Boost Your Retirement Income With Master Limited Partnerships

Last Updated Nov 9, 2009 12:29 PM EST

If you're retired and looking to earn more income on your investments, you might want to consider what are called master limited partnerships. These investments can often produce income distributions between 6 and 8 percent a year, and can provided a valuable boost to your cash flow in this era of record low interest rates.

What Are They. A master limited partnership (MLP) is a business structure that consists of a general partner and a number of limited partners. The general partner runs the business and the limited partners are the investors. Many MLPs are publicly traded, meaning you can purchase a limited partnership interest in the entity on one of the major stock exchanges. As a limited partner, you have the right to receive certain income distributions from the MLP each year depending on the success of the entity.
  • MLPs have a special status under the tax code, which requires them to basically earn 90 percent of their income from certain types of natural resource endeavors. If they do that, then they don't have to pay a "corporate" or entity level tax, which means there's more money to pay out to investors.
  • While distributions will vary depending on market conditions and the MLP's operations, the distributions often grow over the years. So not only do you receive a healthy distribution today, but there's a fair chance that distribution will grow to help offset the effects of inflation over time.
  • Only certain types of companies can be organized as MLPs, and they tend to be concentrated in natural resource industries. They often include mining, exploration and energy companies, or companies involved in the storage and transportation of natural resources. You can visit the website for the National Association of Publicly Traded Partnership for more information about companies in these industries.
Tax Favored. In addition to the healthy income distributions, in many cases, a percentage of the distribution that you do receive is treated as a "return of capital," which basically means the income isn't subject to current taxation. This helps boost your spendable cash flow today. When you eventually sell your ownership interest, however, you'll be required to "recapture" those deferred distributions and pay tax on them.

Tax Compliance. With all of these nice income and tax features, MLPs come with some tax compliance issues.
  • Because many MLPs are organized as partnerships, you'll receive what is called a K-1, which is a tax return that lists your share of the income, gains, losses and credits from the partnership for the year. You then have to separately report those items on your tax return each year.
  • Many MLPs have excellent investor websites that walk you through the reporting items. But, if you aren't familiar with partnership tax (and most people aren't), you should consider having your accountant handle the federal and state tax reporting. It costs a few extra dollars, but it can be worth it considering the higher income payments and tax deferred nature of some of the distributions.
IRA Issues. Because MLPs generally don't pay tax on their earnings, the IRS doesn't want you holding these in your IRA, which is also tax deferred. Basically, you would be getting a double tax deferral on the money. Consequently, the distributions from MLPs are often subject to something called unrelated business taxable income if held in an IRA. There's a small exemption of about $1,000 a year. But in general, you should avoid holding these in an IRA or other type of tax qualified account.

Diversify. While MLPs may sound like a great option, remember they're just one of many investments you should be considering when building your income streams for retirement, such as other dividend paying stocks and high-quality fixed income holdings. Because MLPs tend to be concentrated in the natural resources industry, the price and the distributions can be volatile. Thus, think of them as potential income enhancers to your portfolio.

Bottom line. MLPs offer good income opportunities but they're more complicated from a tax perspective. If you're going to venture into them, consider doing so with the guidance of your accountant and financial professional.

As with all financial matters, consult your individual advisor prior to making any financial decisions.

Learn More: Want to learn about a simple way to manage your personal finances and prepare for retirement, investigate my upcoming book Your Money Ratios: 8 Simple Tools For Financial Security, available for pre-order at amazon.com
Your Money Ratios
  • Charlie Farrell

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