The 30-year-old Coffey went 2-4 with a 4.76 ERA in 69 appearances with Milwaukee in 2010. In six major league seasons, he is 19-17 with 11 saves and a 4.15 ERA in 369 games, all in relief, with the Brewers and Reds.
He is the latest addition to a Nationals bullpen that general manager Mike Rizzo began rebuilding last season.
Coffey's contract includes a chance to earn up to $275,000 in performance bonuses: $75,000 each for 60 and 65 relief appearances, plus $125,000 for 75 relief appearances.
He pitched in 69 games last season, and 78 in 2009; his career high was 81 appearances in 2006 with Cincinnati.
Also Monday, the Nationals designated right-handed starter Shairon Martis for assignment. They needed to make room on their 40-man roster for utility player Jerry Hairston Jr., who agreed to a $2 million, one-year deal last week.
Martis went 6-6 with a 5.33 ERA in 20 games -- 19 starts -- for Washington in 2008 and 2009, then spent 2010 at Triple-A Syracuse, going 8-7 with a 4.09 ERA in 27 starts.