You are not required to pay the early withdrawal penalty at all. "Separation from service" means you left the job, whether by retirement, quitting, fired or laid off. The distribution (withdrawal) in 2016, from your previous employer's 401k, does qualify for the separation from service exception, to the early (before age 59-1/2) withdrawal penalty because you were 55 or over when you separated. There is no time limit for the withdrawal.
Had you rolled over the 401k to an IRA, any subsequent distribution from the IRA would not qualify (but might qualify for the home buyer exception). Home buying is not a penalty exception to a 401k distribution (only IRAs).
Is the remaining money still in the original 401(K) plan, or did you roll it over?
You are not required to pay the early withdrawal penalty at all. "Separation from service" means you left the job, whether by retirement, quitting, fired or laid off. The distribution (withdrawal) in 2016, from your previous employer's 401k, does qualify for the separation from service exception, to the early (before age 59-1/2) withdrawal penalty because you were 55 or over when you separated. There is no time limit for the withdrawal.
Had you rolled over the 401k to an IRA, any subsequent distribution from the IRA would not qualify (but might qualify for the home buyer exception). Home buying is not a penalty exception to a 401k distribution (only IRAs).
I understand that the 1st withdrawal in July 2015 meets the "Separation from service" exception. However, will a withdrawal now (July 2016) meet the separation exception now, since I have become employed? And, no I have not rolled it out of the original 401K plan.
Because you separated from service from the employer providing the original 401(k) plan in or after the year you reached age 55, ALL distributions you make from the original plan in or after the year in which separation occurred qualify for the age 55 exception. As Hal_Al indicated, a distribution in 2016 (or any other distribution you may make from the original 401(k) plan in the future) qualifies for this exception.
The the administrator of the original 401(k) plan should know your age and your separation date, so the administrator should code the distribution with code 2 in box 7 of the Form 1099-R reporting any distributions from the plan. Code 2 indicates that an exception known by the administrator (the age 55 exception) applies. In such case, no Form 5329 will be generated by TurboTax with regard to this distribution. If the administrator uses code 1 instead, it will be your responsibility to claim the age 55 exception on Form 5329.
Sorry for the confusion. I left out a key word. When I said "There is no limit for the withdrawal"; I meant to say There is no TIME limit for the withdrawal. I've corrected that above
Thank You to all that responded. I feel I can move forward in comfort now.
A clarification question. Turn 55 in 2018 & separate from employer in June 2018. Would a 401K distribution in March 2018 still be exempt from the 10% penalty? ..or do you need to distribute after the separation in June to qualify for the exemption?
No, a distribution prior to separation from service does not qualify for the age-55 exception.
clarifying question - if I retire from company after age 55, meaning no W2, but continue doing some work for the company as a consultant, meaning 1099, does that still meet rule of 55 definition of "separate from service"?
The answer likely depends on the amount of service provided as an independent contractor. I'm not sure of the threshold, but if the amount of service provided as an independent contractor is a significant fraction of the amount provided as an employee, the IRS can consider you to be still employed with the company. However, the IRS is probably not going to question a code-2 Form 1099-R provided by the plan.