What are Sinking Funds?

Sinking Funds are defined by Frugal Dad as follows:  "In the personal finance world we can use sinking funds to help prepare for large, infrequent expenses that come along throughout the year. A prime example of such an expense is car insurance. Many insurers allow customers to pay monthly premiums for a convenience fee (my company charges $4.00 per monthly payment). I can easily save $24 by rejecting the monthly payment arrangement and agreeing to pay once every six month, when the auto insurance policy renews. But this means I have to come up with a hefty sum of money twice a year to cover the premium. This is where sinking funds can help."

Dave has a great form for such Lump Sum Payment Planning that works beautifully. The idea behind it is that you list your pricier infrequent expenses (you know, those things that you only have to buy every so often - usually only once or twice a year) and rather than having to come up with a large chunk of change when it's due, or paying a convenience fee to give the company the honor of setting you up on an installment plan, you save the money in your own savings account in the months leading up to when that bill is due, and pay it in full, with cash.

Our current sinking funds are $300 a month, for a total of $3600 over the course of the year. This includes auto insurance, renters insurance, car tag/taxes and fees, car maintenance (tires, oil changes, other services), and life insurance. Here are our yearly expenses on these items:
Car Insurance: $1300
Amanda Life Insurance: $350
Jonny Life Insurance: $450
Car Tax/Tags: $300
Renters Insurance: $350
Car Service/Repairs: $850
Total: $3600.

We actually had our car service and repairs a little less (only $700) when we initially started working on this, but when we divided the total amount out by 12 and our monthly savings were to be $287.50, we decided to round it up to $300. This way, if something happens and it's a little more expensive, we've got a little more wiggle room in there.

If you're first starting out, and trying to get your sinking funds caught up so that you can go forward with the correct monthly amount, you'll need to figure out how many months you have until that expense is due, and how many months portion you are behind on that item. Lets look at our example again, from a monthly standpoint, and taking into consideration when our due dates are:

Car Insurance: $1300/12 = 108.33 per month, Due in May and November ($650 every 6 months)

Amanda Life Insurance: $350/12 = 29.17 per month, Due in January

Jonny Life Insurance: $450/12 = 37.50 per month, Due in November

Car Tax/Tags: $300/12 = 25.00 per month, Due in December

Renters Insurance: $350/12 = 29.17 per month, Due in October

Car Service/Repairs: $850/12 = 70.83 per month, Varies.

Total: $3600.

To clarify, I have a separate savings account that I dump the entire $300 per month into, and I keep track on an excel spreadsheet how much belongs in what category.

For illustration purposes, let's pretend that I just got my tax return back, and rather than putting that amount towards our debt snowball, I wanted to get current on my sinking funds before putting any remaining amount towards debt. This way, starting next month, I'll just need to add the budgeted $300 to the sinking funds savings account. How much money would I need to put into the SF account to bring me up to speed?

Car Insurance is due in May. There is only 1 more month between right now and May, so to get caught up, I need 5 installments of the car insurance. $108.33 * 5 = $541.65

Amanda Life Insurance is due in January. I have 9 months between now and January, therefore, I need to pay 3 installments: $29.17 * 3 = $87.51

Jonny Life Insurance is due in November. I have 7 months between now and November, therefore, I need 5 installments: $37.50 * 5 = $187.50

Car Tax/Tags are due in December. I need 4 installments: $25.00 * 4 = $100.00

Renters Insurance is due in October. I need 6 installments: $29.17 * 6 = $175.02

Car Service/Repairs due dates vary. You can start with the current month and only add $70.83, or keep in on a calendar year basis. I'm going to assume this is a calendar year  thing, and save up from January through December. Therefore, I will save 3 installments now, which will catch up January, February and March, for a total of $70.83 * 3 = $212.49

Now, I'll add all these installments up: $541.65 + $87.51 + $187.50 + $100.00 + $175.02 + $212.49 = $1304.17 needed in my savings account for the month of March. In April, I will add $300 to it. In May, I will add another $300 to it, but I will also pull $650 from it, to pay my semi annual Car Insurance. In May, I'll add another $300, etc etc etc. Car service money will be pulled from it as needed, but make sure you don't spend more than you've currently built up for the year for car repairs. If you need more than you've built up, you'll need to budget to pay it back in future monthly installments.

Here's a list of other Sinking Fund expenses you may need to consider budgeting for:

Real Estate Taxes
Homeowners Insurance
Home Repairs
Replace Furniture
Medical Bills
Health Insurance
Life Insurance
Disability Insurance
Car Insurance
Car Repair/Tags
Replace Car (You should watch this video! As for the skeptic comments by users - just remember that the stock market AVERAGE is 12%. No, it's not 12% right now, but over a period of time, thats the average. Don't over-think the concept because of technicalities, or you'll end up just being another boring NORMAL person. Be WEIRD!)
Clothing
Tuition
Bank Note
IRS (Self-Employed)
Vacation
Gifts (inc. Christmas)
Other 

*If you're reading this on Facebook, please go to http://proverbs227.blogspot.com/ to read the original post for links to videos and other websites.