Why Annaly Capital Is Right for Your IRA

This article is part of our Right for Your IRA series, in which Foolish writers each pick a stock or ETF that could be a great fit in a tax-advantaged retirement account.

Perhaps the best part of investing in your IRA is the fact that the dividends you receive from your stocks can compound tax-deferred, at least until you take money out of the account. That makes an IRA a great place to invest in companies that are required to pay large dividends. You get the cold-hard cash from those dividends to compound in the company or another investment opportunity, and you don't owe the tax man a dime until you take the money out of the account.

Of course, to take advantage of that tax-deferred dividend compounding, you first need to get money into your IRA. If you had earned income in 2011 and are eligible to contribute, you can make your 2011 contribution up until this year's filing deadline of April 17.

One stock that looks like a great fit for dividend-heavy IRA investing is Annaly Capital Management (NYS: NLY) .

Why I like the stock
Annaly is one of the few strong mortgage-related survivors of the financial and housing collapse. It survived in large part because it doesn't directly make mortgage loans or own real estate. Instead, it's a Mortgage REIT, or real estate investment trust, that buys mortgage bonds guaranteed by U.S. government agencies. While it is leveraged, and thus exposed to interest-rate risks, the government guarantee on the bonds it buys means its assets would be very unlikely to become worthless.

Contrast those guaranteed assets with Annaly's sister companies, Chimera (NYS: CIM) and Crexus (NYS: CXS) , which are also mortgage REITs managed by the Annaly team. Like Annaly, Chimera also buys residential mortgages, but its assets are more diversified and not generally government-guaranteed. Crexus, on the other hand, focuses on commercial debt, which also comes with no government guarantee that it will be paid.

In the heavily leveraged mortgage REIT industry, you need to manage money incredibly well in order to survive through interest rate cycles, or else an inverted yield curve could be devastating. Annaly has proven itself capable of managing through tough cycles, having been around since 1997 and still going strong. That staying power makes it one of the few companies in its industry worth considering.

Annaly's strong management team gives its sister companies Chimera and Crexus legitimate shots at long-term survival, but the fact that their assets don't carry a government guarantee does add risk. After all, if we suffer another financial catastrophe like the one we're only now emerging from, any heavily leveraged company could get struck.

Why it's good in an IRA
Because Annaly is a REIT, it must pay out at least 90% of its taxable earnings as dividends. Because of that requirement, in profitable times its yield can be quite high. In fact, its yield currently stands at 13.9%, but it's not a stable yield, and it's one that has been cut before and is currently trending down. Additionally, because Annaly is a REIT, its dividends do not qualify for the current 15% rate on dividend payments.

Take those two factors (high yield and non-qualifying dividends) together, and you get a situation where, if you're going to buy Annaly's stock, the ideal place to own it is inside your IRA. That way those hefty dividends can compound tax-deferred while you're still in your accumulation phase in your account. Also, since Annaly's dividends are not qualified, when the time comes to spend your investment income in retirement, the tax rate you'll pay on spending those dividends won't be any higher than if you had owned those shares in a regular brokerage account.

The risk/reward trade-off
Of course, owning Annaly does have risks, as it relies on heavy leverage and is unable to retain much of its earnings due to its REIT structure. The clearest of these risks is to its dividend, which, as you can see in the chart below, is anything but stable:


Data from Yahoo! Finance as of April 2, 2012.

But as long as the company stays smart and retains its ability to manage its way through rocky interest rate cycles, those tough times will be a risk only to its near-term income -- not its very existence. Indeed, in spite of the risks, Annaly's ability to survive the recent mortgage meltdown makes it a stock I'm willing to own in my own portfolio (in my IRA, of course).

While I'm confident enough to own Annaly's stock and to give it an outperform CAPSCall, it is a five-year time horizon, as it may take that long for it to play out, given the risks of rising short-term rates. I'm willing to put my own CAPS All-Star rating on the line by handing out a green thumb to its shares in Motley Fool CAPS, but also well-aware that the thesis may not be realized tomorrow.

Annaly's unstable dividend may not make it the ideal stock for a person seeking current income in retirement. Still, its high mandatory payout, the non-qualified nature of its dividends, and its ability to survive the recent financial meltdown, makes it worthy of consideration for an IRA investment.

See what else our Foolish writers would add to an IRA; click back to the series intro for links to the entire series.

At the time thisarticle was published At the time of publication, Fool contributorChuck Salettaowned shares of Annaly Capital.Click hereto see his holdings and a short bio. The Motley Fool owns shares of Annaly Capital Management.Motley Fool newsletter serviceshave recommended buying shares of Annaly Capital Management. The Motley Fool has adisclosure policy.
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