5 Popular Investments That Are Tax Free

Investing offers a path to financial growth, yet the returns generated are often subject to various taxes, diminishing the overall benefit. Understanding investment vehicles that provide significant tax advantages can help individuals retain a larger portion of their earnings. These “tax-free” investments generally refer to situations where income, growth, or withdrawals are exempt from federal, and sometimes state and local, income taxes. By strategically choosing tax-advantaged options, individuals can maximize their wealth accumulation over time, allowing for greater compounding of returns.

Municipal Bonds

Municipal bonds are debt securities issued by state and local governments or their agencies to finance public projects such as schools, hospitals, and infrastructure improvements. The interest income earned on these bonds is generally exempt from federal income tax. If the bondholder resides in the state or locality that issued the bond, the interest may also be exempt from state and local income taxes. This dual exemption makes municipal bonds particularly attractive for individuals in higher tax brackets, where the tax savings can significantly enhance their after-tax yield compared to taxable bonds.

Municipal bonds typically fall into two main categories: general obligation bonds and revenue bonds. General obligation bonds are backed by the full faith and credit of the issuing government, meaning they are repaid from the issuer’s general tax revenues. Revenue bonds, conversely, are repaid from the revenue generated by the specific project they finance. Investors generally purchase municipal bonds through brokerage firms. While municipal bonds offer substantial tax benefits, their interest rates are often lower than those of comparable taxable bonds due to their tax-exempt status.

Roth Retirement Accounts

Roth retirement accounts, primarily Roth Individual Retirement Accounts (IRAs) and Roth 401(k)s, offer a distinct tax advantage: contributions are made with after-tax dollars, but qualified withdrawals in retirement are entirely tax-free. This contrasts with traditional retirement accounts, where contributions may be tax-deductible, but withdrawals in retirement are taxed as ordinary income. The core benefit of Roth accounts lies in the tax-free growth and tax-free withdrawals of both contributions and earnings, provided certain conditions are met, such as being age 59½ and having held the account for at least five years.

For 2025, the general contribution limit for Roth IRAs is $7,000, with an additional $1,000 catch-up contribution permitted for those age 50 and older. Eligibility for contributing to a Roth IRA is subject to income limitations. Roth 401(k)s, available through employers, have a higher contribution limit of $23,500 for 2025, with a $7,500 catch-up contribution for those age 50 and older. Investments held within Roth accounts grow tax-free, allowing for significant wealth accumulation for retirement planning.

Health Savings Accounts

A Health Savings Account (HSA) is a tax-advantaged savings account designed for healthcare expenses, available exclusively to individuals enrolled in a high-deductible health plan (HDHP). HSAs offer a unique “triple tax advantage.” First, contributions to an HSA are tax-deductible. Second, the funds within the account grow tax-free. Third, qualified withdrawals for eligible medical expenses are entirely tax-free.

For 2025, the annual contribution limits for HSAs are $4,300 for individuals with self-only HDHP coverage and $8,550 for those with family HDHP coverage. An additional catch-up contribution of $1,000 is allowed for individuals age 55 and older. While HSAs are primarily for current medical expenses, they can also function as a long-term retirement savings vehicle for healthcare costs. After age 65, withdrawals from an HSA used for non-medical expenses are taxed as ordinary income, but withdrawals for qualified medical expenses remain tax-free at any age.

Education Savings Plans

Education savings plans, particularly 529 plans, offer substantial tax advantages for saving for future education expenses. These plans provide tax-free growth on investments and tax-free withdrawals when funds are used for qualified education expenses. Qualified expenses include tuition, fees, books, supplies, equipment, and room and board for students enrolled at least half-time in an eligible educational institution. Additionally, up to $10,000 per year can be withdrawn tax-free from a 529 plan per beneficiary for K-12 tuition expenses.

While contributions to 529 plans are not federally tax-deductible, many states offer a state income tax deduction or credit for contributions made by their residents. Anyone can open and contribute to a 529 plan for a designated beneficiary, and there are no income limitations for contributors. The funds can be used for a wide range of beneficiaries. Coverdell Education Savings Accounts (ESAs) are another option, but typically have lower annual contribution limits, generally $2,000 per beneficiary, and are subject to income restrictions, making 529 plans a more flexible option for many families.

U.S. Savings Bonds

U.S. Savings Bonds, specifically Series EE and Series I bonds, offer distinct tax advantages, particularly regarding state and local income taxes. The interest earned on these bonds is exempt from state and local income taxes. Federal income tax on the interest can be deferred until the bond is redeemed or reaches maturity, whichever comes first.

A significant conditional federal tax exemption applies to U.S. Savings Bonds: the interest can be entirely federal tax-free if the bond proceeds are used to pay for qualified higher education expenses. To qualify for this education savings bond program, certain income requirements must be met, and the bond owner must be at least 24 years old at the time the bond was issued. Both Series EE and Series I bonds can be purchased electronically through TreasuryDirect. These bonds are considered a safe investment because they are backed by the full faith and credit of the U.S. government.