It was nice to move the money from savings to checking and send the tax man a check without affecting our monthly cash flow. A few years ago, I probably would have been cashing a credit card convenience check to raise the cash to pay the bill.

This is the third or fourth annual (or semi-annual) bill we’ve managed to save for using sinking funds. Here’s the strategy we use:

How to Set up a Sinking Fund

1. Open a dedicated savings account at your local bank (or online bank) or credit union.
2. Determine the item(s) for which you wish to save for all year long.
3. Divide the annual expense by the number of paychecks you plan to receive before the next bill is due. For instance, a $500 annual expense would work out to about $20 per paycheck since I am paid 26 times a year.
4. Automate the process by establishing an automatic transfer from your primary checking account to your sinking fund savings account. If your bank doesn’t allow this, contact your payroll office and have the amount siphoned from each paycheck.

This can all be accomplished within a single savings account by adding up the total dollar amount of those once or twice a year expenses and dividing by the number of paychecks you receive.

You can use a ledger, Microsoft Excel, or some other tool to help keep up with the balance and which savings goal it applies to.

Some banks, such as ING Direct, allow you to open multiple savings accounts rather easily and you can even give them a “nickame.” Here, you might have four accounts labeled Property Taxes, Car Tags, Vacation, Insurance Premiums.

The bookkeeping is certainly easier with separate accounts, but some like the idea of just having one additional account. Do what works for you.

Other Uses for “Sinking” Funds

Our “sinking fund” has graduated over the years to represent a sort of first-line emergency fund, in addition to a fund to cover annual expenses. We have a “Car Repair” fund, where I occasionally dip into for those hard-to-plan-for flat tires, dead batteries, early-summer air conditioner servicing jobs, etc.

We’ve also created a “Christmas Shopping” fund to plan for annual Christmas shopping for our family. This helps to smooth out these large, once or twice a year expenses so as to not upset the budget in the month in they occur.

Around Thanksgiving each year, we make out Christmas shopping list, gather up any coupons and deals we can find, and do our Christmas shopping within the budget established by the balance in the Christmas shopping fund.

We usually just put it all on a credit card for simplicity, and because much of the shopping is done online to score better deals (and because I hate crowded stores!). When the credit card bill arrives in December, we pay it off electronically from the Christmas savings account and avoid the debt hang over that often carried well into the New Year in years past.

What used to be a budget buster, like a car repair or home air conditioner servicing, is now just a blip in the budget in the form of an online transfer and a check for payment of services.

For large emergencies, our larger emergency fund is there. However, psychologically, I enjoy being able to handle smaller emergencies without dipping in the fully-funded emergency fund.

Kimberly Lankford, contributing editor at Kiplinger’s Personal Finance magazine, put together five smart uses for your tax refund. I’ve expanded on her ideas, and added eleven of my own to the list below.

