This paper investigates the interaction between Si nanoclusters Si-nc and Er in SiO2, reports on the optical characterization and modeling of this system, and attempts to clarify its effectiveness as a gain material for optical waveguide amplifiers at 1.54 m. Silicon-rich silicon oxide layers with an Er content of 4–6 1020 at./cm3 were deposited by reactive magnetron sputtering. The films with Si excess of 6–7 at. %, and postannealed at 900 °C showed the best Er3+ photoluminescence PL intensity and lifetime, and were used for the study. The annealing duration was varied up to 60 min to engineer the size and density of Si-nc and optimize Si-nc and Er coupling. PL investigations under resonant 488 nm and nonresonant 476 nm pumping show that an Er effective excitation cross section is similar to that of Si-nc 10−17–10−16 cm2 at low pumping flux 1016–1017 cm−2 s−1, while it drops at high flux 1018 cm−2 s−1. We found a maximum fraction of excited Er of about 2% of the total Er content. This is far from the 50% needed for optical transparency and achievement of population inversion and gain. Detrimental phenomena that cause depletion of Er inversion, such as cooperative up conversion, excited-stated absorption, and Auger deexcitations are modeled, and their impact in lowering the amount of excitable Er is found to be relatively small. Instead, Auger-type short-range energy transfer from Si-nc to Er is found, with a characteristic interaction length of 0.4 nm. Based on such results, numerical and analytical Er as a quasi-two-level system coupled rate equations have been developed to determine the optimum conditions for Er inversion. The modeling predicts that interaction is quenched for high photon flux and that only a small fraction of Er 0.2–2 % is excitable through Si-nc. Hence, the low density of sensitizers Si-nc and the short range of the interaction are the explanation of the low fraction of Er coupled. Efficient ways to improve Er-doped Si-nc thin films for the realization of practical optical amplifiers are also discussed.