How to make tax-free investments

1 min readLast updated June 13, 2024by Rachel Carey

Large tax bills are the enemy of any investor. But what if there were ways to invest tax-free? Here’s a roundup of the top eight ways to invest tax-free.

What are tax-free investments? 

Avoiding excessive tax on your investments is a key concern for many investors. It can be disheartening to make a modest profit and lose much of it to federal, state, and local capital gains taxes.

These taxes, depending on how long you've held the asset, can be up to 37% of your profit.

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Thankfully, there are legal ways to invest and pay far less tax, or even none at all, on the profits you make — without coming up against the IRS. 

Tax-free investments are an excellent way to build your financial future and can include everything from improving your local area to your children’s future.

Here are eight tax-free investment options. 

What tax-free investments can you incorporate into your portfolio?

If you’re ready to start making your tax-free investments, here are some options to consider: 

1.Tax-exempt mutual funds

Mutual funds can be a great option if you’re looking for a more diverse investment than a single bond.  

Some have tax-exempt status, meaning you won’t pay capital gains taxes on any money you make.  

Tax-exempt mutual funds typically invest your money in government or municipal bonds—but check the fine print to ensure they’re triple-tax-free. Some bonds, like Treasury bonds (T-bonds), are exempt from local and state taxes but not federal taxes.  

2.Tax-exempt exchange-traded funds (ETFs)

ETFs are similar to mutual funds, except you can trade them on the stock market at any point. They can be cheaper to invest in, as many track the performance of an index like the S&P 500 rather than employ a fund manager to buy and sell shares.  

Tax-exempt ETFs are generally focused on bonds. Many providers offer ETFs catering to your goals, with options for a range of timelines—including short-term investments and long-term, retirement-focused savings.  

3.Municipal bonds

Also known as “muni” bonds, these bonds are used to help local governments pay for public projects, like building roads, schools, and public facilities. Think of them like a loan, but instead of borrowing from the bank, the government borrows the collective funds of individual investors. As they’re issued and backed by the US government, there’s virtually no risk of you losing money. 

You’ll get a guaranteed return in the form of interest payments and a clear timeframe for being paid back in full. However, returns from muni bonds are modest and can be impacted by inflation and interest rates. Nevertheless, municipal bonds are a good option if you’re looking for a steady, ultra-low-risk, and tax-free investment. 

4.Qualified opportunity funds

You can get tax breaks for investing in economically disadvantaged areas via a fund.  

This is a popular option for people who’ve made a large gain from selling a business, property, or other investment and want to defer their capital gains tax obligations. Your taxable gain reduces every year you hold the investment, so long-term investors can potentially avoid tax altogether.   

5.Qualified small business stock

You can invest in a C corporation and sell your stocks for $10 million or more without paying tax. No, we’re not joking. The rule also applies to owners and employees who hold stock in a US C corporation but not those who own or are invested in sole proprietorships, LLCs, or subchapter S corporations.  

If your stock was issued for money, property, or services after August 10, 1993, and the business had less than $50 million in total gross assets, you could take advantage of a serious tax break.  

6.Indexed Universal Life (IUL) insurance

While it’s not a traditional investment, an IUL policy is a good route for setting your loved ones up for tax-free gains.  

With this type of life insurance, you’ll earn tax-free interest on the cash you pay in and can take a tax-free loan from your pot anytime. Even if you take money out, your spouse or children will still get your death benefit—which is also tax-free.

7.Roth IRA/401(k)

A Roth IRA or 401(k) are two smart routes to investing tax-free for retirement.  

The only drawback is their limits; $6,500 per tax year for an IRA and up to $30,000 for a 401(k). However, if you’re investing a modest amount per year and are happy not to use the funds until you’re 59 ½, these could be the ideal investment vehicles.  

8.Health Savings Accounts (HSAs)

If you’re worried about medical expenses on your high-deductible insurance plan, an HSA is an excellent option. Your contributions are made pre-tax, which reduces your overall annual tax bill, and you can withdraw funds tax-free for qualified medical expenses. Some HSAs also let you invest, making your money potentially go even further.  

How to find the right tax-free investment

One thing to consider about tax-free investments is that they tend to generate lower returns or have a ceiling for how much you can invest via certain channels each year. If you’re a lower earner, you’ll be subject to lower tax rates, meaning you may not have to pay as much tax on traditional investments as you initially thought. You may also have to pay investment fees, which, combined with modest returns, mean tax-free investments aren’t as rewarding.  

Working with a trusted advisor is sensible when choosing the right tax-free investment. They’ll also help you avoid scammers who claim to help you invest tax-free but end up placing your money in illegal tax avoidance schemes. 

Find the right advisor for you through Unbiased today.

Senior Content Writer

Rachel Carey

Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.