Are There Any Tax-Free Investments? A CFP Explains
Two things are certain in life: death and taxes.
Nevertheless, as an investor, you should do what you can within the confines of the law to minimize your tax liabilities. The lower the taxes you pay, the more of your money you can keep.
In a world where taxes seem to nibble at every dollar earned, saved or invested, the idea of tax-free investing sounds almost mythical. But it’s not a fantasy. Whether you’re planning for retirement, saving for college or just looking to keep more of your returns, understanding tax-free investment options can be a game-changer.
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Thankfully, there are many tax-efficient and tax-free investments you can make in the U.S. to reduce your tax liability and maximize your investment returns.
For the sake of clarity, these are divided into five categories:
— Individual investments.
— Insurance policies.
— Specialty savings accounts.
— Retirement accounts.
— Investment funds.
Individual Investments
Municipal Bonds
Municipal bonds are debt instruments issued by state governments, local governments and government agencies to raise money for a variety of purposes.
When you purchase municipal bonds, you will receive interest payments in the form of coupons, and the initial capital invested will be returned at maturity.
Unlike Treasury and corporate bonds, the coupons (interest payments) you receive from municipal bonds are tax-free at the federal level. In other words, you won’t pay federal taxes on them.
Also, if you purchase bonds issued by the state or municipality where you reside, you will be exempt from state or local taxes. However, if you purchase bonds issued by a state or municipality outside of your residence, only federal taxes will be exempt.
Note that this tax exemption does not apply to capital gains. If you sell municipal bonds for profit, you will still pay capital gains tax.
Insurance Policies
Indexed Universal Life Insurance
These are insurance policies that tie your earnings to the performance of a given stock index, while guaranteeing the protection of the principal.
In other words, when the market is down, there is a guarantee that your principal cannot lose value, and when the market is up, you will earn a return equal to the index’s rate of return minus a given percentage. For example, if the index’s rate of return is 10% for a year, you may get 8%. The 2% deducted covers the principal protection offered on the downside.
These insurance policies also have tax benefits. The cash value grows tax-free, and withdrawals up to the total amount of premiums paid are tax-free.
Also, you can borrow against the policy’s cash value without paying taxes. You may also not repay the loan during your lifetime. Any unpaid balance will be deducted from the death benefit. Interestingly, even death benefits to beneficiaries are tax-free.
Specialty Savings Accounts
Health Savings Accounts (HSAs)
These are tax-advantaged accounts where families and individuals with high-deductible health insurance plans (HDHIP) can save for medical expenses not covered by those plans.
For the year 2025, an HDHIP is a health plan with an annual deductible that is not less than $1,650 for individuals and $3,300 for families, and for which the out-of-pocket expenses do not exceed $8,300 for individuals and $16,600 for families, according to the Internal Revenue Service (IRS).
Similarly, contributions to HSAs are capped at $4,300 for individuals and $8,550 for families, while those 55 and older can make catch-up contributions of up to $1,000.
In an age where health care costs in retirement are rising, many are once again rediscovering the importance of HSAs. There are three ways to enjoy tax benefits from HSAs:
— You can contribute pre-tax income to reduce your taxable income.
— Your contributions to the account grow tax-free.
— Qualified withdrawals from the account (for prescription drugs, medical care, co-payments, vision care, dental care, psychiatric treatment, etc.) are also tax-free.
529 Education Savings Plans
The 529 education savings plan is like an HSA for education rather than health care expenses.
It is often considered an alternative to student loans for those who look forward to a college education for themselves or their children.
These plans are available in most states in the U.S., and you don’t need to be a resident of a state to access them. Over 30 states and the District of Columbia offer tax benefits, such as a state income tax deduction or a state tax credit, for contributions to a 529 college savings plan. The specific benefits vary significantly by state, and most require you to contribute to your own state’s plan to qualify.
Though contributions are not tax-deductible at the federal level, there are still two main tax benefits that apply. First, your contributions will grow tax-free. Second, all qualified withdrawals from the account (K-12 tuition, college and post-secondary costs, standardized test fees, educational therapies, online learning subscriptions, credentialing and licensing programs, etc.) are tax-free.
Retirement Accounts
Roth 401(k)
The Roth 401(k) is a variant of the traditional 401(k), the popular employer-sponsored retirement plan.
