Three Strategies to Grow a $1 Million Roth for Heirs

Retirees holding more in tax-deferred accounts than they will spend can cut heirs' tax bills by spending down 401(k)s first and passing on Roth and brokerage assets, which inherit a step-up in basis.

"Money they inherit in tax-deferred accounts will eventually be taxed as ordinary income, which can result in monster tax bills if they are already high-earners," said William Bernstein, author of "The Four Pillars of Investing."

Barron's asked three longtime market observers how to invest $1 million sitting in a tax-free Roth that will not be touched for 30 years. Bernstein recommended a single global index fund; retired financial advisor Harold Evensky proposed a four-fund blend with regular rebalancing; and Larry Swedroe, who advises wealth managers, suggested a portfolio mixing equities with illiquid funds.

The choice matters because the account is expected to grow untouched for three decades, and the tax treatment of what heirs receive differs sharply by account type. Roth accounts are funded with after-tax dollars and gains are tax-free, while brokerage holdings pass on with a step-up in basis that erases capital-gains tax during the owner's lifetime.

The Tax Case for Spending Down 401(k)s First

Unless leaving money to charity, which owes no tax, retirees do heirs a favor by spending down tax-deferred accounts themselves and passing on brokerage and Roth accounts. Money inherited in tax-deferred accounts is eventually taxed as ordinary income, which can produce large bills for high earners. These rules reflect current U.S. tax law and can change; readers should verify against the latest official guidance.

One Fund, Four Funds, or a Blend

Bernstein keeps it simple: put the entire $1 million in a global index fund such as the Vanguard Total World ETF or the State Street SPDR Portfolio MSCI Global Stock Market ETF. The Vanguard fund holds 64.9 percent of assets in North America, 13.7 percent in Europe, 11.1 percent in the Pacific region, 10 percent in emerging markets and 0.3 percent in the Middle East, with an annual expense fee of 0.06 percent. A more complex portfolio with a value tilt might outperform over 30 years, but the odds are little better than 50-50, Bernstein said, and it takes more work. "It gets complicated fast," he said. For those who can handle complexity, he suggested adding Avantis U.S. Small Cap Value, Dimensional US Small Cap Value and Avantis International Small-Cap Value, and splitting emerging markets between Avantis Emerging Markets Value and Dimensional Emerging Markets Value. "How much tilt you add in is a matter of taste and risk tolerance — up to perhaps one-third of the overall stock allocation," Bernstein said.

Evensky, who pioneered the bucket approach to keep investors calm, also favors global equity holdings but prefers four funds with regular rebalancing: 40 percent in the iShares Core S&P 500 ETF, 20 percent in the iShares Core S&P Small-Cap ETF, 25 percent in the iShares MSCI EAFE ETF and 15 percent in the iShares MSCI Emerging Markets ETF. While that portfolio should perform best over time, Evensky, who built his reputation on investor psychology, thinks most investors would sleep easier keeping 10 percent in cash, which they could also use to buy stocks during downturns.

Swedroe suggests a portfolio blending equities and illiquid investments — funds where it may take years to get all money out. He says diversified illiquid investments that are uncorrelated or low-correlated to each other can deliver equity-like performance with less volatility. "If you're owning an illiquid asset, you should get paid for it with higher expected returns," said Swedroe, who says a slight majority of his personal investments are in illiquid assets. He would put a sixth of the illiquid portion into each of AQR Style Premia Alternative, Hamilton Lane Private Infrastructure Class I, Stone Ridge Reinsurance Risk Premium Interval and Cascade Private Capital, and a twelfth into each of Cliffwater Corporate Lending, Cliffwater Enhanced Lending, JPMorgan Real Estate Income Trust and Blackstone Real Estate Income Trust. The equity portion would go into the two value-focused ETFs Bernstein also recommended: Avantis U.S. Small Cap Value and Avantis International Small Cap Value.

The three approaches share a common thread — heavy global equity exposure suited to a 30-year horizon — but differ on complexity and liquidity. A single fund offers the lowest cost and simplest execution, while the four-fund blend adds rebalancing discipline and the illiquid mix trades liquidity for potentially higher returns. Retirees should weigh their own risk tolerance and how much hands-on management they want before choosing.

This article is for informational purposes only and does not constitute professional or investment advice.