Tax-Free Savings Accounts and Other Places to Save Tax-Free

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Tax-Free Savings Accounts and Other Places to Save Tax-Free

Most savings accounts, as well as comparable locations to store your money, such as money market funds, require you to pay taxes on the interest you earn. A few kinds of savings accounts and other financial instruments are exceptions to this rule and may be worth considering if you want to lower your tax burden while still stretching your resources.

Savings accounts may help you save money on taxes in two ways. Some accounts let you to contribute pre-tax funds, which reduces your taxable income in the year you contribute. Other accounts enable you to earn interest on your money tax-free, lowering your future tax burden.

Key Takeaways

  • Interest earned on savings accounts is usually taxed.
  • Certain tax-advantaged retirement accounts, college savings accounts, and other savings vehicles allow you to reduce your taxable income.
  • Some of these accounts allow you to contribute pre-tax funds, while others allow you to grow your money tax-free.

Tax-Advantaged Retirement Accounts

Saving for retirement should be a top goal, whether you’re just starting out or nearing retirement. Certain kinds of accounts can reduce your taxes, allowing you to save more for retirement.

Individual Retirement Accounts (IRAs)

Individual retirement accounts (IRAs) may help you save money on taxes in a variety of ways. The money you put into a Roth IRA was taxed when you placed it, and the interest you earn will not be taxed when you take it for retirement. You are also not taxed on any interest placed into the account prior to withdrawal.

Traditional IRAs allow you to deduct your contributions from your income, minimizing your tax burden for the year. Your money grows tax-free in the account, and you pay no taxes on the interest it produces. When you withdraw the funds, you must pay income tax at your current rate on both your deposits and the interest generated while the funds were in the account. Traditional IRAs include SEP IRAs and SIMPLE IRAs.

401(k) Plans and Other Similar Savings Accounts

Employer-sponsored 401(k) plans allow you to save a portion of your income for retirement. Because you are not taxed on any income you contribute to a 401(k), every dollar you donate reduces your total taxable earnings for the year. Your company may contribute to the account in certain situations, making it even more attractive.

403(b) plans, like 401(k) plans, are accessible to public school workers and select tax-exempt organizations, while 457 plans are offered to certain government and non-profit employees.

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Earnings on your investments are tax-free in all of these accounts until you remove them. Both donations and profits are then taxed at your current marginal tax rate. Furthermore, for businesses that wanted to provide one, the 401(k) has included a Roth 401(k) option since 2006. As with a Roth IRA, you contribute after-tax income and do not get a tax deduction. However, the account grows tax-free, and withdrawals are tax-free. Employer matching contributions, if any, are taxed upon withdrawal, much like a traditional 401(k) (k).

Flexible Spending Accounts and Health Savings Accounts

Flexible spending accounts (FSAs) and health savings accounts (HSAs) are programs that aid with healthcare bills and, in the case of some FSAs, childcare expenses as well. Although the names are similar, there are several significant distinctions.


  • An employer must sponsor you.
  • Must be established with a deposit amount that is normally disclosed at the beginning of the year and cannot be amended.
  • Do not roll over your money—if you do not utilize it, you will lose it.
  • Are offered to cover both healthcare and childcare costs.
  • You are not required to have a high-deductible health insurance plan.


  • There is no need for an employer sponsor.
  • Anyone with a high-deductible health insurance plan may establish an account.
  • Can be carried over from year to year—you don’t lose money if you don’t spend it.
  • Can earn interest
  • Can only be used for eligible medical expenditures.
  • Can be used as an additional source of retirement funds

For consumers with a high-deductible health plan, health savings accounts may be created. According to the IRS, a high deductible health plan includes a minimum annual deductible of $1,400 for self-only coverage or $2,800 for family coverage in 2021 and 2022.

In addition, yearly out-of-pocket payments under a high-deductible plan do not exceed $7,000 for self-only coverage or $14,000 for family coverage in 2021, but do not exceed $7,050 for self-only coverage or $14,100 for family coverage in 2022. Deductibles and co-payments are examples of out-of-pocket expenditures, but not monthly insurance premiums.

