Sinking funds explained: how to save for known upcoming costs

A sinking fund is a pot of money that you pay into regularly for an expense you know is coming. 

The goal could be for a one-off large payment, like paying for a holiday, or a bill that comes up every year, like an MOT or an annual insurance bill. 

Sinking funds allow you to spread out these costs so you have a better idea of how much money you have to spend. If you have a sinking fund, you’re less likely to need to use your credit card or Buy Now Pay Later for these planned expenses. 

Use our Budget planner to see how much you’re able to save.

The biggest difference between an emergency fund and a sinking fund is what you plan to spend the money on. If it’s something you know you’re going to need to pay for, then that should have a sinking fund. An emergency fund is for things that are unexpected. 

For example, your mum’s birthday comes around every year – that is not an emergency, so you would not use your emergency fund to pay for a gift. However, if your car breaks down or you lose your job, having an emergency fund can help you cover the costs. 

If you’re starting from scratch with your savings, it’s better to build your emergency fund first. Having one month’s worth of expenses in a savings account is a great place to begin. 

Find out more about how much to save in your emergency fund.

Sinking funds work best for something expensive that you pay for less than a few times a year. 

It does not make sense to have a sinking fund for your monthly rent payment, or if your annual car tax is only £20. Having too many sinking funds can be complicated. 

Here are some ideas for what you can save for using a sinking fund:

• car expenses - insurance if you pay annually, car tax, MOT and service costs 

• home insurance

• boiler service

• school expenses - shoes and uniforms, payments for clubs or bus passes

• gifts, or you could set up a sinking fund just for celebrations like birthdays, Christmas, Eid, or Lunar New Year 

• holidays

• weddings

• savings for a new baby

• glasses 

• dental treatment

• vet bills.

1.  List the costs you expect in the next 12 months
   • Think of all the events and bills coming up over the next year. Keep a note of the dates for all the bills you do not pay monthly, as well as expensive times of the year like celebrations and holidays. 
2. Estimate the amount for each
   • You can use last year’s statements for a rough number to aim for. It’s helpful to save 10% extra in case prices go up. 
3. Work out the weekly or monthly amount to save 
   • Once you have the date and amount for each goal, do the maths to work out how much you need to put aside each pay day. Divide the total amount you need by the number of times you’ll get paid before then to get the monthly or weekly amount. 
   • The MoneyHelper Savings calculator makes this really easy. Once you start, choose the second option that says: “Know when you need your savings and want to see how much you need to save regularly?” 
4.  Decide where to keep the money 
   • A savings account is an obvious option, but if you’re making multiple sinking funds, then an account that allows you to use saving pots could be a good idea. 
   • Some people use a cash envelope system, but most bills you cannot pay for in cash. Although it can be motivating to see your savings in real money, it might not be as convenient, and you won’t earn any interest.  
5. Automate it 
   • It can be a lot of work to remember to move different amounts of money to lots of different accounts or saving pots. That’s why it’s smart to set up standing orders. These are instructions which tell your bank to send a certain amount to a different account on a date you choose. These can either be one-off or recurring.  
   • If you get paid at the end of the month, setting up a standing order to go out on the 1st of the next month can help you avoid spending that money before it goes into your savings.  

An easy-access savings account is likely going to be the best place to keep your sinking funds. Some banking apps have helpful features like saving pots and budgeting tools, but whatever is easy for you to use is the right option. 

If you’re planning on keeping savings in cash, there’s a risk you could lose them, and you’ll usually need to pay the cash into a bank to be able to use it for bills. 

Find out more about choosing a savings account.

Using a budget planner can help you find out how much money you have left over after you cover your fixed monthly costs. 

At first, sinking funds can seem too expensive. If your annual car insurance is due in 2 months, that’s a lot of money to save up in a short amount of time. However, the next year your regular payments will be much smaller.  

By moving money into savings just after you get paid, you’re paying yourself first. This helps you avoid the temptation of seeing all your money in one account. If your savings are in sinking funds, you’ll know that this is money you’ve set aside for later. 

One big mistake that can make sinking funds feel overwhelming is having too many of them. It’s probably best to have 5 sinking funds or fewer. 

Combine your sinking funds by just having one for ‘Kids’ instead of separate funds for birthday gifts, days out, school costs and clothing, for example. 

You can also underestimate how much you need to save. Avoid this problem by using real amounts from old bank statements instead of just guessing. Prices often go up each year, so try and save a bit extra so you’re not caught out when you find out how much your goal will cost. 

If you end up with extra money in your sinking fund after the bill is paid, roll it over for next year, or move it into other types of savings.  

It’s quite common to dip into your savings towards the end of the month when money gets tight. This can slow down any progress with your sinking funds. 

If you find yourself doing this, it could be a good idea to move your sinking funds into a different bank than the one you use for day-to-day spending. Hopefully it should make it less tempting to transfer money out of savings.