What are the potential tax implications of an annuity?

The correct choice highlights that annuities grow tax-deferred, meaning that the investment gains accumulate without being subject to taxes as they are earned. This feature allows for potentially greater growth over time since the entire amount can remain invested rather than being reduced by taxes each year.

However, when withdrawals are made from an annuity, those distributions may be subject to income tax, especially on any gains above the originally invested principal. This means that while the initial investment is generally not taxed upon withdrawal, the earnings portion is taxable as ordinary income.

Understanding this aspect of annuities is crucial for financial planning, as it impacts how individuals assess their retirement income strategy and potential tax liabilities upon accessing their funds. Tax implications can vary based on the type of annuity and how it is structured, reinforcing the importance of comprehensive knowledge of annuity products when advising clients.