Dividend Stocks Yielding Over 6% That Every Roth Should Hold

Editor’s note: This article has been corrected to remove Enterprise Products Partners and MPLX. An earlier version incorrectly treated distributions from master limited partnerships the same as BDC dividends for tax purposes. MLPs have distinct partnership tax treatment, including basis adjustments and potential unrelated business taxable income considerations when held in retirement accounts.

A $500,000 equal-weight basket of business development companies Ares Capital and Blue Owl Capital currently throws off roughly $51,500 a year based on their current base dividends and recent share prices. Much of a BDC’s distribution is typically taxed as ordinary income in a taxable account, although the final tax character can vary from year to year.

For an investor whose distributions are taxed at a 24% federal rate, that creates potentially significant annual tax drag. Inside a Roth IRA, qualified withdrawals are tax-free, allowing distributions and reinvestment to compound without an annual federal tax bill.

Tax Delta: Roth Versus Taxable at 24%

BDCs are generally less tax-efficient in taxable accounts than companies paying qualified dividends. Because BDCs must distribute most of their taxable income to shareholders, much of those distributions is commonly reported as ordinary income rather than receiving the lower tax rates available for qualified dividends.

That makes BDCs strong candidates for tax-advantaged accounts such as Roth IRAs, although investors should review the final tax classification reported by each company every year.

Ares Capital (NASDAQ:ARCC | ARCC Price Prediction) pays a $0.48 quarterly dividend, or $1.92 annualized. At a recent share price near $20, that works out to a yield of roughly 9.6%. CEO Kort Schnabel has pointed to more than 17 years of stable or increasing regular quarterly dividends. Ares Capital’s distributions have historically been heavily weighted toward ordinary income, making the tax shelter of a Roth particularly valuable for income-oriented investors.

Blue Owl Capital (NYSE:OBDC) currently pays a $0.31 quarterly base dividend, or $1.24 annualized. At a recent share price near $11.30, the base dividend alone produces a yield of roughly 11%. OBDC also declared a $0.02 supplemental dividend following its second-quarter results. Q2 adjusted net investment income of $0.34 per share covered the $0.31 base dividend, while CEO Craig Packer cited “healthy dividend coverage” with leverage at a two-year low of 1.11x.

OBDC’s own tax disclosures demonstrate why investors should not assume every BDC distribution has exactly the same tax treatment every year. The company notes that its distributions are generally not qualified dividends and that the majority are ordinarily taxable, but portions can receive different tax classifications.

Run the numbers on a $500,000 portfolio split equally between ARCC and OBDC using their current base dividends and recent prices:

• Estimated gross annual income: approximately $51,500
• Illustrative federal tax at 24% if the distributions were fully taxed as ordinary income: approximately $12,360
• Illustrative taxable-account income after that federal tax: approximately $39,140
• Roth IRA distributions: no current federal income tax inside the account
• Potential annual tax avoided under the full ordinary-income assumption: approximately $12,360

These figures are an illustration, not a prediction of an investor’s actual tax bill. The final tax character of BDC distributions can include ordinary income, capital gains and other components, and individual tax circumstances vary.

Bracket Multiplier: Same Portfolio, Different Tax Bill

The potential benefit of sheltering ordinary income increases with an investor’s marginal tax rate. Using approximately $51,500 of annual distributions and, for illustration, assuming the entire amount is taxable as ordinary income:

Under that simplified assumption, an investor in the 37% bracket could face roughly $7,700 more in annual federal tax than an investor in the 22% bracket on the same amount of ordinary income. That is before considering state taxes.

Again, the table deliberately illustrates the maximum ordinary-income comparison. Actual BDC tax reporting can result in a different taxable amount.

Compounding Insight Most Investors Miss

The bigger advantage of a Roth is not simply avoiding one year’s tax bill. It is keeping more money invested.

If an investor can reinvest thousands of dollars that otherwise would have gone toward annual taxes, those additional dollars can themselves generate investment returns and future distributions. Over long periods, that compounding can make the difference between taxable and Roth account placement substantially larger than the sum of individual annual tax bills.

That is one reason a dividend strategy built to live off the checks without ever selling a share can be especially powerful inside a Roth.

There is still investment risk. ARCC non-accruals ticked up to 2.4% at amortized cost, while OBDC non-accruals rose to 2.8% at cost. Distribution coverage matters at these yields, and changes in interest rates can pressure the spread income BDCs earn from their lending portfolios.

Concrete Actions

• Review the tax forms for BDCs you already own. Do not automatically treat the entire cash distribution as qualified dividend income or assume every year’s tax classification will be identical.
• When deciding what assets to hold in a Roth IRA, compare high-yield BDCs and other ordinary-income investments with more tax-efficient holdings such as stocks paying qualified dividends.
• If you are considering a phased Roth conversion, compare the one-time tax cost of converting traditional IRA assets with the potential long-term benefit of tax-free growth and qualified Roth withdrawals.
• Do not assume a high-yield investment automatically belongs in a Roth. Tax treatment, valuation, distribution safety and the opportunity cost of limited Roth space all matter.

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