Is a Novated Lease Really Worth It in Australia?

If you're based in Australia and considering a new car purchase, there's a financial product that can legally cut your income tax, some GST, and in some cases  leave you paying almost nothing extra. It's called a novated lease, and most people who have one still don't really understand how they work. Get this wrong and it could cost you thousands! Get it right and it's one of the cheapest ways to purchase a car in Australia.

A novated lease works by using pre-tax salary to pay for a car and its running costs. But note, the savings only hold up if the fringe benefits tax side of it is structured properly. That's the part most people skip over, so that's a big focus of this blog post.

What is a novated lease and how does it actually work?

A novated lease is a three-way deal between you, your employer, and a leasing/finance company. You pick the car, and the leasing company buys it on your behalf. Instead of paying the leasing company yourself, your employer takes over the repayments and funds them out of your salary, before tax comes out.

That last part is the whole point. A chunk of your pay never gets taxed as income, so you end up being taxed on a smaller number. If you earned $2,000 a week and your lease cost $200, you'd only pay income tax on the remaining $1,800, not the full $2,000. Business owners will understand this concept as a 'tax shield', which effectively reduces the cost of the underlying purchase.

Most novated leases don't just cover the car either. Fuel, insurance, servicing and registration usually get bundled in too. It might sound overly technical, but in essence, you're just switching up the way you pay for the car so the cost comes out of pre-tax income, instead of after-tax.

How much tax can a novated lease actually save you?

Say you earn $100,000 a year and your total car costs, lease payments and running costs combined, come to around $15,000 a year. Instead of paying that out of your take-home pay, it gets taken out of your salary before tax. So instead of being taxed on $100,000, you're taxed on roughly $85,000.

You haven't earned any less. You've just changed how car payments are paid, before tax touches it. Because Australia's income tax is progressive, cutting your taxable income at the margin matters. At a marginal tax rate of 37%, that shift works out to somewhere around $5,500 a year in tax saved. Your own number will depend on your income and lease costs, but the mechanism is the same.

Pre-tax money is doing work that after-tax money used to.

Why isn't everyone on a novated lease?

If it really was this simple, everybody in Australia would have one! There's a catch, and it's not a small one. Sitting behind all of this is something that can wipe away the entire benefit if it isn't set up correctly. Many get caught out by this. Don't just hear "pre-tax income" and "cheaper car" and sign up without understanding what's actually happening underneath!

When your employer pays for something on your behalf, like a novated lease in this case, the tax office treats that as a fringe benefit. Of course, there's a tax called Fringe Benefit Tax, of FBT. FBT is calculated in a way that roughly lines up with the top marginal tax rate, so a poorly structured novated lease can end up handing back most of the saving you thought you were getting.

How do most novated leases get around the fringe benefits tax?

Most novated leases in Australia are set up so a slice of the payments come out of your after-tax income rather than your pre-tax income. It sounds like it defeats the purpose, but it doesn't. Contributing part of the cost from after-tax salary offsets the fringe benefit, which reduces the FBT liability.

The result gives you some of the benefit of paying with pre-tax dollars, but with the benefit of not incurring the extra tax that would otherwise cancel it out. This after-tax contribution method is how the majority of novated leases are structured today, not the simplified "all pre-tax" version that gets talked about.

Does an electric vehicle change the numbers?

Yes, and it's one of the more useful quirks of the current rules. Under the eligible EV exemption, electric vehicles don't attract fringe benefits tax at all. That means there's no need to offset anything with after-tax contributions, which makes the lease much more efficient than one on a petrol or diesel car. It's a big part of why novated leases and EVs get talked about together so often.

What else do you get from a novated lease beyond the tax saving?

The tax angle gets most of the attention, but cashflow is another big reason why people opt for a novated lease. Ordinarily, costs of running a car like rego, insurance, servicing and fuel are lumpy throughout the year. With a novated lease, these are all folded into one regular payment so there's steady cash outflows during the lease.

You may also get a better price on the car since leasing companies often buy at fleet pricing. This can result in you getting a better price than what you'd pay walking into a dealership. And once it's set up, it's pretty easy from there. Payments happen automatically and everything is managed through one payment.

What are the real costs and catches to watch for?

It's important to remember that a novated lease, despite its benefits, it not a free car. You're still paying interest to a finance company, just like any other loan, and there are fees and administration costs built into its structure. And, of course, the car still depreciates like any other car.

At the end of the lease there's also a residual value, a lump sum you have to pay if you want to keep the car after the lease. As with any loan balloon, this means your average balance remains higher throughout the amortisation schedule, so the overall interest bill may be higher than an ordinary loan. So if you want to own the car at the end of the lease, you must account for paying this balloon at its maturity. This could amount to $10,000+, depending on the terms of your lease.

In some cases, the total cost of a novated lease can actually work out higher than buying the same car with cash. How you structure a novated lease is what determines its effectiveness, so just be mindful of this.

Who does a novated lease actually suit?

Generally, novated leases work better for higher income earners as they sit in higher tax brackets. Moving the payments to pre-tax means they're effectively offsetting income at a much higher marginal tax band (as high as 45% in Australia). They can also be a good fit for anyone looking at an EV, given the FBT exemption removes one of the more complicated parts of these.

If you change jobs often, it's worth thinking through carefully however as the lease itself stays with you, but the salary-packaging arrangement through your employer usually doesn't carry over automatically. Novated leases are a complex product with real tax implications, so it's worth running your specific numbers past an accountant before signing up. This article is general information only, not personal financial advice, and it doesn't account for your individual circumstances.

What are the most common novated lease mistakes?

The biggest one is focusing on the tax saving, and not considering the total cost. That's usually what pushes someone from a reasonable purchase into something pricier they wouldn't have otherwise considered. On paper the after-tax cost looks smaller, but this is still a lending product with dealers and leasing companies making money out of you regardless.

The second is not planning for the residual value at the end of the lease. That final payment can be very substantial, so you need to ensure you budget for this. Then there are the smaller line items, like fees, interest rates and packaging costs. These are often baked into the package to make them less obvious upfront.

So, is a novated lease worth it?

A novated lease isn't a magic trick and it isn't free money. Structured properly, with the FBT side handled correctly, it can be a smart way to run a car in Australia. Treated a novated lease as an excuse to spend more because it "feels cheaper" after tax, can just as easily cost you. The saving is real, but so is the risk of getting the whole thing completely wrong.

Frequently Asked Questions

Is a novated lease only available if my employer offers it?

Yes. A novated lease requires your employer to agree to make the payments on your behalf through salary packaging, so it isn't something you can set up yourself with a leasing company.

What happens to a novated lease if I lose my job or change employers?

The lease itself stays with you as an individual, but the salary-packaging arrangement is tied to your employer. If you switch employers, your new one will need to agree to take it over. If they don't, you may need to pay the lease from after-tax income instead.

Can I buy the car outright at the end of a novated lease?

Yes, but only by paying the residual value. This is a lump sum set at the start of the lease. Your regular lease payments don't consider this amount, so it's an extra cost to plan for if you want to keep the car at the end of the lease.