The Best Yields for the Next 10 Years

The U.S. government wants you to get 7% yields, and then give you a huge tax break on your investment.

But it won’t come from investing in the well-known dividend payers like Annaly Capital (NYSE: NLY  ) and Altria (NYSE: MO  ) -- despite their obvious appeal to yield-hungry investors.

If you’re like me, you’re probably chuckling in amusement. The government ... giving away tax breaks ... on yields earned from investments? Impossible!

But actually, it’s 100% true. As James Early -- advisor of Motley Fool Income Investor -- clarifies, “Technically, Uncle Sam simply wants to promote energy infrastructure, but if that also means promoting our pocketbooks, we’ll take it.”

And take it we will
The investments I’m referring to are “master limited partnerships,” or MLPs. Back in the 1980s, Congress wanted to expand the growth of oil and natural gas pipeline facilities across the country. Since they allow citizens the right to form partnerships (which don’t have to pay corporate taxes), these MLPs are able to have more money to invest in new projects, thereby advancing Congress’ agenda.

But it gets even better. There is also a hidden tax benefit for the individual who owns units of an MLP, which pay out nearly all their cash to investors -- something that isn’t available to non-MLP dividend stalwarts like XTO Energy (NYSE: XTO  ) or ConocoPhillips (NYSE: COP  ) . Because of accounting regulations, MLPs make more in cash earnings than they do in accounting earnings -- it can be something like five times as much. But investors in MLPs are only taxed on the lower, accounting earnings, while it is a share of the larger, cash earnings that they actually receive.

Now is the time to get in
The yields on MLPs are -- quite simply -- astronomical, even before you add in the tax benefits. MLPs frequently yield 7%, and sometimes even higher than that. Yet most investors are missing out.

Moreover, because MLPs run monopoly like toll businesses, their cash flows are less tied to speculation than those of oil and gas companies and REITs like First Industrial Realty Trust (NYSE: FR  ) , Pennsylvania Real Estate Investment Trust (NYSE: PEI  ) , and Developers Diversified Realty (NYSE: DDR  ) .

A Wells Fargo analyst recently praised MLPs for the “fee-based stable nature of their cash flows, the diversity and breadth of their assets, investment grade credit rating, and superior access to the capital markets.” And the analyst's two favorite MLPs are also currently recommended by James Early in his Income Investor newsletter.

For all these reasons, James believes that MLPs will be among the best yielders for the next 10 years. Since I know you’re eager to know more, I will tell you that one of the MLPs is Magellan Midstream Partners, which operates a massive pipeline system running from Texas through the Midwest, and currently yields 6.8%. To see the name of the other -- along with all the MLPs that James believes are fantastic investments today -- I invite you to check out his Income Investor service, completely free. You can read all about MLPs -- plus his other favorite dividend payers -- and see which ones he likes, free for 30 days. Simply click here for more information. 

This article was originally published on Nov. 13, 2009. It has been updated.

Adam J. Wiederman owns no shares of the companies mentioned above. Magellan Midstream Partners is a Motley Fool Income Investor pick. The Fool owns shares of XTO Energy. The Fool’s disclosure policy is outlined here.


Read/Post Comments (19) | Recommend This Article (55)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 14, 2009, at 5:27 PM, Fool wrote:

    Haven't read MF in a while, as stiil too much of shill for the MF newsletters. Appears nothing has changed

  • Report this Comment On December 14, 2009, at 6:51 PM, malachhamovess wrote:

    It's hard to assess how a MLP with contracts that may turn over a year at a time can be considered to have any more stable a cash flow than landlords who write leases for 20 years.

    MLPs are subject to numerous risks including the obsolescence of their pipelines or other tangible assets, changes in regulation, and competition from other sources or a drop off in traffic as supplies and demand shift.

  • Report this Comment On December 14, 2009, at 7:01 PM, oldindi wrote:

    Haven't read MF in a while, as stiil too much of shill for the MF newsletters. Appears nothing has changed.

