Thursday, November 1, 2012

MLPs and Retirement Accounts

If you're not familiar with Master Limited Partnerships (MLPs) I suggest reading my Boring Terms post for an overview. In that article I mentioned the pros and cons of MLPs and dividend investing. In short, MLPs are a great investment vehicle for generating dividend income, but because of their tax implications they aren't a great option for dividend reinvestment or retirement accounts. In fact, many brokers won't allow MLPs in retirement accounts. And that's a shame since the way MLPs are structured would make them a great choice for retirement accounts.

Well some of the larger MLP companies have figured out a way for us to invest in a MLP within a retirement account without the tax headaches. Kinder Morgan Energy Partners (KMP) and Enbridge Energy Partners (EEP) were the first two companies to solve this problem. They created "Companion Corporations" which are basically a corporation that owns stock of a MLP. KMP's companion corporation is Kinder Morgan Management (KMR) and EEP's is Enbridge Energy Management (EEQ).

So essentially KMR owns stock in KMP. That is their business, simply to own stock in KMP. Every time KMP pays a distribution (dividend), KMR receives that payment.  Now, instead of KMR passing that dividend on to its shareholders, it instead gives its shareholders additional shares of its stock.  So it pays its shareholders with more shares. The easiest way to think of this is that KMR automatically reinvests your dividend into more shares, just like we want. An added bonus is that receiving these shares is not seen as a taxable event. Where as with a regular dividend payment you still owe taxes, you are not taxed on these additional shares until you sell the shares  (unless of course its a Roth IRA). EEQ operates the same way. So if you want to see what kind of yield you would be getting when investing in these companion companies you should look at the "parent", KMP or EEP.

I personally took advantage of KMR in my Roth IRA several years ago. Since my original investment, my share total has increased nearly 30% through additional stock I have received. And yes, KMP has been increasing its dividend each year which of course has translated into more shares paid out by KMR. So the compounding affect is working its magic.

Since investing in KMR, I've been on the lookout for another "companion corporation" to invest in. Since EEQ is in the same business as KMR (energy distribution via pipeline), I preferred to be only invested in one or the other. Well just recently another popular MLP, Linn Energy (LINE), finally created a third companion corporation, Linn Co (LNCO).

LINE is different from KMP and EEP as it is in the business of energy production, specifically oil and natural gas. And LNCO will be different from KMR and EEQ as it will actually pay a cash dividend that equals LINE's dividend (less corporate taxes LNCO has to pay so its dividend will be slightly less than LINE). This dividend will be considered a normal dividend in the IRS's eyes so LNCO can be added to retirement accounts without additional tax headaches and paperwork.

So for investors looking for MLP dividend income within your retirement account, you may want to consider LNCO. And for the younger investors who would like to benefit from the favorable dividend policies of MLPs to reinvest and grow in your retirement account, you may want to consider KMR, EEQ and LNCO. I have made a purchase of LNCO in my Roth IRA recently. I believe these companion corporations are fantastic way to take advantage of MLPs in a retirement account and look forward to watching my shares grow.

Disclosure: I am long KMR and LNCO

Related Posts:
Boring Terms - MLP


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