6 Dividend Monsters for Your IRA

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Like chocolate and peanut butter, dividend stocks and IRAs are two great tastes that taste great together. The best dividend stocks are gifts that keep on giving, with great price appreciation and a steady stream of income to reinvest, compounding your gains.

IRAs, of course, are one of the greatest wealth-building tools available, thanks to their flexibility and immense tax advantages. They're especially good places for dividend stocks. Why? Simple: In an IRA, those dividend streams don't generate the annual tax consequences that they would in a regular account.

That doesn't just simplify your life at tax time, it leaves even more money in the market to grow and compound -- right up until you retire. And dividend stocks continue to offer special advantages after you retire as well.

But to take best advantage of this great combination, you've got to have the right dividend stocks. Fortunately, finding them isn't hard.

Great stocks to buy right now -- and any time
What should we look for when seeking dividend stocks that can help us build a prosperous future?  Here's what I like to see:

  • A great company in a stable (or growing) business. A great dividend isn't worth much if the company can't keep paying it, after all. Cyclical changes can take today's high-yield stock (or high-yield industry) and leave it for dead. We want to avoid that.
  • A company that can afford its dividend. A company like Frontier Communications (NYSE: FTR  ) might look like a hot buy with its flashy 8.7% dividend, but look further: Frontier actually cut its dividend last year, and its growth prospects aren't strong. 8.7% sure sounds tempting, but we want payouts we can collect for years to come. With so many companies raising their dividend payments, we don't have to settle for less.
  • A history of dividend increases. In fact, some of the best stocks in this category have decades-long histories of annual dividend increases. That's good for a reason beyond the obvious: A company that increases its dividend year after year will be perennially popular with investors -- and that means its stock price should keep going up. We won't always find this, but we like it when we do.

Where do we find stocks like these?

These 3 places turn up great dividends
Ever heard of "dividend aristocrat"? It sounds like a silly throwaway headline, but it's actually a term worth knowing. Standard & Poor's uses it this way: "The 50 highest dividend yielding S&P Composite 1500 constituents which have followed a managed dividends policy of consistently increasing dividends every year for at least 25 years."

The list includes some of the bluest blue chips, as well as some lesser-known companies with surprisingly high yields. But don't overlook the big names just because they're obvious: McDonald's (NYSE: MCD  ) , which pays 3%, and PepsiCo (NYSE: PEP  ) , currently yielding 2.9%, are both well-run companies with huge global brands. And in both cases, the yield isn't the whole story: Each should see nice growth over the next decade. Either of those would be solid candidates for the more conservative corner of our long-term portfolio.

But what if we want a really big yield? One place to look is at real estate investment trusts -- or REITs -- which are required to distribute at least 90% of their taxable income to investors. That makes for huge payouts from the very best: Companies like Annaly Capital Mangement (NYSE: NLY  ) and Chimera Investment (NYSE: CIM  ) both have dividend yields around 14%. Both of these well-run companies invest in mortgages -- and while each might take a hit as yields rise, even a 50% cut in their dividends would still leave us sitting pretty. Annaly in particular has a reputation for outsized performance in bad times, making it an especially intriguing buffer to have in your portfolio.

Another source of eye-popping (but stable) dividends comes from master limited partnerships. These are typically companies that develop and own energy infrastructure, and benefit from a tax-law quirk that allows them to be set up as partnerships. That lowers their cost of capital -- but like REITs, they're required to pay out most of their taxable income to investors. Two of the big names here are Energy Transfer Partners (NYSE: ETP  ) , yielding 7.5%, and Enterprise Products Partners (NYSE: EPD  ) , paying 5.9%.

What's good here? Plenty. Each of these partnerships has solid management, stable payouts, and maybe best of all, heavy exposure to natural gas and gas infrastructure. While nearly all commodities have been on huge bull runs over the last couple of years, natural gas is one place where there's still value to be had. In fact, Fool Dan Dzombak recently pointed out that natural gas is trading below many producers' cost of production -- a great opportunity for investors seeking value. And natural gas (and gas infrastructure) could be poised to soar if certain green-minded legislators have their way.

Of course, the low price of natural gas doesn't mean these partnerships are value-priced -- they aren't, though they're not unreasonably expensive -- but it does mean that there's plenty of potential upside to these already-solid businesses.

Grab your share of these cash flows now
There's no question that dividend investing is hot right now. But as we've just seen, there are still rock-solid high-yielding opportunities to be had. Adding a few to your retirement portfolio today is a great way to put the compound growth of reinvested dividends to work for your future now.

So take action -- spend some time looking at the six stocks I've mentioned above. If you'd like even more ideas, help yourself to a free report from the Fool's expert analysts called "13 High-Yielding Stocks to Buy Today." Hundreds of thousands of investors have already requested access to this report, and you can join them right now at absolutely no cost. To get instant access to the names of these 13 fat dividend payers, simply click here -- it's completely free.

Fool contributor John Rosevear owns shares of Enterprise Products Partners. You can follow his investment-related musings on Twitter at @jrosevear. The Fool owns shares of Annaly Capital Management and PepsiCo. Motley Fool newsletter services have recommended PepsiCo, Enterprise Products Partners, and McDonald's, as well as creating a diagonal call position in PepsiCo. You can try any (or all!) of our Foolish newsletter services free for 30 days.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy pays the biggest dividends in the business.