    Agree!

  • Report this Comment On December 14, 2009, at 7:55 PM, wolfhounds wrote:

    A minor but important correction. Investors are not taxed on MLP's accounting (GAAP) earnings, but on taxable earnings. You should have explained that very large depreciation, amortization, and depletion deductions - which are non cash items - are responsible for the large difference between reported GAAP earnings and taxable earnings. Taxable earnings are almost always negative, but I won't go into the tax implications.

  • Report this Comment On December 15, 2009, at 3:08 AM, GoNuke wrote:

    More hype, more mistakes. Morningstar is going to eat the Fool's lunch. I'm sorry I even read this article.

  • Report this Comment On December 15, 2009, at 9:05 AM, dudemonkey wrote:

    In my research, I was always led to believe that the tax implications of holding an MLP are significant. Can someone clear that up?

    Most articles about MLPs advise that you retain a tax lawyer to help out with figuring out your tax exposure.

  • Report this Comment On December 18, 2009, at 2:29 PM, tretbone wrote:

    I would like to thank AlexisMachine for the insightful commentary and presentation of facts involving the tax ramifications of MLP's. Having subscribed to MF for about 2 months, this was the best material I have seen, that includes the newsletters from MF which seem to be intent on promoting the purchase of more newsletters. I will give MF another month before I seek a refund.

  • Report this Comment On December 18, 2009, at 4:32 PM, lewellen180 wrote:

    Re the taxes ... anything that needs that long of a commentary to explain the ramifications, means it won't be in my portfolio again.

    I made the mistake of having a few MLPs in my portfolio once. They typically send out their tax-prep forms very late, and they complicate things even if you use a program like TurboTax or TaxCut.

    As a ROMWAG, I figured I would want to bring in at least $5k more than I would from an alternate investment to make the extra hassle worth it. (What can I say - I value my time and don't like tax-time surprises or late deliveries.)

    Since that would be a difference in yield of around 2 - 3%, let's say, that would mean at least $150k invested in an MLP. That would be too large a fraction of my total portfolio ... so until I have a lot more money saved up, MLPs just don't seem worth it to me.

    Best,

    - Lewellen

  • Report this Comment On December 18, 2009, at 10:32 PM, kmcoms wrote:

    I agree with tretbone, I joined briefly many of the subscriptions and I am down to one. The articles just push the prescriptions.

  • Report this Comment On December 18, 2009, at 10:35 PM, kmcoms wrote:

    all the mf does is push subscriptions and the returns are suspect at best.

  • Report this Comment On December 18, 2009, at 11:55 PM, bf51ef49 wrote:

    I have to agree with the above reports on your idea

    to make big returns. My wife does tax work and has

    told to never again buy these pain in the rears!

    I am really getting tired of poor information on todays

    market. Its hard to make due on tax losses.

  • Report this Comment On December 19, 2009, at 11:40 AM, Spears40 wrote:

    I had 6 or 7 Limited Partnerships back in the 80's agree they are a pain in the rear. However, I do invite Tretbone and KMCOM who indicate they are new members to Stock Advisor Motley Fool to spend some time reading up Boards of the stocks recommended over time by the Staff. Agree the sales pitches are just that and I ignore them also. However, they do a solid stock program that does get results. The annual cost can be made up with the stocks you might buy. The education you will get is well worth the money spent. The have a staff and invite umput from the members to follow each stock. Many members put in alot of time in doing research on the Pros and Cons of each stock. Sorry now this sounds like a sales pitch. Just wanted to say "Get involved and do so reading on the background information available before you decide to drop out or Join in. Duane (Disclosure been a Fool for 5yers)

  • Report this Comment On December 19, 2009, at 9:00 PM, tequilaandtacos wrote:

    For the pseudo advantages being involved with an MLP initial investment of less than $100,000, the agony of preparing the tax report and late submittal of forms by the Master Partner (often after April 15) do not make any sense for my portfolio.

