Please be sure to read Part One before you read this part. In it, I discuss the very real possibility that a retiree, if his money is invested in a tax-deferred account such as a traditional IRA or a 401(k), may be forced to withdraw more from his account than the recommended 4%.
So you find yourself in the somewhat enviable position of being required to withdraw more annually from your IRA of 401(k) than you actually need or want to spend. You don’t want to spend this “extra” money, but you can’t put it back into the account from which you withdrew, and you can’t open a new tax-deferred IRA.
But there is still one way to get tax-deferred income, without the use of a tax-deferred investment account.
The option that I really like is to open a taxable investment account, but to fill it with Master Limited Partnerships, or MLPs.
An MLP is great in an income portfolio, because it pays out a large part of its income as distributions to its partners, i.e. shareholders. These distributions are then subject to a very favorable tax treatment, which makes investments in these types of partnerships extremely attractive. Specifically, there are two advantages that can benefit the investor: The first is that, as a partnership, the income is not subjected to corporate income taxes, which allows more of the income to be passed along to the partners.
Secondly, the distributions of an MLP are not considered income under the current tax code. They are considered a return of capital, and thus are not taxable to the receiver; they do, however, reduce the cost basis of the investment itself. Thus, when the investor finally sells, his cost basis will be reduced by the amount of distributions that he has received, so his taxable gain will be more. Therefore, you will only pay the tax on the distributions when you actually sell your position, and it will be considered capital gains.
You will still be assessed a share of the partnership’s actual net income every year, but this tends to be significantly less than the amount of distributions, and is also reduced by the partnership’s deductions for depreciation.
In other words, an MLP pays out a high percentage yield to its partners, and most of that yield is tax-deferred. What could be more perfect for someone who is not eligible for tax-deferral via a traditional IRA?
My recommended MLPS
I’ve been examining dividend-paying stocks and MLPs for quite a while now, using a proprietary system that I developed to rate companies based on a combination of 7 factors: Dividend yield; number of years raising dividends; 5-year dividend growth rate (DGR); forward 5-year earnings growth rate (EGR); PE ratio; dividend payout ratio; and total return over the past twelve months.
I chose ten companies for my Perfect Dividend Portfolio, of which 2 are MLPs. I present them here for your consideration.
High yield plus share price growth
My first recommendation is Enterprise Products Partners L.P. (NYSE:EPD), which was the third company that I selected for my portfolio back in December. At the time, Enterprise Products Partners L.P. (NYSE:EPD) scored an 18 on my system, and I continue to re-score it every few months, to make sure it still is performing as I want.
The company is currently trading at approximately $61, up from $50, where it was trading when I chose it, and yields 4.3%, which is actually down from the 5.3% it initially was yielding, as the share price has increased more quickly than the dividend.