It is past the middle of the financial year 2009-10. Tax planning measures should already have been initiated by individuals. If not, it is the right time to start planning, rather than waiting for March.

Tax planning should be a well thought of and planned exercise. It is not just a matter of saving tax today. It is also a matter of planning your future cash flows and tax liabilities. There are limited tax-planning options which one may choose from. It is advisable to make the best use of these options.

Taxsaving instruments for deduction

There are a number of taxsaving instruments qualifying for deduction under Section 80C of the Income Tax Act.

Section 80C allows a deduction of Rs 1 lakh from the gross total income for specified investments. These include provident fund (PF), public provident fund (PPF), life insurance, national savings certificate (NSC), equity-linked savings scheme (ELSS), and home loan repayment, to name a few.

An employee's contribution to a recognised provident fund qualifies for deduction under Section 80C.

One can also invest in PPF. It is safe and has high post-tax effective returns (eight percent tax-free returns work out to effective returns of 11.57 percent for those in the highest tax slab).

The tenure of a PPF is 15 years and one must open an account in the early years to take advantage of the effect of compounding. The minimum investment required is Rs 500 per year. The maximum contribution allowed in any year is Rs 70,000.

The contribution may be for self or dependants. Then there is the NSC sold through post offices. NSC has a lock-in period of six years and an interest rate of eight percent compounded half yearly. The interest received is taxable and hence the effective posttax yield is low.

Banks offer 5-year fixed deposits which are eligible for deduction. However, the interest received is taxable. The lock-in period is lesser. Premiums paid for life insurance plans are deductible. One may take insurance for himself or his family members.

One may also choose ELSS. ELSS offers the twin benefits of tax-saving and equity investing. ELSS is an equity mutual fund with a lock-in period of three years. The dividends declared are tax-free since the gains are long-term in nature. There is no capital gains tax on these. Investments can be made in small amounts. These are suitable for investors with a high risk appetite.

Taxsaving instruments qualifying for deduction

Investments in post office time deposits, senior citizens' savings scheme, notified tax saving schemes and contributions to pension funds also qualify for Section 80C deduction. Home loan principal repayments and tuition fees of children also qualify for this deduction.

Besides returns, one needs to consider age, risk appetite, cash inflows and outflows, fund requirements, lock-in periods, safety of principal, and interest while taking investment decisions. A reasonable allocation must be made over various instruments. It is best not to keep all eggs in one basket. One should diversify the investment portfolio so that risk is minimised.

It is very important to consider the tax status of the returns. In some cases (like interest from fixed deposit and NSC), the returns are taxable. While in others, like interest on PPF, it is exempt from tax. This affects the effective yield from the investments.