5 tax-efficient financial vehicles (and how to use them)

It’s not always immediately obvious which financial vehicles are more tax-efficient for your situation, and in many cases, investors aren’t focused on the tax implications of their financial vehicles until after they’re retired, at which point it may be too late to make the kind of changes that can help you save money as you’re drawing down on your accounts. As you’re building wealth and setting yourself up for retirement, here are some tax-efficient financial vehicles you may want to consider. However, it may be a good idea to speak to a tax professional before making any decisions.

Roth IRAs

An important thing you should know about a Roth IRA: Whenever you make qualified distributions, they will be tax-free.

Keep in mind that Roth IRAs aren’t for everyone. For 2025, single tax filers under 50 years old can contribute up to $7,000 (or if you’re 50 or over, $8,000) but only if you earn under $150,000 for the year. Once your income hits $165,000, you can’t contribute at all. If you’re married and filing jointly, you can contribute up to $7,000 for 2025 (or, if you’re 50 or over, $8,000) if your household income is under $236,000 annually. Then the sliding scale comes back into play, and when your income reaches $246,000, you won’t be able to contribute.

If you exceed the income limits to contribute, there may still be a way to move assets to a Roth IRA. A backdoor Roth (or Roth conversion) allows for some or all of traditional IRA or 401(k) assets to be converted to a Roth IRA, subject to applicable taxes for the year of the conversion. You can discuss with your tax professional whether a Roth conversion would be suitable for your situation. If you are ineligible to contribute to a Roth IRA and choose not to pursue a Roth conversion, a traditional IRA may be a preferable option under your circumstances.

Traditional IRAs

If eligible, a tax deduction may be available for contributions to traditional IRAs. Deductibility qualification depends on whether you (or your spouse) are covered by a retirement plan at work and your income exceeds certain levels. You can still contribute your after-tax income to a traditional IRA even if you do not qualify for the tax deduction. The 2025 annual contribution limit for traditional IRAs is $7,000 (or $8,000 if you’re 50 or over).

Unfortunately, you may not be able to save enough in an IRA to fund your entire retirement nest egg, but with the help of compound interest, it could add up to be a powerful tool in your tax-advantaged arsenal.

Employer-sponsored 401(k)s

Your employer may offer a 401(k), and you may have the option to choose if your contributions will be treated as pretax or after-tax (like those for a Roth IRA). With a pretax 401(k), 100% of the withdrawals you make are subject to income tax but the tax advantages you get up front may make this account a compelling option to fund your retirement.

With a Roth 401(k), your contributions are after-tax, which means contributions do not lower your taxable income for the year, but your withdrawals are tax-free if they’re qualified. The definition of a qualified distribution from a Roth 401(k) is similar to the definition of a qualified distribution from a Roth IRA, but it is not exactly the same. Please consult your tax professional for details.

Just keep in mind that like an IRA, a 401(k) also has a limit to how much you can contribute – you may be able to contribute up to $23,500 to a 401(k) in 2025. (And if you’re 50 or over, you may be able to contribute an additional $7,500 or more). In addition to allowing employee 401(k) contributions, your employer’s plan may offer matching contributions. An employer match is “free” money, which is hard to find anywhere else.

Municipal bonds

Like most bonds, municipal bonds pay interest each year. That interest is generally exempt from U.S. federal income tax. If the bond was issued by a municipality in the same state you live in, the interest is usually also exempt from state income tax, and if the bond was issued in the city where you live, the interest may be exempt from local tax as well – which is why select municipal bonds are sometimes called “triple-tax-free.” If you live in a state with high income taxes (think New York, California or New Jersey, for example), an investment in municipal bonds may give you an opportunity for additional savings.

There are differences between owning an individual municipal bond and owning a municipal bond fund. Among other things, municipal bond funds may distribute capital gains at the end of the year, and all investors (regardless of the state they live in) will be responsible for paying the applicable taxes on those gains.

While bonds may be part of your portfolio diversification, please consult your financial advisor to determine whether municipal bonds are a suitable investment for your situation.

Exchange-traded funds (ETFs)

If you’re trying to decide between exchange-traded funds (ETFs) and mutual funds with a similar investment mandate, keep in mind that ETFs may be more tax-efficient. Both ETFs and mutual funds are subject to capital gains tax, and you must pay taxes on dividend income from both types of funds. However, the structure of ETFs may result in lower tax costs for the investor. This is because there are generally fewer taxable events in a conventional ETF structure than that of a mutual fund – specifically, passive ETFs tend not to distribute as much in capital gain dividends as mutual funds, due to the lower turnover of securities generally found in such ETFs compared to mutual funds. Also, the method most ETFs use to rebalance their holdings is generally more tax-efficient compared to that of typical mutual funds.

Health savings accounts (HSA)

If you have a qualifying high-deductible health insurance plan, you may want to look into taking advantage of a health savings account (HSA), where your contributions are deductible and your withdrawals may be tax-free as long as you use the money for a qualified medical expense.

Also, keep in mind that an HSA is not the same as a flexible spending account (FSA), because the funds you put into an HSA are yours to keep for life until your account passes to a beneficiary. Unlike an FSA, an HSA does not require you to “use it or lose it” every year, so you can use it for medical expenses in your 30s, or you can wait and tap into that account to pay for health care-related costs in your 70s and beyond. And if you invest the money in your HSA, it may continue to grow until you decide to spend it.

Keep in mind that not everyone qualifies for an HSA – you must be on a high-deductible health plan as defined by the IRS – and like an IRA and 401(k), there are annual contribution limits. For 2025, HSA-eligible singles can contribute up to $4,300 to an HSA, and if you have family coverage, you can kick it up to $8,550.

The bottom line

As you look to your financial future, know that having a mix of both taxable and tax-advantaged accounts and other financial vehicles may be the way to go. They all have their benefits and pitfalls, so one thing you can do is consider being diversified – not just with your investments and other financial vehicles, but with the types of accounts you hold. Also, to help make sure you’re on track, consider meeting with a financial advisor who can help you make the necessary adjustments.

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