"After having repeatedly examined my conscience before God, I have come to the certainty that my strengths, due to an advanced age, are no longer suited to an adequate exercise of the Petrine ministry," Benedict said in a statement released by the Vatican.
"In order to govern the bark of Saint Peter and proclaim the Gospel, both strength of mind and body are necessary, strength which in the last few months, has deteriorated in me to the extent that I have had to recognize my incapacity to adequately fulfill the ministry entrusted to me."
Benedict XVI, born Joseph Aloisius Ratzinger in 1927 in the Bavarian town Marktl am Inn, spent his entire life in the Church. He was ordained priest at the same time as his older brother Georg in 1951, and began teaching theology at Freising College in 1958. He was made pope in April 2005.
Chancellor Angela Merkel said on Monday the German-born pope deserved "respect" and "gratitude" for his nearly eight years as pontiff.
"If the pope himself decided after considerable reflection that his strength no longer enabled him to carry out his duties, that has my deepest respect," Merkel said a press conference in Berlin.
She paid tribute to his work in reaching out to other churches and other religions, including Jews and Muslims. Merkel, the daughter of Protestant pastor, said the pope had "touched the heart of believers" on his trips to his ancestral homeland and that his address to the German parliament in 2011 was "still remembered."
"He is and remains one of the most significant religious thinkers of our time. As chancellor I thank him for his efforts and wish him from my heart all the best for the coming years."
The 85-year-old Benedict is only the second pope in history to resign.
His brother Georg Ratzinger said the pope had been advised against making any further transatlantic trips and that he had been considering stepping down for months.
"My brother wants more rest while getting older," Ratzinger said, adding it was a "natural process."
The pope is expected to live out his days in cloister inside the Vatican monastery.
Joseph Ratzinger gained a reputation as a Church conservative while serving as the head of doctrinal matters for his predecessor Pope John Paul II.
His appointment as pontiff excited German Catholics, who hoped it would re-energize the Church.
Germany's biggest newspaper Bild famously put "Wir sind Papst!" ("We are Pope!") on its front page at the time.
However, Benedict's decision to rehabilitate a breakaway group of fundamentalist Catholics that included a well-known Holocaust denier would infuriate many Germans and even spark a rare rebuke from Merkel.
The pope was also criticized for not doing enough to stop child abuse by Catholic priests while he was archbishop of Munich.
But across Germany on Monday, tributes to Benedict far outweighed criticism of his tenure at the head of the Church.
"Pope Benedict has given the entire world a shining example of the true understanding of responsibility and and vibrant love of the Church," said Archbishop Robert Zollitsch, head of the Germany Bishops' Conference.
"We German bishops thank the Holy Father for his service on the Chair of St. Peter and are filled with great respect and awe by his decision."