Mr Key made the announcement at his weekly press conference this afternoon.
His voice shaking with emotion, Mr Key said he told his Cabinet of his decision this morning
"This is the hardest decision I've ever made and I don't know what I'll do next."
Mr Key has been credited with lifting and keeping National high in the polls since his elevation to Opposition leader after toppling Don Brash.
Mr Key cited family reasons for leaving, saying the job had required great sacrifices "from those who are dearest to me".
His wife Bronagh had endured "many lonely nights" and his children Stephie and Max had been put under "extraordinary levels of intrusion".
"Bronagh has made a significant sacrifice during my time in politics, and now is the right time for me to take a step back in my career and spend more time at home."
Bill English is expected to take over as Prime Minister and Steven Joyce is expected to take on the finance role.
The National Party caucus will hold a meeting on December 12 to decide the new party leader and prime minister.
Mr Key said he would support whoever the caucus chose, but he endorsed Bill English as his replacement.
"Whoever the caucus votes for will have my unwavering support, but if Bill English puts his name forward then I will vote for him.
"For 10 years now Bill and I have worked closely as a team. I have witnessed first-hand his leadership style, his capacity for work, his grasp of the economy, his commitment to change and most of all his decency as a husband, as a father, a colleague and as a politician."
Mr Key said there was no way he could have serve out a full fourth term.
"I do not believe that if I was asked to commit to serving out a full fourth term I could look the public in the eye and say yes.
"And more than anything else in my time here, I have tried to be straight and true with New Zealanders.
"Making the decision to resign has not been easy, and I have no plans as to what comes next in my professional life."
Mr Key said leaders seemed to stay too long and he felt this was the opportunity to go out on top.
He said he was looking forward to enjoying a slightly quieter life in which he would take posts on boards and spend time travelling with his spouse.
He also said it was the right time to leave, as National were polling at nearly 50 per cent and the economy was growing.
"It leaves the Cabinet and caucus plenty of time to settle in with a new Prime Minister before heading into election year with a proud record of strong economic management," he said.
"I am hugely confident that National can and will win the next election - just as I as am confident that the caucus has a number of people who would make a fine Prime Minister."
Asked what his legacy would be, Mr Key said stabilising and growing New Zealand's economy after the global financial crisis and weathering crises such as the Canterbury earthquakes.
Mr Key said his main regrets were failing to ratify the Trans Pacific Partnership, not getting the Kermadec Ocean Sanctuary opened, and not changing the national flag.
He had "given everything" to the job but had "nothing left in the tank".
Mr Key said that he wanted to thank the Cabinet and Caucus for their loyalty and energy, and his staff for their hard work over these last eight years.
"I want to acknowledge and thank our support partners ACT, United Future and the Maori Party without whom the strong and stable government we have delivered would not have been possible.
"The Board, office holders and members of the National Party have my grateful thanks for everything they have done during my 10 years as their leader.
"I want to thank the people of the Helensville electorate who have returned me to Parliament every three years since 2002. It has been a great privilege to be their MP."
He will remain MP for Helensville before stepping down closer to the next election.
Mr Key cancelled his weekly scheduled interview with NewstalkZB at the NZME offices in Auckland this morning, and instead was interviewed over the phone from Wellington.
New Zealand First Leader Winston Peters said of the resignation: "The fact is that the economy is not in the healthy state that the Prime Minister has for so long claimed, and there are other issues which have caused this decision as well.
"The New Zealand public should have been informed of this a long time ago.
"Clearly the Prime Minister does not believe the superficial polls any longer.
"Contrary to certain perceptions the Prime Minister and his Finance Minister are unable to muddy the waters anymore."
Mr Key has led the National party since 2006.
He built a career in foreign exchange in New Zealand before continued success in the industry overseas.
He entered Parliament in 2002 as National's representative for Helensville. In 2004 he was appointed Finance Spokesman for the party and succeeded Don Brash as party leader in 2006.
Mr Key led his party to win the election in November 2008 and repeated the victory in 2011 and 2014.
He has governed the country through the recession of the late-2000s, formed the Canterbury Earthquake Recovery Authority in response to the aftermath of the 2011 Christchurch Earthquake and created a much-protested policy for the partial privitisation of five state-owned enterprises.
He has also withdrawn the NZ Defence Force from Afghanistan and worked to establish the TPP with the United States.
CAREER HIGHLIGHTS AND LOWLIGHTS
- Under Mr Key, the government guided the economy through the Global Financial Crisis, with economists branding New Zealand the ``rockstar economy'' of the OECD in 2014 and the dollar taking a hit on the resignation
- * National's stability and conservative style of fiscal management won praise from other governments, particularly from across the Tasman _ but it didn't announce its first surplus until 2015, despite long-time promises
- * In recent years it's also struggled to put a lid on skyrocketing house prices and rising housing unaffordability, particularly in Auckland
- Mr Key led the nation through the Christchurch earthquakes and rebuild, and visited the families of the 29 men killed in the Pike River Mine disaster - both of which continue to make headlines years on
- More recently, he's overseen the response to the Kaikoura quake, which has left the government with an unexpected bill
- During his time as PM, the government passed wide-ranging and often controversial reforms, including tax cuts, welfare policy, labour law changes, an overhaul of the justice sector and a partial selldown of state assets
- It also oversaw the introduction of same-sex marriage in New Zealand _ which Mr Key voted in favour of
- Under Mr Key's leadership National has polled consistently well, still nudging 50 per cent in some research ahead of his third-term resignation
- He also proved popular with other world leaders, playing golf with US President Barack Obama in Hawaii and striking up a so-called ``bromance'' with Aussie PM Malcolm Turnbull.
- Mr Key was left disappointed after fronting an unsuccessful campaign to change the country's flag earlier this year _ seen by some as a ``legacy project``
- He came under fire and made global headlines after pulling 26-year-old Auckland waitress Amanda Bailey's hair against her wishes while she was working
- Mr Key oversaw the signing of the much-protested Trans-Pacific Partnership Agreement _ and was still championing the free trade deal in the days before it was put on ice by US President-Elect Donald Trump
- The Prime Minister also gained a reputation for moments of awkwardness over the years: being caught in a three-way handshake with Richie McCaw at the 2011 Rugby World Cup, showing off some less-than-elegant dance moves and drawing fire over a few radio interviews which struck some as too casual
