My wife was forced to change jobs in 2008, the year she turned 55 years old. The medical practice she worked for was bought out by the local hospital and she then wound up working for the hospital. It took them a year to "close out" the 401K account and she took a lump sum distribution in 2009, at age 56. Box 7 of her 1099-R was marked "1", but that doesn't seem correct because of her forced job change. Doesn't she qualify for exemption from the withdrawal penalty? What documentation would be needed to prove the Box 7 information as incorrect?

If she is separated from service from her place of employment that adminsiters the 401(k) in the year she turned 55, then indeed the withdrawal is penalty-free. The issue here is that since she continued in her job after the merger she was not "separated from service." The IRS defines separation of service as meaning "death, retirement, resignation, or discharge, and not when an employee continues on the same job for a different employer as a result of the liquidation, merger, consolidation etc. of the former employer" (details are here: http://www.irs.gov/pub/irs-drop/rr-00-27.pdf ). Consequently the withdrawal incurs a penalty if she was under 59-1/2 years of age.

However, it would still be worthwhile to call the plan administrator to get clarification on this. If she wants to object to the code "1" on the 1099-R, she can file form 5329 with her tax return and indicate reason code 1 - which (to be confusing) on this form means she was separated from service at age 55 or later.

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Originally Posted by ebaines

If she is separated from service from her place of employment that adminsiters the 401(k) in the year she turned 55, then indeed the withdrawal is penalty-free. The issue here is that since she continued in her job after the merger she was not "separated from service." The IRS defines separation of service as meaning "death, retirement, resignation, or discharge, and not when an employee continues on the same job for a different employer as a result of the liquidation, merger, consolidation etc. of the former employer" (details are here: http://www.irs.gov/pub/irs-drop/rr-00-27.pdf ). Consequently the withdrawal incurs a penalty if she was under 59-1/2 years of age.

However, it would still be worthwhile to call the plan administrator to get clarification on this. If she wants to object to the code "1" on the 1099-R, she can file form 5329 with her tax return and indicate reason code 1 - which (to be confusing) on this form means she was separated from service at age 55 or later.

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Additional information: As a result of the merger she was forced to accept a different position at considerably less pay with the new employer.