Party treasurer Barbara Hendricks said a resounding 76 percent backed the left-right coalition pact after a postal ballot among its 475,000 members.
The unprecedented binding referendum, which drew nearly 78 percent turnout, marked an unqualified triumph for Social Democratic (SPD) chief Sigmar Gabriel nearly three months after his party's bruising loss to Merkel's Christian Democrats (CDU) in the general election.
"I have never seen my party so politically engaged in the 36 years I have belonged to it," a beaming Gabriel told reporters, flanked by the party leadership. It's been a long time since I was so proud to be a Social Democrat."
As a result of the vote, Merkel can be formally re-elected by the Bundestag lower house of parliament, making her only the third chancellor in German post-war history to serve a third term.
The CDU welcomed the outcome of the high-stakes vote by its new junior partner.
"We want to secure and fortify the foundations of prosperity and solidarity in our country," CDU general secretary Hermann Gröhe said in a statement. We are pleased that our work as a government can now quickly begin."
Mother-of-seven as defence minister?
The coalition is to make formal announcements on the cabinet on Sunday, but leaks to media revealed many of its most prominent members.
Finance Minister Wolfgang Schäuble, one of the main architects of Germany's tough-love response to the eurozone crisis, is to stay on.
Frank-Walter Steinmeier of the SPD is awaited back at the foreign ministry, where he served during Merkel's first 2005-09 term.
Meanwhile Gabriel is to head up a "super-ministry" in charge of the economy and Germany's ambitious energy transformation away from nuclear power and toward renewables.
In one surprise, Germany appears poised to tap its first woman defence minister, mother-of-seven Ursula von der Leyen. She had until now held the labour brief.
And Merkel's chief of staff, Ronald Pofalla, unexpectedly announced his exit.
As coordinator of the secret services, Pofalla had been widely ridiculed for a mild response to the scandal over mass snooping by the US National Security Agency, culminating in the explosive revelation in October that it had tapped Merkel's mobile phone.
Media reports said he was leaving for "personal reasons" and would be replaced by Environment Minister Peter Altmaier, another close Merkel confidant.
Merkel and her CDU romped to victory in the September general election, winning 41.5 percent of the vote on the back of a strong economy and falling just short of what would have been an extraordinary absolute majority.
The Social Democrats, a 150-year-old political force, limped to second place with 25.7 percent in their second worst showing since World War II.
The pro-business Free Democrats, Merkel's junior partner during her second term, crashed out of parliament for the first time since 1948.
Gabriel called the SPD's binding rank-and-file vote, the first in German history, to rally his often fractious party around the left-right government
and drove a hard bargain during the coalition talks that wrapped up in late November.
He extracted a number of concessions including Germany's first national minimum wage, permission for dual citizenship for children of immigrants, restrictions on temporary jobs and a lowering of the retirement age to 63 for those who paid into the system for 45 years.
He said he believed the Social Democrats had set a precedent for direct democracy that could shape future governments.
"This day will not only go down in the history of Social Democracy but also, I believe, go down in the history of German democracy," he said.
A poll for public broadcaster ZDF published Friday showed that 49 percent of Germans are looking forward to a grand coalition government while 33 percent oppose it.