IRAs are a great way for investors to save money on taxes. Not only can we pump money in our Traditional IRAs to cut our current taxes, but these vehicles allow investors to defer capital gain taxes for years. Even better, unlike 401(k)s, there are very few restrictions as to what investments can be made within an IRA.
That being said, there are some stocks that we should avoid putting in our IRAs, especially in the energy sector. Here are three types of stocks that we think just don't belong in a retirement account.
Dan Caplinger: Master limited partnership Enterprise Products Partners (NYSE:EPD) has a lot of potential to participate in the continued energy boom in the U.S., and it's likely to reward shareholders along the way. But holding Enterprise Product Partners and other MLPs in IRAs has a couple of negative effects that take away from their appeal within tax-favored retirement accounts.
One concern that's often overhyped is that MLPs produce unrelated business taxable income. UBTI can cause problems in IRAs, but with a $1,000 threshold before UBTI-related tax kicks in, it's not typically a problem for most investors.
The bigger issue is that holding MLPs in an IRA turns any appreciation into income that's eventually taxed at an ordinary tax rate when you withdraw it from the IRA. Enterprise creates substantial amounts of distributable cash flow that doesn't qualify as taxable income, and therefore doesn't get passed through to unitholders for inclusion on their tax returns. In taxable accounts, most Enterprise investors can use the adjusted basis in their partnership interest to shelter tax liability until they use it all up. Those features aren't available in an IRA, so using IRA assets to own Enterprise or other MLPs typically wastes the tax breaks of the retirement account. That's why those interested in Enterprise should think twice before putting it in an IRA.
Jason Hall: One stock that probably shouldn't be in your IRA is Seadrill, Ltd. (NYSE:SDRL). The reasoning is simple: Stocks that still have a relatively high level of downside risk are probably best kept in your taxable investing account, if you invest in them at all. Hear me out.
Seadrill is heavily leveraged right now, with more than $13 billion in long-term debt, as well as subsidiary North Atlantic Drilling's (NYSE:NADL) $2+ billion debt, for which the company recently became a guarantor.
As investors learned last year, when Seadrill was forced to suspend its dividend, the company is heavily exposed to oil prices and demand right now, and frankly, the company's strength -- its relatively young and high-specification fleet of drilling ships -- may not matter if onshore production continues to meet lagging global demand growth.
Seadrill's picture isn't necessarily getting any better in the near term, with the company still on the hook for another 15 new ships that will be delivered over the next several years, at a cost of more than $4 billion. As things stand today, the company faces some pretty major headwinds until the global demand and onshore supply dynamic settles out. That could take another year to happen.
Until the picture clarifies, Seadrill stock is risky, and the company is exposed to big losses. If you invest in this stock, buying in a taxable account would at least give you the ability to get a tax loss if things turn for the worst.
Matt DiLallo: I wish Jason would have warned me not to put Seadill in my IRA a bit sooner. At the time, it made sense to me, as I wanted to defer taxes on the company's generous dividend. However, the dividend was cut because of the one-two punch of high debt and a business leveraged to oil prices.
That mistake taught me a valuable lesson: High-risk stocks, especially those tied to commodity prices and that carry a lot of debt, are better left out of an IRA. That's because if things start to go south, it leaves investors without the option to take a tax loss on the losing stock.
Smaller, growth-oriented independent oil companies like Halcon Resources (NYSE:HK) and SandRidge Energy (NYSE:SD) fit the bill of stocks to avoid buying in an IRA. Both borrowed billions over the past few years to take advantage of the triple-digit oil prices by rapidly growing oil production. We can see the ballooning debt on the following chart:
Both companies now readily admit that they borrowed too much money, and in hindsight borrowed a billion dollars more than they should have. This excess leverage has really weighed on both stocks, as each has dropped far more than the price of oil.
If oil prices remain weak for a couple of years, it's very possible that either of these two oil stocks could go bust because of their bloated balance sheets. That would leave investors owning these stocks in an IRA without the option of taking a tax loss to ease their pain. That's why I'd avoid owning stocks that have the dangerous combination of being tied to commodities while having a debt-heavy balance sheet.
Dan Caplinger has no position in any stocks mentioned. Jason Hall owns shares of Seadrill. Matt DiLallo owns shares of Enterprise Products Partners, SandRidge Energy, and Seadrill. The Motley Fool recommends Enterprise Products Partners and Seadrill. Try any 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 Motley Fool has a disclosure policy.