The star made the surprise statement during a recording of The Late Show with David Letterman on Thursday.
Letterman, 66, is one of the biggest names on US TV. He has spent 21 years hosting the CBS talk show, following 11 years on NBC's Late Night programme.
He said he had told his CBS bosses he would step down in about a year's time, when his current contract expires.
Referring to CBS chairman Leslie Moonves, Letterman told his audience: "I phoned him just before the programme, and I said, 'Leslie, it's been great, you've been great, and the network has been great, but I'm retiring.'"
Letterman thanked "all of the people who have worked here, all of the people in the theatre, all the people on the staff, everyboLetterman is known for his mixture of big-name interviews and comedy features like his irreverent top 10 lists and segments like Monkey Cam, in which a TV camera was strapped to a monkey while it roamed the studio.
The star began his career as a radio talk show host and local TV weatherman, before becoming part of a comedy troupe on a CBS variety series starring Mary Tyler Moore in 1978.
He was given his own morning programme on NBC show two years later. It only lasted a matter of months, despite winning two Emmy awards.
Late Night with David Letterman followed, and he began to be seen by many as the natural successor to Johnny Carson on The Tonight Show.
dy at home - thank you very much".
But when he lost that slot to Jay Leno following Carson's retirement in 1992, Letterman moved to CBS and began a long-running rivalry with Leno.
Leno was on top in the ratings for most of their two-decade duel. Letterman's departure comes two months after Leno stepped down from The Tonight Show.
Leno was replaced by Jimmy Fallon, whose show averages 5.1 million viewers a week, compared with 2.9 million for Letterman, according to Nielsen ratings.
CBS chairman Leslie Moonves praised Letterman's "wit, gravitas and brilliance".
He continued: "Dave has given television audiences thousands of hours of comedic entertainment, the sharpest interviews in late night, and brilliant moments of candour and perspective around national events.
"He's also managed to keep many celebrities, politicians and executives on their toes - including me."
Replacement rumours
Jimmy Kimmel, who hosts a rival talk show on ABC, tweeted: "David Letterman is the best there is and ever was."
Speculation has already begun about his replacement, with Craig Ferguson, Jon Stewart, Conan O' Brien, Chelsea Handler and Stephen Colbert among those being tipped.
Lena Dunham, star of the HBO show Girls, tweeted that she hoped CBS would cast a wider net.
She wrote: "I love Letterman but I am really excited about what this could mean for the diversification of late night. Trying not to be a pessimist..."
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