Primeminister Dmitry Medvedev said the president's proposals would significantly change Russia's balance of power.
PM Dmitry Medvedev said the president's proposals would significantly change Russia's balance of power.
Mr Putin asked Mr Medvedev to become deputy head of the National Security Council, which is chaired by Mr Putin.
The announcement comes four years before Mr Putin's fourth term of office is due to end.
Under the existing constitution he would not be entitled to another term and the Russian leader said during his speech to both chambers of parliament that there would be a nationwide vote on changes that would shift power from the presidency to parliament.
The government's resignation came as a surprise. Mr Medvedev has been prime minister for several years. He previously served as president from 2008-2012, switching roles with Mr Putin - a close ally - after the latter served his first two terms as president.
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Russia's constitution only allows presidents to serve two consecutive terms.
Even when he was prime minister, Mr Putin was widely seen as the power behind then President Medvedev.
"These changes, when they are adopted... will introduce substantial changes not only to an entire range of articles of the constitution, but also to the entire balance of power, the power of the executive, the power of the legislature, the power of judiciary," Mr Medvedev said of Mr Putin's proposals.
"In this context... the government in its current form has resigned."
Mr Medvedev made his announcement on state television with President Putin sitting next to him.
Mr Putin thanked Mr Medvedev for his work but said "not everything" had been accomplished.
BBC Moscow correspondent Sarah Rainsford said the reason why Mr Putin had removed Mr Medvedev was unclear.
The outgoing government will remain in situ until the new one is appointed although a new prime minister to replace Mr Medvedev must be appointed within two weeks.
Correspondents say possible candidates to succeed Mr Medvedev as prime minister include Economy Minister Maxim Oreshkin, Mayor of Moscow Sergei Sobyanin and Energy Minister Alexander Novak.