Types of Hedge Fund Investors

SEP-IRA in a particular year, income must be less than $200,000. Because
of the higher contribution limits (more than 10 times larger than the maxi-
mum IRA contribution), SEP-IRA plans are more likely to have sizable bal-
ances than traditional IRAs even though SEP-IRAs were created more
recently, in 1998.
401(k) Plans
A 401(k) plan is a voluntary defined contribution plan.
Workers set aside part of their salaries to invest in a tax-deferred fund. Of-
ten, employers match or partially match contributions to employee 401(k)
plans. Contributions are limited to 12.5 percent of income, capped at
$12,000. Because 401(k) plans have been in existence for many years and
have become very common, many workers have 401(k) balances that are
high enough to invest in hedge funds, especially if the participating hedge
fund or funds reduces the required minimum investment.
A small number of companies have begun to offer hedge fund alterna-
tives in their 401(k) plans. Goldman Sachs and Mesirow Financial (two
broker-dealers that are actively involved in the hedge fund business) offer
one or more hedge fund choices in their company plans. CS First Boston al-
lowed employees to invest in the Campbell Fund (probably more accu-
rately described as a commodity pool) and enjoy hedge fund type returns
beginning 25 years ago.
Roth IRA
The Roth IRA differs significantly from the plans described ear-
lier. Contributions to a Roth IRA do not reduce taxable income, so the
Roth IRA does not enjoy the benefit of investment return on a deferred tax
liability on earned income. However, investors pay no tax on either princi-
pal or investment return withdrawn from a Roth IRA. Because hedge fund
returns are mostly taxed as ordinary income, it makes sense to place hedge
fund assets in a Roth IRA and to hold common stocks in an ordinary in-
vestment account, to get the benefit of reduced tax rates and deferred tax
liability on long-term capital gains on the stock.
Several provisions limit the ability of hedge fund investors to accu-
mulate significant assets in a Roth IRA. First, income tests prevent high-
income individuals from funding Roth IRAs. Second, similar limits
restrict investors from rolling traditional IRA assets into a Roth IRA. Fi-
nally, even when an IRA or a rollover IRA can be rolled into a Roth IRA,
such a rollover requires the investor to report the rolled amount as tax-
able income. The acceleration of tax liability on a rollover reduces the
value of the tax savings compared to a traditional or rollover IRA.
Educational Savings Plans
Both the so-called 529 plans and Coverdell
Educational Savings Accounts (ESAs) are tax-advantaged saving plans,
Types of Hedge Fund Investors
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