What are MLPs?
Master Limited Partnerships (MLPs) are publicly traded limited partnerships that combine the tax benefits of a partnership with the liquidity of publicly traded securities. They trade on a securities exchange and are primarily focused on natural resource industries such as oil, gas, coal, timber, and commodity transportation.
A MLP is made up of two types of partners:
- General Partners (GPs): Manage the MLP's daily operations and administration.
- Limited Partners (LPs or Investors): Provide capital by purchasing units (similar to shares) in the partnership and receive regular income distributions.
MLPs can be attractive to income-focused investors because they typically offer higher yields than many traditional equities and also provide exposure to the energy and natural resource sectors. However, they also come with greater risk and complexity.
What are some potential benefits and risks of investing in MLPs?
Benefits of MLPs
Pass-through entity
MLPs are considered a type of pass-through entity: a business structured so that it is not subject to corporate taxation. However, the distributions to MLP unitholders are generally subject to income taxes. A key benefit of the partnership structure is that the income distributions are not taxed twice the way the dividends of a common stock are taxed.
Potential for higher yield
MLPs tend to generate higher yields than bonds and stocks due in part to the favorable tax structure. Investors relying on MLP income payments should be aware that forecasted distributions can fluctuate or be reduced.
Liquidity
Most MLPs are listed on national exchanges and are therefore typically more liquid than traditional partnerships.
Drawbacks of MLPs
Complex tax consequences
MLPs must meet certain criteria, including earning at least 90% of their income in "qualifying income." Investors are typically issued a schedule K-1 document directly from the partnership. MLPs may incur Unrelated Business Taxable Income (UBTI) that could be taxable even within an IRA. Investors should consult a qualified tax professional to learn more.
Interest rate risk and legislation risk
The high yields associated with MLP investments make them sensitive to changes to interest rates as well as legislative changes to tax codes which could affect an MLP's pass-through tax structure.
Volatility
MLPs have historically experienced higher volatility than stocks and bonds.
Schwab's perspective on MLPs
We encourage investors considering MLPs to approach them as part of the equities allocation of their overall portfolio. While MLPs have historically had periods of strong returns, they have also experienced high levels of volatility.
Common types of MLPs
Pipeline MLPs
Own and operate pipelines that transport commodities, including crude oil, natural gas, and refined products.
Gathering & processing MLPs
Gather and process natural gas to move the commodity from the well to the market.
Exploration & production MLPs
Engaged in the exploration, development, and production of crude oil and natural gas.
Specialty MLPs
Focus on specific commodities or other resources.
How do I invest in MLPs at Schwab?
You can buy and sell MLPs on your own with a Schwab One® Brokerage Account or access MLPs through one of Schwab's managed portfolio solutions. Remember, different asset classes can fill multiple roles in a portfolio. Carefully consider how MLPs can fit into your asset allocation model.
Frequently Asked Questions about MLPs (Master Limited Partnerships)
Publicly traded Master Limited Partnerships (MLPs) can be purchased as inexpensively as stocks. You'll just need enough for the cost of the shares, plus any brokerage commissions and fees. At Schwab, you can buy and sell listed MLPs online for $0 commission.1 Private or non-traded MLPs usually have a significant minimum investment required and are generally for accredited investors. It's important to note that MLP investors will have limited voting rights and do not own an interest in, vote with, or control the General Partner (GP).
MLPs can be attractive investments as they offer relatively high yields and tax advantages, but they carry significant risks. MLPs, while liquid, are generally less liquid than stocks and historically more volatile. Since MLPs are typically concentrated in energy sectors, they can be hit hard during sector-specific downturns. They are sensitive to interest rate changes–if rates rise, an MLP's unit price is reduced and borrowing costs increase, which can reduce distributions. Additionally, future tax code changes could affect an MLP's pass-through tax structure. Also, an MLP may issue additional common units, diluting existing unitholders' interests. Lastly, if at any time the GP owns 85% or more of the issued and outstanding limited partner interests, they have the right to purchase all remaining interests at a price that may be undesirable to the holder.
No, MLP distributions are not tax-free; however, they receive different treatment compared to regular dividends. MLP income distributions are not taxed twice, unlike dividends of a common stock, which is a key benefit of the partnership structure. While distributions to MLP unitholders are subject to income taxes, most of an MLP's distribution is considered a return of capital, which reduces your cost basis. Note that cash distributions are not guaranteed and may fluctuate based on the MLP's operating or business performance. Furthermore, MLP unitholders may be required to pay taxes on MLP income even if they do not receive cash distributions.