With a Roth 401(k), you will contribute after-tax dollars. Thus, your money will grow tax-free, and all qualified withdrawals of both contributions and earnings will also be tax-free. For a withdrawal to be qualified, you must make it at age 59½ and above, and the account must be at least five years old.
A Roth 401(k) is preferable if you expect your tax rate in retirement to be higher than it is now. By paying taxes now, you avoid paying higher taxes in the future.
The annual contribution limit for 2025 is $23,500, while those age 50 and older can make a catch-up contribution of up to $7,500. Those between the ages of 60 and 63 can make an additional $11,250 (beyond the original $23,500) if the plan allows it.
Roth IRA
A Roth IRA is a retirement account where you invest after-tax dollars and make tax-free qualified withdrawals of contributions and earnings in retirement. Contributions also grow tax-free.
Like the Roth 401(k), this is a preferable option to a traditional IRA if you expect to be in a higher tax bracket in retirement.
Unlike a Roth 401(k), you don’t need an employer sponsorship to participate in a Roth IRA. If your modified adjusted gross income is within the limit ($165,000 for single filers and $246,000 for those married and filing jointly), you can contribute up to the limit ($7,000 for 2025, with $1,000 catch-up contribution for those age 50 and older).
Investment Funds
Tax-Exempt Mutual Funds and ETFs
Some mutual funds and exchange-traded funds (ETFs) aim to minimize the tax liability of investors by purchasing tax-exempt securities like municipal bonds.
Also, ETFs seek to be tax-efficient by using an in-kind redemption process (investors receive securities instead of cash) to avoid triggering capital gains distributions and paying capital gain taxes.
Thus, if tax minimization is a major factor, you may prefer ETFs to mutual funds.
Donor-Advised Funds (DAFs)
These accounts are created to manage the charitable donations of individuals, families and organizations. A record $54.8 billion was granted to charitable organizations across the U.S. through DAFs in 2023, according to the National Philanthropic Trust.
Contributions to a DAF are tax-deductible, thus leading to a lower tax liability for the relevant tax year. Also, contributions grow tax-free until you have decided on what charitable cause to support with it. When the contributions and earnings are finally sent to the relevant charity, the withdrawal is tax-free.
You can also contribute investment assets like stocks (public and private), bonds and crypto, among others, to a DAF. These assets will grow tax-free until you are ready to make the charitable contribution. When they are sold for this purpose, capital gains tax will not apply.
Qualified Opportunity Funds
These are vehicles that are designed to stimulate investment in economically distressed and low-income communities (opportunity zones). To qualify, a community must have been so designated by the state government, subject to the approval of the Treasury secretary.
Investors are given tax incentives to encourage investment in these communities. For example, if you use capital gains to fund qualified opportunity funds within 180 days of the sale, the taxes on such gains would be deferred until the fund is sold or until Dec. 31, 2026.
Second, the capital gains tax payable on such capital gains will be reduced the longer you hold on to a qualified opportunity fund. If held for at least five years, 10% of the deferred gain won’t be taxed; if held for at least seven years, 15% of the gain will be excluded.
Third, when you hold a qualified opportunity fund for at least 10 years, the capital gains from the sale will be exempt from federal taxes.
Community Development Financial Institutions
The New Markets Tax Credit (NMTC) is another program designed to encourage private investments in low-income and financially distressed communities. These investments are channeled from investors to the communities through Community Development Entities.
Like qualified opportunity funds, there are tax benefits that incentivize investments in these communities. In this case, it is a tax credit of up to 39% of the amount invested that can be claimed against federal taxes and spread over seven years.
Also, from July 2025, this tax credit is now exempt from the alternative minimum tax (which was designed to ensure high-income earners pay their dues even after qualifying for deductions and credits).
The NMTC continues to make an impact in these communities. It generated $8 of private investment for every $1 of federal funding, resulting in the construction or rehabilitation of over 268.2 million square feet of commercial real estate and the creation or retention of more than 888,200 jobs (with an additional 125.6 million more jobs projected), according to the Community Development Financial Institutions Fund.
Bottom Line
In the end, tax planning is only a component of sound retirement and financial planning. Thus, minimizing taxes cannot be the only consideration when making investment decisions.
Your financial advisor will be in a better position to tell you which of these tax-efficient routes to take based on your financial goals and current financial situation.
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Are There Any Tax-Free Investments? A CFP Explains originally appeared on usnews.com
Update 02/27/26: This story was published at an earlier date and has been updated with new information.