Master Limited Partnerships
Along the same lines as dividend-paying stocks, we have master limited partnerships. MLPs are operating businesses that tend to be concentrated in the oil and gas sector. Like dividend-paying stocks, a large chunk of their total returns come from their cash distributions, but because MLPs are organized as partnerships rather than corporations, they avoid paying federal corporate income taxes.
In nutshell, this means they have 35% more cash at their disposal to distribute. And because many MLPs have large non-cash expenses, such as depreciation, those distributions often end up being tax-free for years at a time. Not bad.
A lot of investors are intimidated by MLPs, and they shouldn’t be. Yes, come tax time, you have to deal with a pesky K-1 form, and no, you can’t hold most MLPs in an IRA account without creating a potential tax nightmare. But most K-1 forms can be uploaded to mainstream tax programs like TurboTax, and if your CPA gripes about them or tries to charge you more to do your taxes … well, perhaps it’s time to find a new CPA.
And as for holding them in a non-IRA account, it’s hardly much of an administrative burden to open a regular brokerage account if you don’t have one.
If you’re bound and determined to hold MLPs in an IRA account, or if you are investing only a modest sum, you could always buy an MLP mutual fund or ETF product, such as the JPMorgan Alerian MLP ETN (AMJ). I use this security in client IRA accounts I manage. But where possible, I prefer to avoid the hefty 0.85% expense ratio and enjoy the favorable tax treatment of holding individual MLPs.