You've probably heard about novated leases, especially given their growing popularity in recent years. In fact, in the September quarter of 2023, novated leases made up a significant 31% of all car loan/lease settlements, reflecting a 14.4% increase from the previous year​​.

But what exactly is a novated lease, and is it the right choice for you? This blog will guide you through the intricacies of novated leases, helping you understand the pros and cons to make an informed decision.

What is a Novated Lease?

A novated lease is a three-way agreement involving you, your employer, and a leasing company. Essentially, it allows you to lease a vehicle through a 'salary sacrifice' arrangement with your employer. The lease payments and vehicle running costs are deducted from your pre-tax salary, potentially offering tax benefits and other financial advantages. However, understanding the specifics is crucial, as there are certain nuances and conditions you should be aware of​​​​.

Advantages of a Novated Lease

There are a number of key benefits and advantages of a novated lease, some of which we’ve outlined below.

• Tax Benefits: One of the primary attractions of novated leasing is the potential for significant tax savings, as lease payments and running costs are deducted from pre-tax income. This can lead to a substantial reduction in taxable income, ultimately putting more money back into your pocket​​​​.
• Vehicle Choice and Variety: Unlike traditional company cars, novated leasing allows you to choose the car that suits your lifestyle and preferences, whether it’s a sleek sports car or a family-friendly SUV​​.
• Maintenance and Running Costs Covered: Routine maintenance, repairs, and other running costs like fuel can be included in your lease agreement, providing financial predictability and ease of management​​​​.
• Additional Benefits: Many novated leases come with added perks like roadside assistance, offering an extra layer of security and peace of mind​​.

Disadvantages of a Novated Lease

A Novated Lease arrangement is not without its drawbacks also, which should be carefully considered.

• Dependence on Employment: The agreement is tied to your employment. If you change jobs, are made redundant, or face employment instability, the responsibility for lease payments may revert over to you​​.
• Residual Value: At the end of the lease term, you face a decision regarding the vehicle’s residual value. This uncertainty can be a source of stress, as you may have to pay a lump-sum amount calculated at the beginning of the lease​​​​.
• Restrictions and Limitations: You might face limitations like sticking with a particular fuel company or being tied to your employer's choice of lease provider, which may not always offer the best deal​​​​.
• Complexity and Hidden Costs: A novated lease can be more complicated than other forms of car financing, and you might encounter hidden costs or up-sells that are not immediately apparent​​.

Making the Decision

Deciding whether a novated lease is right for you requires careful consideration of your individual circumstances, driving habits, and career stability. It's a balance between financial efficiency and fulfilling your automotive desires. The key is to evaluate the potential tax savings, vehicle choice, and the implications of tying your car financing to your employment status​​.

While a novated lease can offer significant advantages, especially in terms of tax savings and convenience, it's not without its drawbacks. Understanding these pros and cons, and how they apply to your specific situation, is crucial in determining whether a novated lease is the best choice for you.

Factors to Consider Before Deciding

• Your Financial Situation: Assess if the tax savings and the overall cost structure of the novated lease align with your financial goals and capabilities.
• Your Lifestyle and Vehicle Needs: Consider the type of vehicle you need and whether the flexibility and choices offered by a novated lease match your lifestyle.
• Your Career Stability and Future Plans: Reflect on your job security and whether you foresee any significant changes in your employment status, as this can directly impact your novated lease arrangement.

Novated Lease Case Study: A Real-Life Scenario

Let's take a closer look at a real-life example to understand the financial implications of a novated lease. Meet John, an employee with an annual pre-tax salary of $120,000, who is considering buying a 2023 Tesla Model 3 RWD valued at $66,100 for personal use. He is exploring the option of a novated lease through his employer.

Step-by-Step Calculations

Initial Vehicle Cost: $66,100 for the Tesla Model 3.

Lease Term: John opts for a 5-year term.

Running Costs: Including fuel (or charging for an electric vehicle), insurance, maintenance, and registration, let's assume a total of $15,000 over five years.

Tax Savings: By using pre-tax income to cover lease and running costs, John can reduce his taxable income, potentially resulting in significant tax savings. For the sake of simplicity, if we assume a tax rate of 37%, John could save around $5,550 on the running costs alone (37% of $15,000).

GST Savings: On the running costs, John can save the GST (10% in Australia), which would be an additional $1,500 over the five years.

Total Lease Payments: Let's say the lease agreement requires monthly payments of $1,200, totalling $72,000 over five years.

Residual Value: At the end of the lease, John has to decide on the residual value. Suppose it's set at 30% of the initial cost, which would be $19,830 for the Tesla.

Overall Financial Impact

Total Cost Without Lease: Purchasing the vehicle outright along with running costs would be $81,100 ($66,100 + $15,000).

Total Cost With Lease: Including lease payments and residual value, minus tax and GST savings, John would pay approximately $85,780 ($72,000 + $19,830 - $5,550 - $1,500).

In this scenario, while John pays slightly more with a novated lease, he benefits from spreading the cost over five years and reducing his upfront financial burden. Additionally, the convenience and tax benefits during the lease term can be significant.

Conclusion

Choosing a novated lease is a personal decision that depends on various factors including your financial situation, vehicle preferences, and employment stability. While it offers benefits like tax savings, convenience, and flexibility, it also comes with commitments and potential downsides such as dependence on continuous employment and complex terms.

Ultimately, a novated lease can be a financially savvy option for some, but it might not suit everyone's circumstances. It's important to conduct a detailed personal assessment and perhaps seek advice from a financial advisor to determine if a novated lease aligns with your financial goals and lifestyle needs.

Are you considering a novated lease and need more information? Reach out to our team of experts for personalised advice and explore your options in detail. Remember, the right decision is the one that best fits your unique situation.

Ally Home Loans Pty Ltd is your ally in finance for all of your home loan, investment property, business and commercial financing needs. With our wide range of lending solutions, expertise in financial planning and investment strategies, and extensive experience in working with both Australian residents and Australian expats, we are your partners for your lending needs.

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Ally Home Loans Pty Ltd is an Authorised Credit Representative (Credit Representative Number – 494608) of My Local Broker (Australian Credit License – 481374). Important Disclaimer: Your complete financial situation will need to be assessed before acceptance of any proposal or product.