What Are Covered Earnings?

Malcolm Tatum

"Covered earnings" is a term that identifies the portion of an employee’s income that are considered eligible for inclusion when calculating the retirement benefits associated with that employee. Typically, any type of income that is considered taxable by a local or national revenue agency may be considered as part of this calculation, meaning that some sources of income other than wages or salary may be included. The idea of identifying covered earnings is crucial to determining the amount of monthly disbursements from a government-sponsored pension plan or some other type of qualified retirement plan, since those plans are usually based on the employee’s earnings up to the point of retirement.

Man climbing a rope
Man climbing a rope

Part of the value of accurately determining the covered earnings associated with a given tax year is that in nations that provide some sort of government-sponsored pension or retirement program, that figure is used to determine the amount of contributions the employee must make in order to participate in the plan. For example, covered earnings are figure used in the United States to assess the amount of Social Security taxes that are withheld and paid into the Social Security Administration. Those contributions are tracked from one year to the next and have a direct impact on the amount of the monthly Social Security check that the individual will receive each month after formally retiring from the work force at a certain age.

The scope of income that may be considered covered earnings will vary somewhat from one nation to the next. Most nations do consider salaries and wages paid by employers in most professions to be eligible for inclusion. In addition, income generated by independent contractors and other individuals who are self-employed will also be used to determine the benefits associated with a government pension program, based on both the amount of covered earnings generated each tax year and the amount of taxes paid into those government pension plans.

There are also some forms of income that may be considered exempt from covered earnings. In some nations, income generated from local governments will not be considered when assessing the covered earnings related to a national government pension plan. In like manner, income earned as part of a given industry, such as the railroad, may also be exempt from consideration. Since regulations will vary, making sure to understand what type of income is and is not eligible for consideration as covered earnings is very important, since it will have some impact on the benefits received from a retirement plan.

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