Smart Things to Do With a Tax Refund

1. Pay off high-interest credit-card debt. Kimberly listed this one first, and for good reason. Eliminating credit card debt is one of the smartest ways to spend any windfall. The higher the interest rate on your debt, the bigger the payoff. Think about it; where else can you get a guaranteed return of 22% on your money?
2. Rebuild your emergency fund. Thanks to unemployment, underwater mortgages, and a general economic funk, many households have had to turn to emergency funds to weather the storm. It makes sense to allocate some or all of your tax refund towards covering future emergencies.
3. Boost your retirement savings. If your debts are paid, and you have plenty of money saved for emergencies, the next biggest bang for your refund buck is to invest in your retirement. Maybe that means funding a Roth IRA, if you are eligible. If not, drop the money in a savings account, increase contributions from your paycheck to your 401k plan, and use the savings to offset the difference.
4. Build your college savings. It’s tough to carve out retirement savings, college savings, and put a roof over your family’s head and food on the table. After all, there are only so many dollars to go around. Boost your kids’ college savings by opening a 529 college savings plan (here’s a look at the best 529 plans).
5. Help your kid save for the future. If you are the parent of a teenager that earns an income, did you know you can help them open a Roth IRA? No kidding. The only requirement is that your teen files a tax return. He or she can invest in a Roth IRA up to their earnings, or the maximum yearly contribution, whichever is smaller. So, if your daughter earned $1,800 last year babysitting, kept meticulous records and files a return, you could gift her $1,800 to invest in a Roth IRA. She’ll be well on her way to becoming a millionaire.
6. Start a side hustle. Ah, the infamous side hustle. Many of the world’s most successful entrepreneurial efforts were started on less than $1,000 (I started Frugal Dad on less than $50!). Use your tax refund to seed a business you’ve always dreamed of running.
7. Invest in a home improvement project. Lean towards projects that improve your home’s efficiency long term. For instance, installing a programmable thermostat and planting a few trees around your property will go a long way towards reducing your future monthly energy costs.
8. Open a “Car Replacement Fund.” Let’s face it; the car you are driving now will eventually die. Why not divert a little tax refund money to start a car replacement fund. If your current car is paid for, save what amounts to be a car payment in this account and when the time comes you can pay cash for your next car.
9. Build a square foot garden. Use a couple hundred dollars of your tax refund to purchase gardening supplies, soil, and seeds. Now’s a great time to plant, and soon you’ll be enjoying tomatoes right off the vine, instead of those shipped across the country in your grocer’s produce section.
10. Give it away. If you’ve been considering giving money to a charity, now is a great time. Donating your tax refund to a worthy cause can even help on next year’s taxes, as most charitable contributions are tax deductible.
11. Pay extra on your mortgage balance. We personally plan to pay off our mortgage early. Why? Because we value the freedom a debt-free lifestyle affords. Sure, we’ll miss a tax break or two, but I’d gladly end sending $14k to my mortgage company each year to save $3k on my taxes.
12. Get your will done. My wife and I recently updated our wills after a death in the family. Identifying guardians for your children, and disposition of your stuff in the event of your death is not fun, but it is absolutely necessary. If you have kids and do not have a will, stop everything, financially, until you have enough saved to visit an attorney and have one drawn up. It is that important.
13. Purchase a gym membership. Many gyms offer significant breaks for those that opt to pay one year in advance. My gym offered two free months and waived the registration fee if I agreed to pay for the full year, effectively shaving $90 off my annual gym costs. Be sure to check out the gym’s refund/cancellation policy before agreeing to such a long commitment.
14. Take a class. It doesn’t have to be an academic class, but it could be. Maybe you’d like to learn more about cooking, or self-defense, or real estate. Investing a little tax refund money in yourself can go a long way.
15. Go on a “paid-for” vacation. My family recently enjoyed our first cash vacation, and it was awesome! I didn’t have any bills to dread on the ride back home.
16. Create your own “car insurance savings account.” If you currently have a $250 or $500 deductible on your car insurance policy, consider raising it to $1,000 and parking $1,000 of your tax refund in a dedicated savings account. You’ll enjoy a permanent way to save money on car insurance premiums, and earn a little interest on your savings account.

If you’d like to avoid getting a large tax refund next spring, and instead get a boost to your take home pay now, check out the withholding tool at Kiplinger.com.

Clear out financing and tax issues with a San Diego tax attorney.

When my wife and I decided to get out of debt, we went at it full force. We felt like nothing was going to stop us. However, almost immediately, financial troubles began to pop up. They weren’t necessarily large, but they were putting a damper on our extreme dedication to get things rolling. For example, my car needed new brakes, rotors and registration ($1000). My wife needed a small amount of surgery ($300), etc., etc. It just kept adding up and it felt like we were getting nowhere. After dealing with those setbacks, I’ve thought about some things that we did wrong (and right) in dealing with them. I’ve broken them down into some tips for dealing with financial setbacks.

Don’t Make Excuses

Over the past few months, I’ve realized that I made a lot of excuses for not paying down as much debt as possible. For example, every time we ran out of cash in our grocery envelope, I thought it was OK to just take it from somewhere else (the debt envelope for example). I figured, eh, what’s one month, we will get it rolling next month. That excuse seemed to pop up almost every month. Maybe one month we needed the extra cash for car expenses and the next we needed it for something else. All I can say is, stop making excuses and start getting angry at your debt.

Have a Small Emergency Fund

Everyone knows the importance of emergency funds. They’re there in case you have a financial setback or lose your job. Having a small emergency fund while in debt insures that if you do have a small financial emergency, you won’t have to accumulate more debt to handle it. Our emergency fund is set at $1,000. It’s a simple, round number that we feel comfortable using. You can make yours whatever you feel comfortable using. I think Frugal Dad actually used a $3,000 emergency fund while he was getting out of debt. Before you start paying off your debt, get an emergency fund set up. It will save you a lot of pain in the long run and it will prevent you from adding on to your debt.

Save Elsewhere

Something that we continued to do even when we had financial setbacks was spend elsewhere. I mean, we had $50 in our clothing budget, so we spent it on clothes. Looking back, we should have rolled that $50 into our debt snowball and postponed the enjoyment of clothes shopping for a month. Would we have gone crazy if we didn’t spend that for one month? No way. When you have financial setbacks, find other ways to save money. Maybe you shop at the discount grocery store that month or brown bag it the whole week. Why not pick up some overtime at work or a side job? These small things can make financial setbacks easier to handle.

