Do your bills surprise you sometimes? Does the sewer bill wreck your plans for making progress on your financial goals? Ours used to, but now we always have the money for our periodic bills because we have a personal escrow account. The benefits don’t stop at funding your periodic bills either.
(checkout the calculator to see how much interest you would earn from a savings account and this system)
I’ll admit that this is a very simple and straightforward solution to a problem. But, a key thing to remember is…SIMPLE WORKS.
There are plenty of periodic expenses that might catch you off guard if you aren’t keeping track of when they are due. When we were first married, we used to think we were doing well with our money, only to realize that some periodic bill was going to be due that month. I decided to start a personal escrow account.
This is similar to a mortgage escrow account that collects 1/12 of the cost of your taxes and insurance each month. I set aside 1/12 of the yearly cost for periodic expenses. It started as money that would just float in our checking account. I would pretend it wasn’t in the account, but in a “savings” account that I tracked on a separate spreadsheet. This was a little after I accidentally paid an extra $1,000 on one of my student loans.
I realized this mistake when we overdrew our checking account because I didn’t know our balance was $1,000 low. Overdrawing resulted in fees, inconvenience, and using a credit card until the next payday.
At that time, we only had our credit cards as an emergency fund, so… no emergency fund. I decided we needed to get things under control. First we refilled the bank account and then put an extra $1,000 in as a mini emergency fund. I tracked all of this separately as a buffer.
Then I decided I should break down periodic payments into the required monthly amount and start putting that into the fake savings as well. This is money that would need to be spent anyway so I set it aside to maintain the monthly budget as predictable as possible.
Personal Escrow and Checking Buffer
I could have put it in a linked savings account with the same bank and collected a minuscule amount of interest. I just kept it in the checking account at first for several reasons:
1) I used to pay all bills just as soon as they came because I thought this was the best way to make sure I paid on time. I didn’t have to worry about the exact balance in the account and my checkbook would show a small negative balance at times until the end of the month. It also makes it more difficult to overdraw the account. I now pay all of our bills on one day or they are paid automatically to batch the work. Regardless of what day of the month they are paid, I count them all as paid on the first of the month for efficiency.
2) It keeps the daily balance up to avoid fees. At the time, our bank required a certain balance to waive ATM fees. Keeping this money in checking kept the balance high enough to avoid the fees.
3) It can be used as a small additional emergency fund.
4) You can only make six withdrawals from a savings account per month, and I didn’t want to use up some of them on this plan. Realistically, this isn’t a problem because as you set this up, you know what bills need to be paid each month so it should only be one withdrawal per month for your personal escrow.
Now Make Money With Your Money!
(a very small amount)
I continued to keep this money in the checking account for a while. It worked well to smooth out our budgeting and avoid bank fees. As I added more items to our personal escrow, I decided I should be putting some of it in a savings account that earned interest. I could have put it all in a savings account, but I still like having a little bit of a checking cushion. I think it’s mostly due to habit at this point though, since we’ve had pretty good control of our budget for years now.
The way I divide the expenses now is by keeping expenses that are quarterly (water, sewer, garbage) in our checking account and the rest in a savings account that earns interest. The yearly total payments from the checking account portion is just over $2,300 but the monthly balance is just over $500. This means we’re only losing out on about $5 in interest each year by keeping this amount out of savings.
The savings account includes yearly expenses (Fire & EMS subscription, farm share subscription, dog medicine, HVAC checkup, museum & zoo subscriptions, preschool tuition, life insurance, Christmas gifts, car registrations, amusement park season passes, and a tax buffer). The yearly expense for this is over $5,000 but the balance hovers around $3,000. This earns us about $23 per year.
Hooray for low interest rates on savings accounts!
I created a simple calculator to see how much interest you can earn and a Google Sheet that can also be used to list your expenses.
The Power of the Float
Since not all expenses are due at once, the balance in these accounts can be used as an emergency fund. This is essentially a way to loan yourself interest free money. Sticklers will note that you would be losing out on the interest earned (a 1% loan in our case).
For example, the refrigerator breaks requiring an immediate outlay of $1,000. This money can be taken from the escrow account to cover the expense. Over the next five months, $200 would be put into the escrow account in addition to the normal escrow amount. If your escrow account is large enough, you could spread out the payments to yourself over a longer period.
This is money that you are spending anyway, so just set it aside in an orderly fashion. That way it will be available when you need it for a budgeted expense and in case of small emergencies. It’s like a present from your past self.
The power of the float is the best part of this system. It provides a buffer for small emergencies, which are the things that often trap people in a multi-month or longer cycle of credit card bills or worse. A real emergency fund or emergency funding strategy, should be created. But, for anyone starting their financially responsible life a personal escrow account is very helpful. The key is that the money set aside is not extra money.
Setting Up The Personal Escrow Account
There’s the easy way, and the detailed way.
The easy way is to go through the last few bank and/or credit card statements to scan for periodic bills. Divide the yearly total by 12 and create an automatic transfer to your savings account. Write down the amount for each periodic payment and when it is due. WRITE IT DOWN.
OK, good. The calculator page has a Google Sheet that can be used for tracking.
Now when a periodic bill comes due, you know how much you had planned for it and can adjust the transfer if needed. For example, our sewer bill has been skyrocketing up due to infrastructure improvements required in our area. As of 2017, we pay just over $1,000/year for sewer service.
When the bill is higher, I just recalculate the transfer as needed.
The detailed way is to create a spreadsheet that has a running balance for each line item you have accounted for. Being an engineer, I use the detailed version.
There it is. Your budget will be simplified. You will earn interest (although a very small amount these days). And, you will have just a little bit more of a cushion when truly unexpected expenses show up.