Many investors confuse the term "tax-free" with "tax-deferred." There's a huge difference between the two. When you make a tax-free investment, the annual income and any profit you make when you sell will not be taxed -- ever. When you make a tax-deferred investment, you will eventually owe tax on the profit the investment generates. However, these taxes can be put off to some future date.
A good example of a tax-free investment is a municipal bond. Interest payments from a muni bond are never subject to federal income taxes (capital gains are taxable), and the interest is also free from state taxes if you live in the state where the bond was issued.
Perhaps the best example of a tax-deferred investment is a traditional Individual Retirement Arrangement (IRA). The investments you make inside the account generate taxable income, but you won't have to pay the taxes until you start making withdrawals in retirement.
