Do novated leases save you money?

Novated leasing, also known as salary sacrificing a car, can help you finance the cost of a car. But will a novated lease save you money in the long run?

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If you're wondering if a novated lease is worth investigating, here's what you need to know.

Salary sacrificing a car is a concept that has been around for decades.

Put simply, a novated lease is a three-way agreement between you, a finance company and your employer. It can help you finance the cost of a car and help reduce your taxable income.

The alternative to a novated lease is a car loan, which doesn’t carry the same tax benefits of a novated lease.

“There are over 1,000,000 novated leases running at any one time in Australia with a growth rate of around four per cent a year, and many make money when they sell [the car] after completing the lease term," Jeff Bowman, national novated leasing manager at Novated Car Leasing Options explains.

"Profits made are also exempt from capital gains tax."

Firstly, you need to ask your employer if they will make lease repayments on a car using your pre-tax salary. This is entirely up to them.

If they agree, then you can take out the lease with a finance company. It will be your employer’s responsibility to make lease repayments to the finance company on your behalf.

Make sure you understand whether the lease will be fully maintained or non-maintained.

A fully maintained novated lease means the car, its running costs and insurance will be calculated in the repayments taken out of your pre-tax salary. For some, the convenience of a single payment to cover the cost of a car is appealing. 

A non-maintained novated lease means only the purchase price of the car is calculated into the lease repayments, meaning you have to cover all other costs.

The terms of the arrangement will be up to your employer, so make sure you have the conversation with them to understand the terms of the arrangement.

Novated lease terms are usually between one and five years.

While novated leasing might lower your taxable income and make for a more economical alternative to a traditional car loan, the cheapest option will always be buying a car outright.

The main benefit of novated leasing is that it can reduce your taxable income and potentially lower the amount of tax you need to pay, Mr Bowman says.

“This arrangement gives employees access to concessional rates of tax not available via traditional car financing models. You also don’t pay GST on the purchase price of the car, which can save you thousands,” he says.

While there are tax benefits to novated leasing, bear in mind that while you get the full benefit of driving a car that you can call yours, the reality is that you don’t own the car with a novated lease until you complete all your contracted lease payments and pay out your residual payout amount.

The benefit of buying an electric car on a novated lease is that certain electric cars are exempt from the fringe benefits tax (FBT).

A fringe benefit is a 'payment' to an employee but in a different form than salary or wages. The FBT is a tax on this benefit that is levied on employers but often passed on to employees who lease their car through work via a novated lease.

However, electric cars priced below the luxury car tax threshold for fuel-efficient vehicles (which is $89,332 for the 2023–24 financial year) are exempt from this tax.

"With this exemption, you're able to make all of the running costs and finance payments for your vehicle out of your salary before the tax is calculated. This process lowers your taxable salary and therefore you pay less tax," explains Mark Telfer, Director at Inside Edge Novated Leasing.

We asked Mr Telfer of Inside Edge Novated Leasing to break down the potential savings from a novated lease using sample case studies.

He took three cars – a luxury electric car in the BMW iX1, a mass-market plug-in hybrid in the MG HS and a mass-market petrol car in the Toyota Corolla – and looked at their associated costs for an individual on a $90,000 salary, with a five-year finance term, who travels approximately 15,000km per year.

Here's how much a novated lease might cost when compared to buying a car on finance or consolidating it into your home loan...

The Australian Taxation Office recommends that you seek financial advice before entering a salary sacrifice arrangement.

The arrangement can’t include salary and wages, leave entitlements, bonuses or commissions that you accrue before you enter an arrangement.

And if it doesn’t meet the requirements of an effective salary sacrifice arrangement, you pay tax on the benefits as taxable income at the time you receive the benefit.

“Think very carefully about the term you choose for your novated lease. The ATO allows a maximum of five years, which is a long time to be committed," Mr Bowman says.

“You can pay these leases out before the expiry of your lease term, but you are committed to pay the full number of lease payments contracted for, plus the residual payout amount.

“Always ask for two lease terms when requesting a lease quote, say three-year and five-year lease terms, and compare the impact on your take-home pay; you will be surprised at how little the difference is. A shorter term could be a wise choice."

A novated lease is tied to the employee, not the employer. This means that if you leave your employment, you will need to take the car with you.

You’ll have a few options at the end of the lease. You can pay off the remaining balance to own the car (known as the residual payment), renew the lease for a longer term or sell the car.

Again, do your sums before making a decision.

Eligibility for a novated lease is similar to other car finance arrangements.

You’ll need to hold a full-time or permanent part-time job beyond your probationary period, your employer needs to offer novated leasing, and you need to be paying tax.

Only you can answer this. You’ll need to calculate whether the payments work for you. The most important number on your quote is NOT the tax savings, but the actual amount your take-home pay will be reduced by each pay day. 

“Make sure you ask for the interest rate to be declared with your quote when being offered a lease quote by the leasing company,” Mr Bowman says.

“The interest rate will be higher than standard personal loan rates, but with standard personal loan arrangements, you don’t get all the significant tax benefits novated leasing offers all employees. Therein lies the trade-off, so always refer back to how much your take-home pay will be reduced by."