A required periodical (usually annual) payment that is designed to amortize a bond or preferred stock issue. In other words, it is an account that facilitates the retirement of a portion of the issue each year. Sometimes, issuers might be required to deposit money with a trustee, which invests the sinking fund amounts and uses the accumulated balance to repay the bonds/ preferred stock upon maturity. Should an issuer fail to meet the sinking fund requirements, the bond issue will be thrown into default.

Retirement may be handled in either of two ways: (1) each year, the issuer may select bondholders subject to bond retirement by a lottery (those selected will be paid back the value of their bonds/ stocks at par), (2) the issuer may purchase the retired amount of bonds/ stocks in the open market. Of course, issuers will be expected to choose the lower cost method. Calling bonds/ stocks through the sinking fund mechanism doesn’t require issuers to pay a call premium.