One of the constraints of Roth IRA investing is that eligible investors face annual limits with their contributions, including the recent congressional allowance to increase the contribution rate from $5,000 to $5,500 annually. Considering this limitation, shrewd investors might be strategizing for ways to make more investable capital available within the hallowed confines of this tax structure that allows for tax-free distributions once you turn 59.5 years old.
An intelligent way to accomplish this is to load up on the high-yielding oil giants in a Roth IRA. That means BP (NYSE:BP) with its current yield around 4.8%. That means ConocoPhillips (NYSE:COP) once the stock price comes down 15% or so. That means the B shares of Royal Dutch Shell (NYSE:RDS.B), which currently yield just a hair over 5%.
However, this does not mean Total S.A. (NYSE:TOT) or the A shares of Royal Dutch Shell (NYSE:RDS.A). In the case of Total, you would have to pay a 30% tax on the dividends that would not be recaptured by an offsetting American tax credit. In tax-deferred accounts, you're simply out of luck when it comes to trying to recapture your tax paid to the French government because tax credits are not issued for French dividends paid out in a tax-deferred account. This makes Total S.A. counterintuitive in that a taxable brokerage account would be a more effective tax strategy than the retirement structures typically associated with tax-protected status.
In the case of Royal Dutch Shell's A shares within a Roth IRA, you would have two options. You could participate in the Scrip Dividend Programme, which would allow you to dodge the Dutch tax, but it would also prevent you from receiving cash deposits in your account. Your ability to dodge the tax is due to the fact that you receive the dividend in A shares rather than cash, and the blessing of 0% taxes is offset by the matching lack of autonomy that compels you to reinvest into more A shares, regardless of price.
The other option is to own the Royal Dutch Shell A shares in a Roth IRA that does not participate in the Scrip Dividend Programme. These dividends, like those of Total S.A., get taxed. However, the rate is 15% instead of 30%, but the net effect is the same: that money is gone forever without a corresponding tax credit.
Now that we've worked through those decision-tree options, it seems that we have three options for getting big dividends in a non-impeded way within a Roth IRA: Royal Dutch Shell's B shares, BP, and Conoco Phillips (once the stock price declines a bit).
If you spend four or so years putting $5,500 each year into these stocks, you are effectively creating a backdoor way to increase the amount of money you have available to make new investments each year, as you fuse your cash contributions together with the dividends generated by your oil investments.
Strategically, it might look like this: Spend the next four years investing into BP and Royal Dutch Shell's B shares at current valuations or better, and add ConocoPhillips into the mix as well provided that the initial yield is at least 4.5% or better. At a minimum, this strategy would offer a blended initial yield of at least 4.79%, and it could increase if with the passage of time if as the Board of Directors at the three companies raise their dividends to owners. Or, alternatively, the price could decline and the valuation could get cheaper, allowing you to lock in an even better starting yield.
Conducted over the course of four years, this strategy would have the net effect of adding $1,053 in cash income that is created internally within the tax shelter of your Roth IRA. This will gives you a boost in your future capital allocation decisions; not only will you have $5,500 in new contributions that can be used for making new purchases, but your personal oil wells will be giving you an additional $1,000+ to allocate as well. Instead of making a $5,500 investment each year, you'll be able to make a $6,553 brand new investment each year as the fruits of your labor and passive holdings commingle together beyond the reach of the tax man.
The point to keep in mind is that Roth IRA's can be great places to store securities that pay big honkin' dividends. You might conclude that tobacco stocks or certain REITs fulfill this strategy objective better than the selected oil stocks, and that could very well work as well. The take-home lesson is that the best way to get around contribution limits is to get cash-generating assets that throw off investable income internally. With the oil-paying giants trading at valuations in the 6-8x earnings range, this could be a golden moment to make oil stocks a large part of strategy within the context of tax-deferred accounts.