Novated leasing is when an employer handles an employee's vehicle lease payments by deducting the payments from the employee's pre-tax salary. This financial arrangement can create tax advantages for the employee and presents a convenient way to finance and manage a vehicle.
However, if approached incorrectly, novated leasing can have some significant risks. Let’s explore some of the most common novated lease traps and discuss the best ways to avoid them, so that you can maximise your tax benefits.
Common novated lease traps
Novated leases can be a convenient alternative to a standard car loan or a traditional car loan. However, like any financial arrangement, there are potential traps or pitfalls associated with novated leases if you don’t know all of the necessary information. Here are some common novated lease traps to be aware of:
1. Unforeseen costs
While novated leasing offers a convenient way to finance and manage car running costs, it also comes with potential risks, particularly in the form of hidden fees. These are charges that may not be immediately apparent upon signing the lease agreement, and could include administrative fees, processing costs, interest rates, lump sum residual fees, or unanticipated penalties.
If you’re considering a novated lease, it’s crucial to thoroughly examine the terms and conditions of the agreement, including the vehicle purchase price or GST savings, and understand the actual costs before signing.
2. Impact on salary packaging
Redirecting part of your pre-tax salary to cover vehicle expenses and novated lease payments can affect your take-home pay. This salary sacrifice could influence your tax bracket and other taxable income considerations. Before entering a novated lease, consider how the modified pre-tax salary impacts your income tax, tax bill, and everyday finances.
3. Residual value risks
Novated leases also carry a large amount of financial risk tied to the residual value, also known as the balloon payment or residual payment, that’s established at the end of the lease term. If this value is set too high, lessees may find themselves owing more than the actual worth of the vehicle when the lease ends.
Conversely, a low residual value could result in higher monthly novated lease payments during the lease term, negatively affecting the lessee's budget. It's essential to find the right balance when determining residual value, as miscalculations in either direction can have significant consequences that severely impact the financial feasibility of the novated lease.
4. Restrictions and penalties
Novated leases carry inherent risks, often placing restrictions on vehicle use such as mileage limits and specific maintenance requirements. Exceeding these limits may incur penalties or additional charges for lessees. This can be a significant downside for individuals whose driving habits may change unexpectedly and potentially result in unforeseen financial consequences.
5. Job changes and early termination
Changes in employment can introduce additional risk to novated leases. If you change jobs and need to end a novated lease early, it can trigger additional penalties and fees that add unexpected financial burden. Additionally, terminating a novated lease early might make you responsible for the residual value or balloon payment of the vehicle, piling on even more financial repercussions.
6. Insurance coverage
Novated leases typically include insurance to safeguard the vehicle and lessee. However, risk can arise when the coverage provided by the novated lease provider doesn't align with your individual needs. It's essential to ensure that the coverage provided by your novated lease suits your specific requirements and effectively addresses all potential risks.
If there are significant coverage gaps, you could face unexpected financial burdens or liabilities in the event of accidents, theft, or other kinds of damage. This is important to note if your new vehicle is an electric vehicle, such as a Tesla.
7. Lack of flexibility
Another potential downside of novated leases is their lack of flexibility, especially when circumstances change. Typically, novated lease agreements have set lease terms that don't easily accommodate unexpected changes.
If you enter into a novated lease agreement too quickly, you may find yourself unexpectedly bound by a rigid agreement and unable to make necessary adjustments. This lack of flexibility could lead to financial strain or result in a leased vehicle that’s impractical for your current needs, unlike a car purchase or a private sale.
How to avoid novated lease traps
Avoiding novated lease traps like these requires a strong understanding of how novated leasing works, as well as careful consideration of your lease agreement. Here are some tips to help you steer clear of the potential pitfalls:
1. Thoroughly review terms and conditions
Thoroughly read the terms and conditions outlined in the novated lease agreement and make sure you understand them completely. Take note of any specific details, like fees, penalties, mileage limits, lease payments, running costs, GST discount, and maintenance requirements.
It’s important to make sure you’re fully informed about all costs related to your novated lease. Not just the monthly novated lease payments, but also potential hidden fees, insurance costs, and any other charges that may arise.
2. Plan ahead for lifestyle changes
You should also consider the flexibility of the novated lease terms and plan for any impending lifestyle changes. Make sure that the agreement you sign allows for adjustments in case of a new job or other unforeseen circumstances, and consider ahead of time what types of penalties or fees may be associated with such changes.
Always remember to periodically review your financial situation and assess whether your novated lease continues to be the right option for you. If your circumstances change, consider whether adjustments to the lease may be necessary.
3. Carefully evaluate residual value
Carefully assess the residual value (balloon payment) at the end of the novated lease term. Make sure that it’s reasonable and aligns with the expected depreciation of the new car or vehicle purchase price. Taking the time and effort to verify a realistic residual value now will pay off later by ensuring you don’t owe more than the car's market value.
4. Ensure adequate insurance coverage
You should also take the time to thoroughly review the insurance coverage that’s provided with the novated lease. Make sure it meets your needs and adequately covers your anticipated level of risk. You may also need to explore additional insurance options if the coverage offered by your novated lease provider is not adequate.
5. Seek professional advice
Before you enter into any novated lease agreement, make sure you consult with reliable experts who can help you make the best choice for your needs. Our expert team can help you find the perfect novated leasing option for your circumstances and lifestyle. You may also want to consult with a financial advisor or tax expert to make sure you fully understand how a motivated lease will affect your income and taxes.
Why is novated leasing a great option?
Novated leasing can be a great option as long as you’re careful and take the time to understand how it works. Here are several reasons why novated leasing can be a fantastic choice as long as you steer clear of the well-known traps.
Tax Benefits: When you sign a novated lease, it will influence how much you owe in taxes. In some cases, this can be a downside. In others, it can be a benefit. The portion of of your salary that’s used to cover lease payments and vehicle expenses can typically be deducted from your pre-tax income, potentially lowering your taxable income.
Fixed Monthly Payments: A novated lease offers the advantage of consistent monthly payments over the entire lease term. This high level of predictability can make it easier to streamline your budget and plan your finances for the future.
Fleet Discounts: Employers often negotiate fleet discounts with vehicle dealerships in order to allow employees to get better prices on vehicles. Opting for a novated lease through an employer with a fleet discount is much more affordable than purchasing a vehicle independently.
Convenient Vehicle Management: Novated leases also provide a convenient way to manage the costs of a vehicle. A novated lease typically covers a range of vehicle-related expenses, such as fuel, maintenance, insurance, and more, making it much easier to budget for the running costs of having a car.
Flexible Vehicle Options: As long as you pay careful attention to the details of your lease agreement, novated leases offer a great deal of flexibility. A novated lease arrangement typically allows you to choose from a wide range of different types of cars to suit your particular needs and lifestyle.
Easi, novated leasing you can trust
Novated leasing is an appealing option for anyone in Australia who wants a straightforward and tax-free way to finance vehicle ownership. By avoiding common pitfalls like hidden costs and inflexible terms, you can enjoy the perks of easy vehicle management, steady monthly lease payments, and potential income tax savings without taking on any unnecessary risks from a standard car loan.
When you choose Easi as your novated lease company, not only do you get access to incredible fleet discounts, but you also get a hassle-free experience and comprehensive administrative support. If you’re interested in an electric vehicle, you can now get one exempt from fringe benefits tax (FBT).
Let us be your trusted ally as you navigate the many potential pitfalls of novated leasing. Our specialists are here to guide you through the entire novated leasing process to make sure you maximise your savings.
