Body corporates have long used sinking funds as a way to regularly set aside money each month to cover future costs like outstanding debts or bonds. This approach helps ease the financial pressure when those payments are due.
A well-managed sinking fund also allows properties to plan ahead for larger, less frequent expenses, such as major repairs or upgrades, without needing to rely on credit cards or dip into emergency savings.
In certain regions of Australia, maintaining a sinking fund is a legal requirement to avoid significant financial and legal issues.
In this article, our specialists at Duo Tax will explain everything you need to know about sinking funds. You’ll discover what they are, why you need them, how to manage them, and, most importantly, how they can be a game-changer for property management.
First Thing’s First: What’s a Bond?
A bond is a debt investment where an investor loans money to an entity, usually a corporation or government. The funds are borrowed for a set period of time at a variable or fixed interest rate.
When you buy a bond, you are essentially lending money to the issuer of the bond.
What is a Body Corporate Sinking Fund?
A sinking fund is a financial reserve set up by a body corporate to cover major, long-term expenses that aren’t part of the regular day-to-day budget. Instead of relying on special levies or scrambling for last-minute funding, a well-managed sinking fund allows property owners to plan ahead and pay for costly repairs or upgrades when the time comes.
Common uses of a sinking fund include large-scale capital works such as roof replacements, repainting the building exterior, upgrading lifts, or restoring shared facilities like pools and fences. It may also be used for replacing communal area items like carpets or flooring, and in some cases, repaying long-term debts related to the property.
The term “sinking” reflects the fund’s purpose—to gradually ‘sink’ money into a reserve that will eventually cover predictable, often expensive works that go beyond routine maintenance. These funds are usually built through regular contributions from strata levies paid by all property owners in the scheme.
Importantly, the sinking fund is separate from other levies like the Administrative Fund, which covers ongoing maintenance and insurance, or Special Levies, which are raised for unexpected, one-off costs.
Having a dedicated sinking fund ensures the owners’ corporation can meet future capital expenses without causing financial strain on owners or delaying essential works.
The Step-by-Step Guide on How to Create a Sinking Fund for Your Property
Once you’ve decided to proceed, establishing a sinking fund is quite straightforward. To initiate the process:
Step 1: Decide on the Purpose of the Sinking Fund Levy
Firstly, identify your saving goals. Will they relate to covering outstanding bonds and debt, or are they more aligned with major structural repairs underway in the financial year? The sinking fund levy involves regular payments collected from unit owners to accumulate a reserve for future capital expenses. These structured plans help ensure owners contribute appropriately, preventing unexpected financial burdens.
Step 2: Build a Sinking Fund Forecast
Having pinpointed your savings target, the next step is determining its price tag. You will need to know the exact figures related to your outstanding debt, as well as analyse the potential costs for any capital expenditures and projected expenses. Regular reviews and adjustments are necessary to ensure adequate funds are available to cover unforeseen expenses.
Step 3: Determine a Timeline
When will you need access to the money inside your sinking fund? For example, you might want to undergo new property improvements within the next six months. You will then need to determine the timeline over an extended period and divide the forecasted amount by six to ensure you have the minimum balance to cover the cost without withdrawing money from an emergency fund.
Step 4: Decide on the Financial Institution to Hold the Fund
Having established your budget and timeline, the next crucial step is choosing a suitable location to store your sinking fund. It’s generally recommended in the industry the use of a high-yield savings account as it guarantees ease of access to your funds when needed, and sinking fund interest received month-to-month.
Step 5: Rework Your Sinking Fund Budget
The next phase involves adjusting your budget to accommodate contributions to your sinking fund. It’s essential to stay grounded in reality—if it’s impossible to set aside the forecasted amount every month for your expenses, you might need to lengthen your timeline or contemplate a less expensive option.
How Many Sinking Funds Should a Body Corporate Have?
There is no ‘preferred’ number of sinking funds that a body corporate should create. It’s essential that you have at least one fund to cover capital and repayment expenses for the upcoming financial year. On the other hand, too many sinking funds can make managing your monthly budget difficult and saving money required for larger outlays.
Legislation mandates considering major capital spending when planning financial forecasts for both the current year and the following nine years.
Often, the number of sinking funds can depend on the size of the property and the predicted expenses for maintenance, future projects, insurance premium changes, debt repayments, regulatory obligations and so on.
What are the Types of Sinking Fund Accounts?
Once you’ve forecasted your capital expenditure needs and budgeted for ongoing contributions, the next step is deciding where to keep your sinking fund. The type of account you choose can affect how accessible your funds are, how secure they remain, and whether you earn interest on your savings.
