ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

The Benefits of Master Limited Partnerships

Updated on May 29, 2013

MLP's for the Average Investor

A Master Limited Partnership (MLP) is a partnership which has the ability to trade on a public securities exchange. There are two core components which are the Limited Partner and the General Partner. The Limited partner is the investor who puts up the capital. The General Partner is the one who manages the operations of the MLP, and is compensated via incentives to increase the cash flow of the MLP. Typically the General Partner would receive about 2% of the annual distribution. The tax code affords certain industries to organize as an MLP. Namely companies engaged in the energy sector such as petroleum and natural gas.

MLP’s demonstrate some degree of similarity to Real Estate Investment Trust’s (REIT’s) in that they are not subject to the double taxation. They avoid the corporate tax with distributions paid directly to the limited partners taxed only at the personal income tax level. Each year the limited partners/investors receive a K-1 detailing the tax liability of their annual distributions. These distributions are typically paid to the investors quarterly. Should the MLP fail to pay the quarterly dividend, it could constitute a default and jeopardize the MLP status. However, the quarterly distributions paid to the investors consist of a portion of repayment of principal which is received tax free. As an example, a $1 dividend paid at the end of the quarter may be compromised of .70 cents principal payment, which is tax free, and .30 cents of taxable income. The repayment of principal component thereby reduces the investor’s basis in the investment. In such an example, if the initial investment was $10 per share in the MLP, the new basis would be reduced to $9.70 per share at the end of the quarter. This has the effect of essentially deferring tax liability for the duration of the period the position is held. In the event that a position is held long enough that all of the distributions have reduced the investors cost basis to zero, then the future quarterly dividends would be 100% taxable to the investor.

Prior to 2004 mutual funds were restricted from the ability to own an MLP, hence making it largely unavailable for the average investor. Even after this restriction was lifted, they were still held in limited circulation among the average investor due to the tax problems presented in holding these positions in retirement accounts. The inherit tax deferral of the IRA negates the tax benefits of holding an MLP in a retirement account. Additionally, the MLP holding can be subject to the Unrelated Business Taxable Income (UBTI) when held in an IRA. However, recently a number of funds have been launched as traditional mutual funds as well as Exchange Traded Funds and ETN’s that circumvent this problem. As an example an ETF compromised of a series of MLP’s can be classified as an investment fund under the Investment Company Act of 1940. (Also known as a 40 Act Fund) This avoids the K-1 reporting and the potential for problems arising from the UBTI tax, and allowing these positions to be eligible for placement in a 401k/IRA or other tax deferred accounts. However, the 40 act fund status then subjects the holding to be taxed as a corporation for Federal Income Tax purposes. As such, the fund’s shares are further reduced by the accrual of any deferred tax liabilities rather than altering the shareholders basis directly. The taxable portion of the quarterly dividend may then be eligible for "qualified dividend" status and potentially reducing the tax liability further. Additionally, holding a series of MLP’s via a mutual fund or ETF can offer the aspect of diversity that is necessary while investing in any asset class.

Yet if the tax benefits of the tax deferral related to an MLP are redundant with the tax deferral in a retirement account, what would be the benefit of holding such a position in a retirement account ??? The answer is unrelated to tax treatment and more of a focus on pure investment returns and asset allocation. The recent returns of the MLP market have been strong over the last two decades. Even more importantly, the correlation between the MLP market indices to the broad market indices such as the S&P 500 have been relatively low when compared to other asset classes in the equity markets. Over the last decade ending in 2012, the Alerian MLP Infrastructure Index has correlated with the S&P 500 only 0.48% of the time while producing total returns in excess of the S&P 500. While continued outperformance of the S&P 500 is by NO means a certainty, the likely reduced correlation is helpful in maintaining a proper asset allocation and reducing overall portfolio volatility.

The risks of investing in MLP’s are not unlike any other investment. If you invest directly into one MLP, you may have simply selected the wrong one which is run poorly. It may also not have the liquidity that you desire. More importantly, due to the restrictions on which industries have business entities that can be organized as an MLP, any investment into this arena is inherently a concentration into a specific sector. In general sector investing is a form of market timing, which is a historically insurmountable task in the context of long term financial planning. So the placement of MLP’s or MLP funds into a long term investment portfolio should be limited as tool to reduce the correlation in the portfolio, while potentially offering tax benefits. The percentage exposure would be client specific. Yet in general, the average investor’s holdings should likely not exceed 5% of their total equity holdings.


    0 of 8192 characters used
    Post Comment

    • LandmarkWealth profile image

      LandmarkWealth 5 years ago from Melville NY

      In a retirement account, it's not really relevant in terms of the tax status if you buy them through an ETF or Mutual fund diversified portfolio. Tax Free ROTH's and Tax deferred Traditional IRA's will not be affected by the tax benefits associated with an MLP. It's just another holding. The purpose is the low correlation with traditional stock based investments. If you buy an individual MLP in any retirement account, you create a world of potential tax problems. Most firms wouldn't even let you place the trade.

      In terms of the tax issue in a non-retirement account, you're correct. There are enough tax benefits through the ETF/Mutual fund holdings, that in my view it's usually a better solution. The other issue is it's not convenient to buy 25 different MLP's in an individual account to create the proper diversity. I would be careful of fund expenses in this arena. In general I am a believer in ETF/Index solutions for most all equity investments, with the exception of Long/Short holdings.

    • bankscottage profile image

      bankscottage 5 years ago from Pennsylvania

      Great explanation of MLPs and their role in a diversified portfolio. I have had a small investment as part of my portfolio for awhile now. In your discussion of holding an MLP in a retirement account, does it make any difference if it is a traditional 401(k)/IRA (tax differed) versus a Roth 401(k)/IRA (tax free)?

      Individual MLPs in a taxable account can complicate a federal tax return somewhat, but I believe it could really complicate state tax returns. You may have to file a return for every state that the MLP earned income in (not just for the state you are a resident of). Seems like this could be another reason for owning MLPs in an ETF or mutual fund rather than individual MLPs.


    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: ""

    Show Details
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the or domains, for performance and efficiency reasons. (Privacy Policy)
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)