Refocus and Get Moving Again

Once the setback is in your rear view mirror, it’s time to refocus and get back into gear. After our setbacks, we really started to attack our debt. We managed to pay off our $1,500 Best Buy credit card in 2 months. It just angered us so much knowing that we could have had it already paid off and we would be almost done with another debt. But, things happen and you just deal with them.

How would you advise a recent college graduate who wants to get married, is in debt but is able to save money every month?

I received this email from Dean who is in this situation right now:

I have about $24,000 of low interest student loans to pay off, and am building up emergency savings. I know it’s smart to pay the minimum on the loans while they are at a low 3% and invest some extra money, but am I really able to invest for a year knowing that I need a full year to gain long-term gains privileges?

Even as I write this it seems like putting in $300 a month would be a good idea, while putting the rest ($400+?) in savings.

I think I’ll have to pay for a ring in about a year (knock on wood), so I should keep that liquid.

What advice would you give Dean?

Before I get started, I have to come clean on my own bias.

I just hate debt. It’s more than just a financial issue. I just don’t like owing money to anyone and I don’t like it for other people either.

My experience tells me that nobody ever got rich having debt.  More important; I’ve never met anyone who had a lot of debt who was really happy.

Of course, plenty of people made money in real estate.  And they did that by taking out mortgages.  But that is just about the only kind of debt that ever makes sense to me. And as recent events prove – mortgage debt can also be dangerous.

Having owned up to that, here are my thoughts for Dean:

1. You have to take a great deal of pride in having the foresight to even look at this issue.   Many young folks don’t even take the time to consider asking for advice. They do what they think is right without bouncing the ideas off of other people.  Dean is a frequent visitor and commenter on many financial blogs.  That means he’s doing what he can to educate himself and make smart decisions.  Bravo Dean!

2. I also like the idea of building up an emergency savings account.  Just make sure you know how much you need in that account.  From the information you provided, it’s tough for any of us to tell you what that amount needs to be but a good rule of thumb is 6 to 12 months of spending.  But remember than an emergency fund is liquid and it’s invested in the bank.  You won’t get much of a return but you get liquidity and safety.  That’s what you should be looking for when you set up an emergency fund.

3. I don’t like the idea of investing the money you could be using to pay off debts.  If you invest that money, it assumes you can do so and earn more than the 3% that you are paying on your debts.  Bank accounts aren’t paying 3% so you must be investing in the stock market.  While you’ve made a killing on that strategy this year (so far), nobody can guarantee that strategy will work out over your own time frame.   In fact, the interest they charge you on your debts could sky rocket just at the time when your stock market investments tank.  Not a pretty picture.  I’d play it safe and throw everything I had at the debt.

4. I’m not a huge fan of making investment decisions based on tax consequences.  The tax angle is important, but it’s secondary. The most important consideration should be your goals and risk tolerance.  You can’t control where the market is going to be when you need the money.  For that reason, if you invest in the market, you should do so with the idea of keeping your money invested for at least 5 to 10 years.  If you need the money in 12 months and you invest in the stock market, you are speculating and therefore, taking on much greater risk.  This doesn’t turn me on all that much.

5. “The Ring” scares me.  Dean, if you are in debt, I’m going to assume that your fiancé knows about it.  Have you discussed your finances with her?  Is a ring the best use of your money when you are just starting out?  Do you think it’s more important to invest in a ring than it is to invest in yourself?  Have you and your future wife considered the trade-offs between the rock and the freedom (of having less debt)?

Again, I admit that I have a bias against spending a ton of money on jewelry and I might be alone on this. In fact, I only bought a “nice” ring for my wife on our 20^th anniversary – when it was well within our budget and at a time when we were fortunate enough to have no debt.

(Had she insisted on having an expensive rock on her finger before we got married, it would have been a huge red flag for me.  It could signal that we had different values and therefore not well suited for each other.)

When considering the choice between a diamond or cubic zirconia, price can play a major factor in that decision.

Four of the Best Online Banks 

Online savings banks were all the rage just a couple years ago. It wasn’t unusual to score a 4 or 5 percent interest rate on online savings accounts. Today, the “high-yield” from high-yield savings accounts has all but been obliterated. Still, there are a few good deals at the best online banks, if you know where to look.

ING DIRECT  I’ve had an ING Orange Savings Account for over two years now, and have to say I am very pleased with the product. We currently have a number of accounts there for targeted savings goals. While higher interest rates can be found elsewhere, I value the ease-of-use from their online interface.

WT Direct  WT Direct also offers a solid interest rate, but with more caveats than other banks. While they do not require a minimum deposit, or charge fees based on your balance, they do offer a lower tiered interest rate for accounts with less than $10,000 (1.16% APY vs. 0.15%APY). If you have over $10k in your emergency fund, WT Direct is a solid option.

