home Insurance
If your mortgage payment does not already include your homeowners insurance, you’ll probably need to pay this bill every six or twelve months.
Property Taxes
Ditto with property taxes. If it’s included in your mortgage payment, don’t worry abut it. If it’s not, you want the money there when its due. Penalties for late property tax payments are wild.
Vehicle Insurance and Vehicle Tabs
The older your vehicle is, likely the cheaper this expense is for you – just something to think about. Take a look at your last invoices for these to see what your annual expense is and about when you are required to pay.
Vehicle Maintenance/Repairs/Replacement
This one is may seem like more of an “emergency fund” type category, but I guaranty you that your vehicle won’t last forever, at least not with some serious repairs and maintenance expenses. Vehicles need regular oil changes and tire replacements. The parts on your vehicle will wear out and require repair. Eventually, the odds are that you will want to replace your vehicle as a whole and start over with something newer. Think about how much you have spent in the past on vehicle repairs and if you can foresee anything major coming up in the near future. This will depend largely on the age and make of your vehicle. Also, think about how long you plan to drive your current vehicle and how much you plan to spend when it is time to upgrade. If you think you can get ten more years our of your current vehicle, and you will spend $20,000-$40,000 on a new vehicle at that time, you should be setting aside $100-$400 each month for that new vehicle, starting now. If that number feels overwhelming, just remember that it is perfectly ok to start small. You can always increase this number as you pay off debt and adjust your spending plan.
Life Insurance
I am not big on spending a lot on investing in life insurance, but I think if you have debt or a family, it’s a good idea to have enough coverage to make sure everything is easily taken care of if something should happen to you or your family members. If you are young and healthy, a basic term policy is pretty inexpensive. If this bill fits into your monthly spending plan, that is just fine. If not, be sure to include it in your monthly sinking fund transfer.
Christmas
First off, stop going into debt for Christmas! You can celebrate beautifully without spending a lot of money. But if you are like us, Christmas is very special and its one of the few times of the year that you go all out. Think about the Christmas celebration that fits your budget and come up with a realistic spending plan for this Christmas. Do not forget to include gifts (including random gifts, like your Secret Santa at work), a Christmas tree if you buy a live one, other decorations, extra groceries, travel expenses, special occasion clothes, donations, your Hallmark Now subscription, etc. Be honest with yourself about how much you will be spending this holiday season and think about that number from a monthly perspective – if you spend $2,400 each year at Christmas that’s $200 each month. Can you afford that? If not, think of ways that you can cut back a bit or earn some extra money to fund your Christmas fund this year.
Gifts (Birthdays, Weddings, etc.)
This one really depends on your personal situation. You may not need to put a lot of money here, or none at all if your spending plan includes enough wiggle room to cover these when they pop up. However, if you know that you are going to be in five weddings this summer, and you have twelve nieces and nephews that you’re going to need birthday presents for, those expenses will really add up, and you will thank yourself for setting aside some money to enjoy those events, rather than needing to worry about taking an extra sandwich home from the party because you won’t be able to afford lunch the next day.
Gym Membership
Thankfully, I don’t have to worry about this one anymore, as we workout at home and our annual streaming subscription is only $100, which fits into our monthly spending plan easily enough. If $100 in one month will throw you off, or if your gym membership is quite a bit higher, plan for it by tucking away some money each month. Side note, if you do not actually USE your gym membership, just CANCEL it. It is not doing you any good to pay for it if you do not actually go to the gym. Save your money and find a way to exercise that fits ino your life!
Clothing/Back-To-School Shopping
Maxing out the credit cards each August has been an issue for people for way too long. If you tend to buy a lot of clothes at once, rather than pieces here and there throughout the year, make it part of your regular budget! A shopping trip should not put you deeper into dept.
Home/Appliance Maintenance/Repairs
This is another one that’s hard to predict and it feels like an emergency when it comes up. You never know when your fridge will go kaput or when your water heater will spring a leak and turn your basement into a hot tub. We wish our things would last forever, but that just is not reality. Even though these things tend to last a long time, they will eventually need to be replaced. You can plan on it. And even if you are not planning a big home remodel, flooring gets worn out, showers start to leak, and shingles take a beating. Start a fund for replacing these things and keeping your home as functional and beautiful as it is now.
Medical Bills/Dental Visits/Vision
Even the healthiest of people have regular medical bills. You will run out of contacts and your glasses will get scratched. Build up enough money that you can at least cover your insurance deductible at the start of each year. If you experience a major medical emergency, how you are going to pay the bills is the last thing you want to worry about.
Annual Vacation
Do you feel broke every June when your family spends a week at the lake or goes on the annual site-seeing road trip? Turn this into a monthly budgeted expense rather than cringing every time you see the post-trip credit card bill.
Family Photos
If you want updated family photos annually, add it to the monthly budget instead of feeling guilty when you get them done each year. It is way more fun to cut that check knowing the money is there.
Propane
Most of your utility bills are probably regular monthly expenses, but you may have some that come less regularly. We have a propane tank that gets filled a few times throughout the year by the gas company. I do not really know when they are coming or exactly how much fuel they will add to the tank. I have been able to figure out about what we spend each year in total on propane and use that to determine how much money to set aside for it. It is certainly nice to have the money available when I get home and see their receipt stuck in the door.
Meat
This one I definitely realize won’t apply to everyone. If you buy meat from the grocery store on an as-needed basis, you do not need to worry about having a meat sinking fund. But if you are like us and raise chickens each spring and buy beef and pork in bulk straight from the farmers, you need to have a fund established so that the money is there to pay the butcher bill when the time comes each year.
Figure Out How Much Your Monthly Automatic Transfer Should Be
With your sinking fund list in front of you, determine how much you need to save in each category each year. Divide that number by 12 for the monthly amount to save. Add up all of the monthly amounts to determine the total needed to transfer to this account each month. Put this into your spending plan as a monthly expense. You may need to make some changes to be able to afford this monthly transfer, or you may need to start a little smaller. Something is always better than nothing – start with an affordable amount and work your way up from there. Do not let the thought that you “can’t afford this” creep up into your head. You are already affording these expenses, they are just popping up as emergencies instead of being part of your regular spending plan.
This account is commonly known as a sinking fund. I have always called it my escrow account, because I started it as a way to make sure I had money to pay for home insurance and property taxes after buying our first house. Whatever you call it, it is a lifesaver. Establishing this fund is a big step towards ditching the debt cycle and creating financial freedom.
I would love to hear your thoughts – please share in the comments below! Have you set up your sinking fund account? Are there any sinking fund categories that you would add to this list?
Also, I have a spreadsheet that I use to track how much money I have in each category within my sinking fund – would you find it helpful if I would share that worksheet with you?
