Here's What Jim Cramer Didn't Mention About IRAs

by: Steven Bavaria

On Wednesday night, Jim Cramer devoted part of his “Mad Money” show to Individual Retirement Accounts (IRAs), emphasizing the importance of taking advantage of their ability to compound earnings tax-free. This means they are a great vehicle for holding high yielding stocks, bonds and other instruments. Good candidates for IRA portfolios would therefore be high-dividend stocks, REITs and high yield bonds, to name some obvious ones. In fact, putting assets into your IRA that are NOT high yielding actually wastes one of the IRA’s most valuable features, its ability to shelter and compound income over the long term.

Where Cramer’s advice last night differed from the conventional wisdom was in his suggestion that investors put master limited partnerships (MLPs) into their IRAs. Most experts recommend against putting MLPs directly into IRAs because of the possibility that MLP income may be characterized as “unrelated business taxable income” [UBTI] and trigger tax liability for the IRA. (For details, see an article earlier this year by “The MLP Investor:” Although the likelihood of this happening is considered minor for most investors, it is a hassle most of us don’t need, and given how widely reported and discussed this potential problem is for IRAs, I was surprised it slipped by Cramer and whoever helps him do the research for his show.

Fortunately, there are plenty of ways around the problem for IRA investors that wish to get high, steady MLP distributions into their IRAs. You can buy any one of at least 16 closed end funds that specialize in MLPs, as well as several ETFs and at least two relatively new open-ended funds. There are also two MLPs that have set up sister companies that own shares in the MLP and then sell their own non-MLP shares to the public, passing through the MLP dividends in the form of stock dividends from the sister (i.e. non-MLP) companies. An IRA can own these and get the benefit of the MLP earnings stream without the tax hassles.

Let’s review these choices in order:

· MLP-focused closed end funds can be easily screened for on the CEF Connect site. Investors should note that because MLPs have become popular over the past year, a number of the funds sell at large premiums, but there is no reason to pay such a premium when other smaller premium or discounted choices are available. I currently hold Clearbridge Energy MLP (NYSE:CEM), which sells at a modest 2.3% premium and yields 6.7% and Tortoise MLP Fund (NYSE:NTG), selling at a slightly higher 5.35% premium (it was at a discount when I bought it) and yields 6.72%. Both funds, like many closed end funds, are slightly leveraged (about 22-23%), which boosts the return a bit but adds additional risk of rising interest rates squeezing the income margin. That is probably not a problem in the near to medium term, given what the Fed has said about short-term rates likely remaining low for the next year or so. More conservative investors may wish to consider MLP & Strategic Equity Fund (NYSE:MTP-OLD), which sells at a 4.7% discount, yields 5.7%, and is not leveraged at all.

· Open-ended MLP mutual funds that I know of include: several SteelPath funds, including the SteelPath MLP Income Fund; and Cushing MLP Premier Income Fund. The SteelPath Funds are no-load, whereas the Cushing fund carries a 5.75% front-end load.

· Exchange traded funds and notes include UBS E-Tracs Wells Fargo MLP ETN (NYSEARCA:MLPW), UBS E-Tracs Alerian Natural G MLP Index Fund (NYSEARCA:MLPG), UBS E-Tracs Alerian MLP Infrastructure ETN (NYSEARCA:MLPI), Credit Suisse Cushing 30 MLP ETN (NYSEARCA:MLPN) and Alerian MLP ETF (NYSEARCA:AMLP). All but AMLP are set up as exchange–traded notes (ETNs) so besides taking the risk of the underlying MLP assets, you are also taking the credit risk of the issuer (Credit Suisse, Wells Fargo, etc.) which is not trivial given the fragility that our financial system has shown in recent years. The yields on the four ETNs are all in the 5.2-5.4% range; while the yield on AMLP, the ETF, is higher at 6.35%.

· Besides the various funds, two MLPs – Kinder Morgan and Enbridge Energy – have thoughtfully provided vehicles that allow IRAs and other investors that do not wish to deal with the tax hassles of owning MLPs directly to achieve virtually the same result. Kinder Morgan Management (NYSE:KMR) and Enbridge Energy Management (NYSE:EEQ) each own shares of their operating MLPs, Kinder Morgan Energy LP (NYSE:KMP) and Enbridge Energy LP (NYSE:EEP), respectively. KMR and EEQ each collect the distributions of their operating MLPs and issue equivalent stock dividends to their shareholders, eliminating any worries about UBTI for IRA holders.

As a predominantly IRA-focused investor, I am a big fan of MLPs, as well as other high-yielding asset classes. But it is important to hold them in a form that is tax-compatible with the IRA structure. I applaud Jim Cramer for the general theme of his advice to IRA investors, but hope investors will do a little more research before charging off into MLPs and regretting it later at tax time.

Disclosure: I am long KMR, EEQ, CEM, NTG.