Again, the most important benefit of saving emergency fund money at an online bank is that is separated from your everyday accounts, limiting the opportunities to spend it away on non-emergencies. I still like the idea of keeping a local emergency fund of $1,000 or so tucked away at a local bank or credit union for smaller emergencies. This smaller, local emergency fund provides quick access without having to wait a couple days for online transfers.

Another thing that helped in our recovery was the mental, and even physical, separation of small piles of money. We accomplished this by opening an online savings account at ING Direct that allowed us to open several additional “sub-accounts.”  We identified a number of unique savings goals and created an account for each one – Christmas savings, a vacation fund, orthodontic services for our kids, etc. We also recently divided our emergency fund into logical (to us) separate piles of money.

Specialized Emergency Funds

The inspiration came from a post I read over at Gather Little By Little about creating specialized emergency funds. I liked the idea of dedicating a portion of money to a specific emergency situation, and the idea folded in nicely with an earlier tweak to our financial plan to create a local emergency fund.

In this economy, it also seemed like a good idea to tag some money available to pay for things like the mortgage, COBRA insurance, etc. in the event of a job loss. Sure, the sum of these expenses could be calculated and serve as your goal emergency fund amount, but knowing I have 6 mortgage payments or 6 months of COBRA in an account helps me sleep at night!

Our Specialized Emergency Funds

• Local emergency fund. This fund represents to the first $1,000 of our larger emergency fund.  Instead of keeping it all in online savings accounts, we like the idea of $1,000 or so saved at a local bank.  We can write local checks for repair services, make cash withdraws, or do business inside the bank branch.

• Mortgage fund. My goal is to have exactly six months of mortgage payments saved in a dedicated account at our online bank. After watching my mom struggle to stay afloat financially after a stroke and six months of unemployment before disability kicked in, it has strengthened my desire to have this fund in place.

• Family health insurance fund. In the event of a job loss it could be difficult getting rehired in this economy. So having 3-6 months of COBRA insurance premiums sitting around would make me much more comfortable. In fact, if I ever venture out on my own, this fund could provide insurance for a few months (COBRA or a family health insurance plan I shopped for somewhere like eHealthInsurance.com).

• Automotive repair/replacement fund. We combined auto repairs and replacement funds (where I will continue sending our car payment after it is paid off this month). When we have enough saved to buy a car for cash, we’ll upgrade my wife’s current car and I’ll drive hers a while longer.  In the mean time, the funds will be used to repair my old van, which has been limping along here lately.

• Household repairs fund. The remainder of our emergency fund is in a generic account we’ve labeled “household repairs.”  This could cover things like a new hot water heater or a refrigerator repair.

I feel compelled to add this small warning – be careful not to add too many specialized emergency funds, and try not to confuse them with other targeted savings goals you may have.  For instance, my car replacement fund really could have stayed separate from my repair fund, much like a “new house down payment” savings fund would likely be separated from household repairs.

Basically, do what works best for you, but don’t too carried away creating dozens of accounts or you will create more headache accounting for the money in the long run.

Think of your emergency as a personal line of credit. It might even help to sign up for an account that offers a debit card. I keep my emergency fund debit card in my wallet with one of those ATM card slips that says, “Break only in emergency!” When Murphy strikes I use that debit card to tap my emergency fund rather than turning to a credit card.

Hang on to your oldest, no-fee credit card until you have established several months of savings. By keeping one credit card with available credit you still have a backstop should you have the unfortunate luck of getting hit by two emergencies in the same month. Be sure that the emergencies are real emergencies – clearance items at your favorite store do not qualify.

Emergency funds should remain in a highly liquid account. The majority of your emergency funds should be socked away in a high-interest savings vehicle, like a savings account with a top online bank. We also keep a local, smaller emergency fund in an interest-bearing checking account (with debit card access). I could get a higher rate of return on this smaller amount elsewhere, but I have discovered that the higher the rate of return on my money the more pressure I feel not to touch it. This is especially true of holding an emergency fund in stocks or mutual funds. If the market is up, I don’t want to cash out because it might go higher. If the market is down, I don’t want to cash out until it goes back up again. Best to simply keep the emergency fund in easily accessible cash.

Make rebuilding your emergency fund a top priority after each expenditure. If your car died last week and the repair bill topped out at $600 you should quickly find a way to refund that $600 back to your emergency fund. Stop paying extra on your debts until that $600 has been replenished – minimum payments only. Take some extra overtime next week. Round up some old books and DVDs and sell them on EBay. The point is to make rebuilding that emergency fund your number one priority. Having that plan in place before the emergency will make it easier to swallow the $600 hit to your emergency fund, because you know it will be quickly replenished.