What Is a Novated Lease and How Does It Work?
A novated lease is a three-way agreement between you (the employee), your employer, and a finance company. It allows you to lease a vehicle and have your employer make the repayments directly from your pre-tax salary. The term "novated" refers to the transfer of your lease obligations to your employer, who then deducts the payments from your salary before you receive it.
This arrangement is particularly popular in Australia because of the potential tax savings it offers. When payments are deducted from your pre-tax salary, you effectively reduce your taxable income, which can result in significant savings depending on your income level and the vehicle you choose.
The lease itself typically covers not just the vehicle repayments but also running costs including registration, insurance, fuel, servicing, and tyres. These are bundled into a single regular deduction, making budgeting straightforward and predictable.
The Tax Benefits of Novated Leasing
The primary attraction of novated leasing lies in its tax advantages. Because lease payments and running costs are deducted from your gross salary, you pay less income tax overall. The higher your marginal tax rate, the greater the potential benefit.
For example, if you earn $100,000 per year and have annual car costs of $15,000, paying for these from your after-tax income means you first pay tax on that $15,000. At a marginal rate of 32.5 percent plus Medicare levy, that represents approximately $5,250 in tax. With a novated lease, you could potentially save a significant portion of this amount.
However, it is important to understand Fringe Benefits Tax, commonly known as FBT. When your employer provides a car for your private use, it is considered a fringe benefit and attracts FBT. The good news is that the Employee Contribution Method allows you to make post-tax contributions to reduce the FBT liability to zero in most cases, while still retaining substantial tax benefits.
Recent changes have made electric vehicles even more attractive under novated leasing. Eligible EVs are now exempt from FBT, making them significantly more cost-effective to salary package compared to traditional petrol or diesel vehicles.
Understanding the Costs and Fees Involved
While novated leasing offers tax advantages, it is not without costs. Understanding these fees helps you make an informed decision about whether it suits your financial situation.
Finance Charges: Like any form of borrowing, novated leases include interest charges. The interest rate is typically competitive with other car finance options, but it pays to compare rates from different providers.
Administration Fees: Lease providers charge ongoing administration fees to manage your lease, process payments, and handle running cost reimbursements. These fees vary between providers and can add several hundred dollars annually to your costs.
Residual Value: At the end of your lease term, you will need to pay a residual amount if you want to keep the vehicle. This residual is set at the start of the lease based on the expected value of the car at lease end. You can pay this outright, refinance it, or trade the vehicle.
Use our car finance calculator to compare monthly costs between novated leasing and traditional car loans to see which option offers better value for your circumstances.
Who Benefits Most from Novated Leasing?
Novated leasing is not ideal for everyone. Several factors determine whether it represents good value for your situation.
High Income Earners: The tax benefits of novated leasing are proportional to your marginal tax rate. Those earning above $120,000 typically see the greatest advantage, as they pay tax at the highest marginal rate. If you earn less than $45,000, the tax savings may not offset the fees involved.
High Kilometre Drivers: If you drive significant distances annually, the running cost component of a novated lease becomes more valuable. Packaging fuel, tyres, and servicing into pre-tax deductions amplifies your savings.
Those Seeking Simplicity: If you value having all your car expenses bundled into one predictable payment, novated leasing offers convenience. You will not face unexpected repair bills or need to budget separately for registration and insurance.
Electric Vehicle Buyers: With FBT exemptions for eligible EVs, novated leasing has become exceptionally attractive for those considering electric vehicles. The combination of fuel savings, no FBT, and pre-tax salary deductions creates compelling value.
Potential Drawbacks and Considerations
Before committing to a novated lease, consider the potential downsides that might affect your decision.
Employment Changes: If you leave your employer, the novation ends. The lease transfers back to you, and you become personally responsible for the remaining payments. While you can potentially novate the lease to a new employer, this is not always possible and depends on your new employer offering salary packaging.
Complexity: Novated leases are more complicated than simply buying a car outright or taking a standard car loan. The interplay of FBT, pre-tax and post-tax contributions, and employer deductions requires careful understanding to ensure you are genuinely saving money.
Locked-In Running Costs: Your budget for running costs is estimated at the start of the lease. If you drive less than anticipated, surplus funds accumulate in your account. While you get these back eventually, your money could have been working harder elsewhere.
Not All Employers Participate: Your employer must agree to administer the salary packaging arrangement. While many large organisations offer this benefit, some smaller employers may not have the administrative capacity or willingness to participate.
Making the Right Decision for Your Situation
Deciding whether novated leasing suits you requires careful analysis of your personal circumstances. Start by calculating your current car costs, including loan repayments or savings for a purchase, fuel, registration, insurance, servicing, and incidental expenses.
Next, obtain quotes from reputable novated lease providers. These should detail the exact salary deductions required, broken down into pre-tax and post-tax components. Compare the total cost against your current or projected expenses using traditional financing.
Consider your job security and future employment plans. If you anticipate changing employers or industries, the risk of having to manage the lease personally may outweigh the tax benefits.
Finally, use our free car finance calculator to model different scenarios. Compare the total cost of ownership under a novated lease against a traditional car loan or saving to buy outright. This comparison should factor in all costs, including the time value of money and the convenience factor of bundled payments.
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Our team of finance experts is dedicated to helping Australians make informed decisions about car loans. We provide accurate, up-to-date information to guide you through your vehicle financing journey.