Retirement income in question: BDCs and MLPs deserve attention

By Jason Lampa MBA

College Savings Bank


Let’s look at two relatively unknown investment vehicles that could be a good option to help your clients avoid the volatility of the stock market, while still providing good returns on investment.

A recent poll found that 59 percent of all people approaching retirement age, when questioned about different issues pertaining to retirement, are most concerned about finances (the other choices were health, staying independent, how will I spend my time, being alone and other).

With retirement savings on the mind of so many people, it is important to look at not only whether a client’s current savings levels are sufficient to allow financial security upon retirement, but also whether they are investing funds appropriately to maximize returns and, more importantly, to protect their nest egg.

Historically, the stock market has been a great way for long-term investors to achieve significant returns, as equity stocks. In fact, if you look at the compound annual growth rate (CAGR) for the S&P 500 for the past 60 years, you will see that the average annual return has been 11.15 percent.

That’s a great rate of return, with a lot of years of historical data to provide some credibility and reassurance to investors. However, the market has taken a beating in recent years, and in the past decade, there have been two significant downturns in the market that have made investing in traditional equity markets seem like a risky proposition.

In 2000, the Internet bubble brought down the S&P 500 by 50 percent, and it took the index more than four years to recover its losses. The stock market crash in 2008 was precipitated by the mortgage crisis (along with a handful of other influencing factors) and lead to a decline of almost 33 percent in the value of the S&P 500 in just a matter of a few short months, and the index still has not yet recovered its losses.

What do these crashes mean for long-term investors?

Well, if you had decided to invest in a S&P 500 index fund in 2000, your CAGR would be .31 percent and if you had made the same investment in 2008, your CAGR would be -3.01 percent. While the long-term CAGR for the S&P 500 is more than 11 percent, the short-term realized return is minimal or negative.

For those clients approaching retirement, it is possible that near term rates may be significantly lower than the historical mean. Let’s look at two relatively unknown investment vehicles that could be a good option to help your clients avoid the volatility of the stock market, while still providing good returns on investment.

Business development companies

Business Development companies are a type of publicly traded equity that was created by Congress in 1980 and are a vehicle that allow regular investors to fund startup companies or to provide equity to rapidly expanding businesses that do not want (or can’t) go public. A BDC is basically one form of venture capital that is available to everyone, not just wealthy investors.
There are tax advantages to investing in a BDC, since these groups are not required to pay corporate level taxes, as long as they pay out at least 90 percent of their annual net income to shareholders each year, and as long as the BDC obtains at least 90 percent of its gross income from capital gains on securities, interest payments and dividends.

This tax advantage allows BDCs the ability to pay out much higher dividend yields than other types of investments, and these yields are not subject to the 15 percent capital gains tax. BDCs have historically been traded on national stock exchanges (such as the NYSE or NASDAQ), but they don’t have to be.

Master limited partnership

A master limited partnership is a publicly traded limited partnership that combines the tax advantages achieved by the limited partnership with the liquidity that publicly traded securities have. MLPs are limited by federal statutes only to be an option for companies that work in specific industries (typically in natural resources; examples include petroleum extraction and transportation), however some real estate companies can qualify as MLPs.

In order for an entity to achieve MLP status, there must be a partnership which has at least 90 percent of its revenue source coming from a qualifying source, such as petroleum extraction. The organizational structure of a MLP allows it to avoid paying federal and state corporate income taxes.

Investors in a MLP may also claim a pro-rated portion of the MLPs depreciation, which will reduce the tax liability for that investor. MLPs pay investors via quarterly required distributions, and the amount of the QRD is established in the contract between the investors and the company.

So how can a BDC or MLP provide security as your clients work towards retirement?
    1) The regular dividend distributions can provide regular income that can fund retirement;

    2) Not having to pay capital gains tax on these dividends means BDC or MLP has a rate of return of 8.5 percent one year — a traditional equity would have to have an increase of 10 percent in order to derive the same amount of net income; and

    3) The opportunity to invest in companies through a MLP or BDC that only truly wealthy investors have historically been able to invest in.
Are there risks associated with investing in a MLP or BDC?

Yes. Make sure to research when considering recommending this type of investment. While there are risks associated with these investments, the reduced tax liability and regulatory requirements regarding payouts make these financial instruments less risky than traditional equity markets.

How can investors access MLP or a BDC?

Many of these funds are available on the NYSE or NASDAQ exchanges.

In conclusion, as you work with clients’ to reach their retirement goals, it is imperative that you have a strategy that provides consistent income and strong returns. Investing in a MLP or BDC provides investors with significant tax advantages that may lead to increased returns.

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