    However a "boon" for the tax preparation service. They love the charges that they levy as a result of interfacing MLP tax reports into one's personal tax report.

  • Report this Comment On December 20, 2009, at 2:10 PM, mrduke15 wrote:

    I have a question about this tax deal:

    The article explains that it is a good deal because the partners (we, the shareholders) get nearly all of the cash but are only taxed on the accounting side. Is the "dividend" from the partnership interest reported as dividend (15% rate) or income (marginal rates)? Also, what if the dividend payout is less than the pre-tax earnings of the LP? That is, some of these LPs appear to have pre-tax earnings greater than the actual dividend payout. Furthermore, the author seems to think that these LPs take the cash from customers and hands it over to the partner/investor...in reality the LPs have massive capex expenditures that often eat away all of the cash flow.

    Seems like another Fool article that simply finds a hot sector or stock, uses 20/20 hindsight to show you what you missed, and then claims to be so smart for seeing it. Once Fool looks into something...the play is over. Furthermore, it appears as though Fool attempts to write as many articles as it can with as many stocks referenced in order to get all over Yahoo.Finance. I wish there was a way to filter out these worthless rearview mirror articles...that are often not even correct.

  • Report this Comment On December 21, 2009, at 9:34 AM, nivekluap wrote:

    The more you read, the more you learn. I've been a SA member for almost two years and am always looking for new insights, stock ideas, and just to see what the rest of the investing world is up to. I skip over the sales pitches and anything to do with the banking industry(no idea on how to value something that's too big to fail) because it's just "noise" to me. As you read more and more and become familiar with how things are organized on the Fool, the better your time will be spent.

    The MLP's that I hold in my Roth IRA are very easy to deal with...No tax headaches.

    Fool on!

    K.D.

  • Report this Comment On December 21, 2009, at 1:57 PM, lilsdad wrote:

    Quick note- I am an MLP investor. There is no way I'm going to take MLP's off the table because it's to confusing to do the taxes. If you are that easily confused, you should probably stick to mutual funds.

    JL

  • Report this Comment On December 29, 2009, at 5:41 PM, justthefactsplz wrote:

    How do these differ within a Roth IRA?

  • Report this Comment On December 30, 2009, at 11:44 AM, Classof1964 wrote:

    Investments in a Roth IRA are paid for with after tax money and money from the Roth is not taxed again. Therefore, no tax returns.

    The point not mentioned above is that much of the "dividend" from MLPs comes in the form of a return of capital (ROC). If my capital is being returned, whether at the rate of 6.8% or 9% a year, it is still my capital, and therefore, it appears to me that until all the capital has been returned, I am not making any money on the investment as with a traditional dividend. In fact is would appear that I am making a long term loan to the MLP.

    There may be capital gains above the basis I have, adjusted for ROC, and there may be capital gains if I sell the MLP. But it only seems that I am getting a return like a dividend after all my capital has been returned. In this case if a MLP is not in a Roth account, the IRS taxes one on the "dividend." I think that my be true even if the MLP is in an traditional IRA or Keogh. I am not certain about this, but I recall reading something like this on the MF boards. MF is well worth the subscription money if one uses all its options.

  • Report this Comment On February 11, 2010, at 3:55 PM, jimratflorida wrote:

    I am suprised that the author did not mention ^AMZ

    This is an index of the biggest players in this style investment. Take a look and see if you still think you don't want to consider buying some of these MLP's. Over a 15-year period, the index is up 300%. I can't tell from the chart whether this includes re-invested dividends....probably not.

    The more recent versions of tax software will handle the K-1s without a hiccup. I agree it is confusing as hell, but so is the rest of the Tax Code.

    These MLP's do not lend themselves to trading in and out. You are getting a return of your capital each time a check comes your way. If you sell after a few years, the R.O.C. serves to reduce your cost basis, so you end up paying the tax when you trade out of your position.

    If you hold them till you croak, then the tax never becomes due. Do not let the tax-tail wag the dog. These have been pretty low-risk investments, but nothing is forever....

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