The code on Form 1099-R determines whether your 401(k) withdrawal is taxable to Pennsylvania. However, you retired after 59 ½ and your 401(k) is an eligible plan so it should be tax exempt.
Code 7 Normal Distribution. This distribution from an eligible Pennsylvania retirement plan is not taxable if you met the plan requirements (the age and/or years of service required by the plan) for retirement, and retired after meeting those requirements.
Unlike the federal income tax law, contributions to a 401(K) or contributions to other types of retirement plans are considered part of the employee's taxable compensation and are subject to withholding requirements. The contributions are treated the same, whether made inside or outside a cafeteria plan.
However, when you retire and start receiving distributions, the amount you withdraw from your 401(K) plan is not subject to PA personal income tax. That is the reason you are seeing a PA tax refund. Your 401(k) provider should not have withheld state tax.
Related Resource:
Are my contributions to a 401(K) plan excluded from employer withholding?
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