Novated leases have changed. If you had one before 2011 you might have had a bad experience with them. We did. The benefits of them used to be calculated around how many kilometres you would travel in your car each year. The higher the kilometres – the higher the tax concessions. If you drove 25,000km or more then the Novated Lease we were offered worked well and was effective for reducing your tax.
For some people like us though, circumstances changed during the period of the lease so that we no longer drove 25,000km each year. While we had Novated Leases explained to us before we took it on we didn’t actually understand much of the detail, but just trusted that it was a good deal. In our case my partner’s job changed and he went from having a 45 minute drive to and from work each day to working on a ship at sea. So he didn’t need a car very often. You can see where this is going…. we had a lot of trouble keeping up the required number of kilometres on the car and in the end the lease was a bad arrangement for us. I have since spoken to other people who had similar experiences. Essentially the rate of Fringe Benefit Tax (FBT) decreased as the number of kilometres increased. So if you drove 5,000km your FBT rate was 20% but if you drove 45,000km your rate was 10%.
BUT Novated Leases Have Changed!!
When the Fringe Benefits Act reforms were introduced in 2011 a flat rate of FBT was applied. So now it doesn’t matter if you drive 10,000km or 50,000km, the FBT is a flat rate of 20%.
So what is a Novated Lease?
A Novated Lease is an agreement between you, your employer and a finance company. Your employer pays the repayments to the lease company for you out of your before-tax salary. This reduces your taxable income and so it can reduce the tax you pay.
How does it work?
If your employer has Novated Leasing as part of a salary packaging offer you can purchase the vehicle you want. There is no restriction on the type of vehicle – it can be new or used, any make or model, size or colour. You buy the car and take out the finance agreement in your name.
Then you, your employer and the finance company sign a Novation Agreement. Your employer agrees to make the lease repayments to the finance company, and makes them as part of your salary packaging arrangement.
What do the lease payments include?
A Novated Lease allows the lease payments, running costs and Fringe Benefits Tax (FBT) to be deducted from your pre-tax salary. This is called a Fully Maintained Novated Lease.
The other option is a Non-Maintained Lease (also called a Finance Only Novated Lease) where only the lease payments and the FBT are deducted from your salary package. In this case you pay for the maintenance and running costs from your after tax income.
In both cases, income tax is calculated on your reduced salary and this can increase your net disposable income (your take home pay) because you pay less tax. Let’s look at the 3 possible parts of the Novated Lease – the Lease Payments, Running Costs and FBT:
Just like the normal leases that I talked about in a previous post, the finance part of it has agreed payments over the term of the lease and there is a lump sum (balloon) payment at the end. The cost of the car, minus the balloon payment is divided over the years of the lease term so you pay the same amount every month. The amount of the balloon payment is based on Australian Tax Office guidelines so the longer the term of the lease, the smaller the balloon payment is. So, if you have a 2 year lease you can expect the balloon payment to be much bigger than if you had a 5 year lease.
As I said, there are two types of Novated Lease – Fully Maintained and Non-Maintained. Some employers offer both, some only one and others don’t offer it at all. The Fully Maintained Lease includes running costs.
These costs are calculated based on the length of the lease and how many kilometres you expect to drive. The kilometres matter here because they determine what car services and maintenance are needed during the lease term. So the costs that are included and paid out of your pre-tax wages include:
- Scheduled servicing and maintenance
- Comprehensive Insurance
- Roadside assistance subscription
Fringe Benefits Tax
All leases now pay 20% FBT and are taxed at 47%. If FBT needs to be paid it can be reduced by paying contributions from your after-tax income. If you are earning less than the top marginal tax rate (the 47%) then the Employee Contribution Method (ECM) can be a useful way of increasing the benefits of the Novated Lease. For every dollar that you contribute in the ECM, you receive a $1 reduction in the FBT liability. This will vary depending on your individual circumstances, so if you take out a Novated Lease make sure you understand whether this applies to you and if you should make extra contributions from your take home pay.
What are the Advantages of a Novated Lease?
- A Novated Lease lets you salary sacrifice some of your pre-tax income to pay repayments on a car. So you are paying for it out of your pre-tax income;
- Lease repayments are fixed for the duration of the lease;
- The lease arrangement can be for 1 to 5 years;
- You can choose what you want the balloon payment to be (as long as it meets the ATO guidelines);
- With a Fully Maintained Novated Lease you fill up with a fuel card instead of using your cash.
- With a Fully Maintained Novated Lease servicing is all built in to the arrangement so there will be no surprises when you pay for servicing during the lease term.
What are the Disadvantages of a Novated Lease?
- The car is yours, so unlike a company car that you just hand back if you leave your employer, with a Novated Lease you own the car. A Novated Lease can be transferred if you move to another employer so this shouldn’t be a problem but if you are used to having a company car just realise that this is a different arrangement.
- If you lose your job you will need to make all the repayments on the lease, just as you would still have to make repayments on any other loans you have. There is insurance you can take out to protect you in case this happens and it can be included in the Fully Packaged Novated Lease.
- The balloon payment at the end of the lease term is your responsibility. If the vehicle has a lower market value than the balloon payment, then you have to pay the difference. This can work in your favour though if the market value is higher than the balloon then you get the difference in value. If you will be doing a lot of mileage over the term of the lease that will tend to reduce the market value of the vehicle, so make sure you understand this part of the agreement.
- If you decide to break the lease early, the payout can be quite high so you want to consider the term of the lease carefully. If your lifestyle may change in a few years (getting married, starting a family, or a new hobby that requires a different vehicle) then consider carefully whether a 5 year term is right for you.
Make sure a Novated Lease is right for You
With a Novated Lease, just as with any loan, you want to be sure that you have all the information you need to make an informed decision. Don’t just assume that because someone you work with has a Novated Lease and says it’s good that the same lease will suit you. Think about what you want to achieve and whether you expect your circumstances to change during the term of the finance.
Find out more
If you would like to find out whether a Novated Lease would be a good fit for you, or your employer offers a Novated Lease and you want to buy your car, just fill in our Enquiry Form and we’ll get in touch with you to talk through the details!
Have you used a Novated Lease before? Would you do it again? We’d love to hear your thoughts!