Often we’re asked by clients if they should lease a new car, or purchase with a loan instead – with an eye on tax savings.
My first admission is that one of the reasons that I really dislike car leasing is it’s more about marketing the sale of new cars than it is about providing you with an effective way to fund your transport. At the expiry of your lease you will often have your lease provider contact you with an explanation of just how easy it is to roll the lease over to a newer model, rather than retaining your existing car.
There are genuine tax savings available through salary packaging a car lease at times, but the tax benefits are rarely enough to make you better off regularly turning over your car than if you just held onto it for a few more years.
Leasing is simply a form of loan for a car, but it is the tax treatment of those payments when they’re salary packaged that can often bring advantages when compared to the alternatives. Usually the alternative is purchasing the car outright using a car loan, funds drawn against a home loan, or just spending cash you have in the bank.
Here’s a scenario that we recently worked through for our client Jess (not her real name):
- Jess works as a manager and her taxable income is over $120,000. This means her marginal tax rate is 39.0% including the Medicare levy.
- Jess wants to purchase a new 2014 Jeep Grand Cherokee and has been quoted a purchase price of $58,296 to buy the car outright.
- If buying outright, she has a line of credit which she could draw on at an interest rate of 5.50% per annum to fund the purchase.
- To pay the loan down over 5 years, Jess would need to make payments of $1,113.52 each month. Running costs such as fuel, tyres, maintenance and insurance bring the total cost to $1,720.34 each month.
- If taking out a 5 year lease, the monthly payment is $1,694.03. Of this monthly payment, $819.40 is able to be salary sacrificed.
- With the lease – there is what’s often referred to as a balloon or residual payment. Jess would need to pay an additional $16,233.78 at the end of the lease.
So in this case, at the end of the 5 years, here’s the total amounts paid:
- Lease: $103,949 paid (including residual)
- Line of credit: $103,220 paid
You can see that the figures are quite close when comparing the lease (high inbuilt interest rate) to the line of credit (lower interest rate). Interestingly the lease quote says the tax saving is $31,459 over the term of the loan! But this is only compared a salary packaged lease to a non-packaged lease, not comparing it to the lowest cost finance available.
This means that if Jess had to take out a secured personal loan at a rate of say 8.00% per annum – the lease is going to be much better. Likewise, if Jess gets the benefits of salary packaging against income in the top marginal rate of 47.0% the lease will improve in comparison. If however Jess has money in the bank earning interest of only 3.0% (rather than paying 5.5% on a line of credit), that would push the numbers back in favour of an outright purchase.
In Jess’ case because the total amounts were so close together she elected to go for the lease. It might seem strange when the total amount paid is $729 higher, but if the running costs are higher than predicted, that makes the lease more favourable, and the line of credit brings more expenditure in the early years – this means that inflation will reduce the real cost of some of the later payments under the lease.
What does this all mean? Simply that the decision to lease over an outright purchase is far from straightforward, and depends a lot on your personal circumstances. You shouldn’t just accept the savings quoted from the lease provider at face value.
If you’d like to talk about your circumstances a bit more and make smarter money choices – give us a call on (02) 6247 1233.
(image credit: modified from flickr user aussiefordadverts)