Individuals may contribute $3,600 to a health savings account each year in 2021, while families can contribute $7,200. The contribution ceiling for 2022, however, is $3,650 for individuals and $7,300 for families.

FSAs and HSAs have one thing in common: you contribute to them before you pay income tax on your wages, which allows you to stretch the funds you have to spend on healthcare. If you have one-time or recurrent medical bills or an anticipated treatment that is not entirely covered by insurance, and you have a fair estimate of your medical (and childcare) requirements for the future year, one of these accounts may be worth considering.

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limited scope FSAs are particular forms of FSAs that may be used in conjunction with an HSA. They may be used for vision, dental, and medical expenditures after your insurance deductible has been met.

Education Savings Accounts

College or other educational expenses are another important expenditure for which individuals save money. Certain savings accounts might assist by lowering your tax bill.

529 Accounts

A 529 plan now allows you to invest for both K-12 and postsecondary education fees. (Previously, only post-secondary expenses were permitted.) Prepaid tuition plans, which allow you to pay now for future attendance at certain institutions (locking in current tuition rates), and savings plans, which are invested and grow tax-free, are the two basic varieties. Many states also provide tax breaks on contributions.

Coverdell Education Savings Accounts

A Coverdell education savings account, like a 529 plan, is a trust or custodial account that may be used to pay for elementary, secondary, or postsecondary education expenditures. When made for qualified costs, distributions are tax-free; however, any money left in the account when the recipient reaches 30 must be dispersed and taxed. A 529 plan, on the other hand, has no age restriction for the recipient.

Municipal Bonds

Municipal bonds (also known as “munis”) are bonds issued by municipal governments to fund public-improvement projects. They typically have a defined rate of return and a specified duration. There are short-term bonds that mature in one to three years and long-term bonds that mature in more than a decade.

Municipal bond interest is tax-free in order to stimulate investment in local government initiatives (some, but not all, municipal bonds are exempt from state and even local tax if you live in the state in which the bond was issued).

Munis pay modest interest rates, although the majority are considered low-risk investments. These bonds are popular among those in high tax brackets because they help them decrease their tax burden while still collecting interest, and they are also popular among elderly folks since they are typically low-risk investments.

A bonus: Investing in municipal bonds issued by your local city or municipality enables you to support initiatives in your own neighborhood. You benefit from increased government resources while earning tax-free interest on your savings.

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A municipal bond fund is an option to investing directly in a municipal bond. You must reside in the state where the bond is issued if you wish to be free from state (and even municipal) taxes.

Permanent Life Insurance

A lesser-known option to accrue tax-free growth and income is to employ cash-valued permanent life insurance plans, such as whole life or universal life. These plans have both a death benefit and a cash component that may be borrowed against (or pulled down) while the insured is still living.

This money increases at a moderate pace each year via dividends, which are not often taxed. You will not have to pay taxes if you withdraw money that you donated (the basis). Alternatively, you may borrow against the cash value of your insurance tax-free and allow the policy payouts cover the interest costs.

What are examples of tax-advantaged retirement accounts that’ll help cut your tax bill?

Investing in individual retirement accounts and 401(k) plans will allow you to retain more money in your pocket. A Roth 401(k) is funded using after-tax monies, allowing for tax-free withdrawals after retirement. Public school workers may contribute to their 403(b) retirement plan, while select government and non-profit employees can participate in 457 programs.

What college savings accounts might help consumers pay fewer taxes in the long run?

If you utilize your assets in a 529 or Coverdell education savings account for eligible education expenditures, you may withdraw them tax-free. In 2017, the 529 was extended to include K-12 education and apprenticeship programs in 2019. With a Coverdell, any money left in the account after the beneficiary reaches the age of 30 must be distributed and taxed.

The Bottom Line

The interest earned on savings accounts is often taxed. So investing in a tax-free account will allow you to stretch your money even farther. Although each form of tax-free instrument has restrictions, they are all instruments that may assist you in meeting your financial objectives.

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