Read/Post Comments (12) | Recommend This Article (17)

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 May 16, 2011, at 1:50 PM, Gonzhouse wrote:

    While I agree with your assessment of these being good dividend paying investments, suggesting they are appropriate for an IRA is another matter. There are 2 main disadvantages to these companies being in an IRA: 1) while dividends accumulate without taxation, when withdrawn they are taxed at ordinary income tax rates, and 2) some dividend paying entities (like MLPs, REITs,etc.) can screwup the tax-deferred classification of the IRA itself. Doing the math on the trade-off between paying a current 15% dividend rate versus the accumulation and tax of ordinary income at a future point is not a trivial analysis.

    To simplify your tax life, keep dividend-payers in a taxable account and high-fliers in an IRA.

  • Report this Comment On May 16, 2011, at 2:47 PM, CMFStan8331 wrote:

    Gonzhouse - I think the best option is to buy dividend stocks in a Roth IRA. Then you'll receive all the benefits of dividends and dividend growth with no tax concerns whatsoever.

  • Report this Comment On May 16, 2011, at 2:49 PM, gabbigirl wrote:

    Gonzhouse - read through this article and had the same thoughts. You put it quite wisely and eloquently.

  • Report this Comment On May 16, 2011, at 3:28 PM, rlv3 wrote:

    I really have to question any article that recommends MLPs for an IRA. The UBIT provisions related to most MLPs can really screw up an IRA. At best they complicate your tax situation and worst cast thay can totally blow it up. Perhaps hte author should do a little more research before proclaiming himself a competent Fool.

  • Report this Comment On May 16, 2011, at 3:49 PM, IlliniBanker wrote:

    One thing to bear in mind with IRAs is UBTI. REITs and royalty trusts don't generate it, but most MLPs do. If you have more than $1000 in UBTI, your IRA is required to report and pay taxes on MLPs.

    Most financial advisors recommend that you do not put MLPs in an IRA- Roth or otherwise. Your IRA trustee will be required to file a tax return and pay taxes on your behalf for the UBTI. The most tax-efficient holdings for your IRA, therefore, are REITs, royalty trusts, and bonds. As other commenters have posted, DONT put MLPs in an IRA This is a common and understandable mistake among financial commentators just starting to learn about MLPs, but they are not an appropriate investment for an IRA.

  • Report this Comment On May 16, 2011, at 4:28 PM, TMFGalagan wrote:

    Responding to the comments on unrelated business taxable income, it's indeed true that if you earn income above the $1,000 limit, it causes additional concerns. Not all MLP income typically counts as UBTI, but the safe thing to do is to make sure you limit MLP holdings within IRAs to avoid going over $1,000 in income. And of course, holding all MLPs outside IRAs may be easier for many investors than keeping track of the limit.


    dan (TMF Galagan)

  • Report this Comment On May 16, 2011, at 5:01 PM, CPACAPitalist wrote:

    At the risk of sounding like one of those whiny free loading readers - this article feels like it doesn't put forth any new information at all. MCD, PEP, NLY, CIM have all been extremely well covered at this point.

  • Report this Comment On May 16, 2011, at 6:20 PM, gcmagone wrote:

    Regarding the tax hassels of a K-1 because of holding MLPs, there are funds that let you avoid this problem. For example, FEN, KYE and KYN. There is also one called Tortoise but I don't recall the symbol. Hope this helps.

  • Report this Comment On May 16, 2011, at 9:08 PM, TMFMarlowe wrote:

    Folks, thanks for the thoughtful comments. The UBTI issue with MLPs is obviously a concern if your position is large enough, but most beginning IRA investors (the audience I had in mind when I wrote this article) won't come anywhere near the $1,000 limit. But it should definitely have been mentioned in the article, and that was my mistake. I'll ask my editor to make a change in the morning to clarify.

    Thanks for reading.

    John Rosevear

  • Report this Comment On May 18, 2011, at 9:26 AM, bikertodd wrote:

    I have been watching Nly for over a year and want to put that into a ROTH IRA. From my understanding the dividends will grow tax free and there will be NO taxes on the withdrawals, is this correct? Thanks for the insight

  • Report this Comment On September 17, 2011, at 12:47 PM, mark3137 wrote:

    Hello Fellow Fools,

    I am in a very similar situation to Bikertodd and have the exact same question.

    I recall reading comments on a different board months ago something about how adding an REIT to a ROTH IRA is against some ROTH IRA RULE (???) ( due to the nature of REIT's ( ???) )

    I was not sure if the comment was just someone's opinion or was a fact.

    I would Love to add NLY to my Portfolio but not if it will cause my ROTH IRA to be turned back into a regular taxable portfolio.

    Any help on this question will be greatly appreciated.

    Thank you

    Mark Hansen

  • Report this Comment On January 07, 2012, at 5:26 AM, DocJava wrote:

    IRS publication 598

    UBTI (Unrelated Business Tax Income)

    in a ROTH is only tax free if the COMBINED

    MLP income

    in the given year is less than $1,000.

    Otherwise, it is a taxable and reportable event;

    You must file a form 990T to the IRS.

    The comment about beginners not having enough money to matter is, perhaps, deceptive:

    For example:

    put $13,000 into a MLP with 7.6% return and you earn $988 in a given year, as a non-reportable,

    tax-free event.

    But, if the dividend goes up to 7.7%, you will have

    $1001 and a taxable event.

    So: be careful!

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