Here are the common account types suitable for sinking funds in Australia:
1. Society Cheque Account
A society cheque account is often used by body corporates for day-to-day transactions and ongoing levy management. These accounts are typically held in the name of the owners’ corporation and require multiple authorised signatories to access funds. While they offer high accessibility and transparency, they usually don’t earn much interest. This makes them ideal for administrative fund use or smaller sinking funds where liquidity is the priority.
2. Transactional Savings Account
A traditional transactional savings account offered by most banks allows the body corporate to easily transfer funds between accounts or make direct payments when needed. These accounts are relatively low interest, but they provide flexibility and ease of use. They’re useful for holding short-term funds or amounts that will soon be allocated to upcoming capital works.
3. High Interest Earning Account(HIEA)
For longer-term sinking funds, a high interest earning account is generally the most effective choice. These accounts accrue higher interest over time, helping the body corporate’s contributions grow and keeping pace with inflation or rising construction costs. Funds are typically still accessible, but some banks may require notice for larger withdrawals or impose limits on transaction frequency. HIEAs are particularly valuable when funds are being saved for major repairs or upgrades several years in advance.
The Advantages of Sinking Funds
Let’s discuss the upside of sinking funds for property owners and body corporates.
Financial Buffer for Unexpected Expenses
A sinking fund can act as a financial buffer for unexpected costs, such as insurance premiums, abrupt repairs, or unexpected repairs. Instead of being caught off guard by these expenses, you can plan ahead, and set aside a small sum over time, mitigating the financial impact when these costs do arise.
Spread Out Expenses Over Time
Furthermore, a sinking fund helps to spread out substantial purchases and long-term expenses over a given period. By regularly contributing a certain amount to your sinking fund, you can accumulate the needed sum without bearing the burden of a hefty one-time payment.
Avoiding Credit & Loans
A sinking fund also serves as an alternative to credit card usage or loans, which are often the first choice for sudden, large expenses. With a well-managed sinking fund in place, you can ensure you have enough money to avoid potential debts and the accompanying interest payments.
Generating Interest
Placing your sinking fund into a traditional or high-yield savings account can also generate a return on your savings. As your fund grows, the accruing interest can help you achieve your monetary goals faster.
Prevent Impulsive Outlays
Finally, having a set plan and purpose for your funds can reduce impulsive spending. When large expenses are expected, and savings are set aside for these costs, it prompts mindful spending habits, saving you from unnecessary and costly purchases.
The Potential Drawbacks of Sinking Funds
Managing sinking funds isn’t always plain sailing. Although they offer many benefits, a community management company or owners’ corporation needs to be mindful of potential stumbling blocks.
Let’s look into some of the drawbacks:
Strata levies spent on debts
While sinking funds are designed for capital expenditures and improvements, they can sometimes be diverted to cover body corporate expenses, such as debts, which can detract from the overall quality and value of the property.
Legal action to recover unpaid levies
If strata levies aren’t paid on time, the body corporate committee may need to pursue legal action to recover the unpaid levy, which can result in the sinking fund falling short. This can create tension and potential conflict within the corporation.
Budgeting complexities
Forecasting future outgoings accurately is challenging, especially when predicting maintenance expenses. There’s the challenge of predicting maintenance requirements, planned projects, changes in insurance premiums, and regulatory obligations. Misjudgments can lead to financial shortfalls.
Underestimation of maintenance costs
Substantial expenses like air conditioning, elevators, interior lighting, and hydraulic pumps can easily be underestimated or overlooked, skewing the sinking fund’s budget.
Chances to increase costs
If maintenance activities are left to luck rather than planned systematically, it could lead to substantial cost increases and higher levies.
Key Takeaways
As a property owner or member of a body corporate in Australia, managing your financial resources effectively is crucial for your property’s maintenance and overall state.
- A sinking fund is a financial safety net predominantly used by body corporates to tackle significant or unplanned property expenses.
- Creating a sinking fund requires careful planning, from the determination of its purpose to choosing the right financial institution to host it.
- Body corporates usually only need one sinking fund, although multiple could be beneficial for larger complexes.
- Sinking funds can be held in various types of savings accounts, each with their own benefits and drawbacks.
- The benefits of a sinking fund include serving as a financial buffer, avoiding credit, generating interest, and preventing impulsive spending.
- Drawbacks can include overspending, the risk of legal action, complex budgeting, underestimating maintenance costs, and increased costs.
A well-managed sinking fund is crucial for maintaining the financial stability of a body corporate. Organising sinking funds can be difficult, which is why seeking professional advice can help make the process flow much smoother.
