Covered Earnings

What Are Covered Earnings?

Covered earnings refer to the total amount of an employee's pay that counts toward the calculation of retirement benefits. Generally, the bulk of covered earnings comes from an employee's base pay, though occasionally other types of compensation factor in as well.

In the U.S., the Social Security Administration uses covered earnings to determine Social Security benefits. Covered earnings also determine the amount of Social Security taxes individuals pay before retirement.

How Covered Earnings Work

Covered earnings typically include most types of wage income and any self-employment income. Some exceptions include earnings from certain state and local governments, as well as from railroads. Retirement benefits, whether from Social Security or pension plans, depend on workers’ earnings for a specific number of years, as well as the total amount paid towards the retirement plan over that span.

Covered earnings come into play when workers are trying to figure out when to retire and receive the maximum benefits, either from Social Security or a pension.

For instance, covered earnings for Social Security purposes leverages a formula that uses 35 years of earnings, each indexed to a particular year. Knowing the formula is far less important than knowing that benefits depend on the last 35 years an employee worked, even if that work took place after retirement or after claiming benefits. It’s also important to know only earnings up to a certain annual cap count toward any future benefits. The taxable earnings cap is $147,000 for 2022 and $160,200 for 2023.

Working an Extra Year

In some cases, working an additional year adds to a retiree’s covered earnings and thus total benefits received, provided that the amount of income in that additional year is higher than the lowest-earning year during the 35-year measurement period.

Conversely, working an extra year at a significantly reduced wage hurts covered earnings if the amount received is less than the lowest-earnings year during the measurement period.

Full Retirement Age

Workers can retire as young as 62 and collect Social Security; however, benefits will be reduced by 25% to 30%. For those who were born after 1942, the full retirement age is 66, with two months added for each year after 1954, and for those born in 1960 and after, it is age 67. By delaying retirement until full retirement age, workers can receive the highest amount of benefits.

Prolonged Unemployment

One group for which delaying retirement usually helps would be those with a prolonged period of unemployment, even if that happened decades ago. For these individuals, a few extra years of full employment boosts their covered earnings.

Mistakes in a person’s work history also affect covered earnings, as under-reporting just a few years might skew eligible benefits. For this reason, the Social Security Administration suggests that, before retirement, individuals open a free account on its website to check their earnings history. Individuals can open the account many years before retirement, so they can periodically verify all the information gathered to be sure their covered earnings are up-to-date.