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How does a car allowance work and is it worth it? Here are six big benefits.

9 minutes to read

Understanding how a car allowance works is important when deciding if it’s right for you. Essentially, a car allowance is where your employer provides you with a cash allowance towards a car. This gives you choice, flexibility and helps with the cost. Sounds good, right? Well, there are a few things to consider first, such as maintenance, insurance and running costs.

Personally, a car allowance is an option that’s been available to me for some time. However, in the past, I’ve always gone down the company car route. Recently, though, I’ve been reconsidering my options and doing some digging. Here’s how a car allowance works and the things you need to know.

Is a company car worth it? – 5 surprising benefits

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How does a car allowance work?

A car allowance works by an employer making a contribution to an employees salary so they can procure a car. Importantly, the employee is then responsible for buying, maintaining and insuring the car. Ultimately though, it can offer a great deal of choice and flexibility, so it may well be right for you.

Essentially, this is the employer contributing towards an employees car, where they have to use it for business purposes. This could be for making business trips as part of the job, such as visiting client sites. Or it could also be simply for commuting to your place of work.

Generally, a car allowance is provided for roles that incorporate a degree of travel, such as sales. However, it is also often seen as a perk in packages aimed at management and executive positions.

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Is a car allowance part of my salary?

A car allowance is a sum of cash, in addition to your salary, paid to you on a monthly basis. This is usually at the same time you get paid.

It is usually packaged by your employer on top of your salary. But, as far as HMRC are concerned, it is still taxable income.

However, unless you are part of a salary sacrifice scheme, you will pay income tax and National Insurance (NI) on your car allowance.

Crucially though, it does not contribute towards pension payments.

Do I pay tax on my car allowance?

You will pay income tax and National Insurance on your monthly car allowance, based on your personal tax circumstances.

For example, on a £6,000 annual car allowance, a higher-rate taxpayer would pay 40% income tax and the additional 2.5% National Insurance rate.

£6,000 x 0.575 (42.5% tax) = £3,450 / 12 months = £287.50 per month.

Remember, this will all be subject to your individual tax circumstances.

How does a salary sacrifice car scheme work?

Rather than a car allowance, some companies may offer a salary sacrifice scheme which means you don’t pay tax.

This is where the company leases the car and the employee finances the car through payroll deductions.

For the company, it is usually cost-neutral. And you benefit from tax savings and the company’s right to make VAT deductions, which is usually passed on.

These schemes are growing in number and are often in conjunction with hybrid or electric vehicles. So, you can get a brand new car at the fraction of a lease cost, and make the planet better. Nice.

Personally, this is the route I’m exploring with my company.

Check out Octopus EV to find out more about salary sacrifice for electric cars. You can even petition your employer to join!

What mileage can I claim if I get a car allowance?

This will come down to how your employer chooses to operate.

If you're offered free fuel for private use

If your employer offers free fuel for private journeys as part of the car allowance package, you will have to pay Benefit in Kind (BiK) tax on this (at your personal income tax rate).

As you only pay tax on miles you drive, if you drive a lot of private miles, this could save you a decent sum. But if you only pootle around town now and again, it may not be worth it.

If you get paid for business miles

Typically, the employer will pay business mileage rates to cover business trips when you use your car.

The rate will be at the employer’s discretion, but many use the HMRC Advisory Fuel Rates.

Plus, if you have another employee from the same company in the car with you, you can often claim an extra pence per mile rate.

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How much car allowance can I expect?

How much car allowance your employer chooses to offer them is at their discretion.

However, it is often influenced by factors such as your role and position within the company. For example, company heads and Directors will typically expect a high car allowance than junior managers.

You can find how much the average car allowance is for various positions here.

What am I repsonsible for?

Fundamentally, when your employer gives you a car allowance, you are responsible for procuring and maintaining the car, which may include;

  • Checking fluids and lubricants regularly
  • Tyre pressure and tread checks
  • Windscreen repairs
  • Security (alarm, possibly off-road parking)
  • Servicing
  • Repairs
  • Insurance (including for business use)
  • Road tax
  • Motoring offences

Often, a car allowance will come with a company policy regarding conditions, limitations and detailing exactly what you are responsible for, so make sure to check this out.

Crucially, make sure you account for these expenses and budget accordingly by allocating a portion each month for your ‘car fund’. Ideally, you would do this automatically when you get paid using something like a ‘pot’ system in your Monzo or Starling bank account. Check out our Budget like a pro article for more details on this.

Six big benefits of a car allowance

1. You get to choose your car (which may be subject to conditions from your employer).

2. Choose how you finance the car – purchase, lease, Hire Purchase, PCP, bank loan, it’s up to you.

3. Get to keep the car – it’s your car, so if you leave the company you still keep it, plus any remaining value if and when you sell or trade it in.

4. Change at any time – you get to change your car when you want, to what you want. If your circumstances change and you now need a family wagon, for example, then you can. By contrast, often with company cars, they are replaced at fixed intervals or at the employers’ discretion, which could be many years.

5. No tracker – many employers fit GPS trackers to company cars, which you may not be comfortable with. But this is your car, so it’s your rules.

6. You may make money – if you already own a car you’re happy with and it meets the employers’ conditions, you could actually pocket the car allowance and use it to invest!

(The benefits above are relevant to a traditional car allowance scheme and not salary sacrifice).

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Three disadvanatges of a car allowance

1. Make and model restrictions – your employer may make stipulations about the car specification, such as four doors, no convertibles etc).

2. You are responsible for the finance – if you funded the car on a PCP or bank loan for a fixed term such as five years, for example, then if you leave the company before this (or worse, get made redundant), you will still be responsible for making the repayments.

3. You are responsible for maintenance and repairs – you can’t get the fleet manager to sort out the service this time, sunshine. Paying for and arranging all necessary repairs and services is on your shoulders, and often on your own time.

So, is a car allowance a good idea?

Ultimately, a car allowance helps you fund a car of your preference and gives you choice and flexibility. But it is seen as part of your salary by HMRC and therefore taxed accordingly.

Remember though, you are responsible for processing, maintaining and insuring the car, so there are lots of additional costs on top of the financing.

Personally, as someone who is equally interested in being tax-efficient and kind to the planet, I’m exploring the electric vehicle via a salary sacrifice route. In today’s modern world, though the technology still has challenges, it will save me money and it feels like the right thing to do for the planet.

Here’s to Financial Fitness.

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EatSleepMoney.co.uk does not offer financial advice and is intended for reference/information only. Remember, you should always carry out your own research and/or take specific professional advice before choosing any financial products or services or undertaking any business or financial venture. If you need financial advice Unbiased can connect you with a suitable professional for free. Investments may go up as well as down and you may get back less than you put in.