"I've resigned from the ministry today and written to the prime minister in those terms," he said.
Senator Hill, considered a moderate in the conservative government, has been defense minister since 2001 and was previously environment minister, serving 10 years in all in the cabinet.
He is also retiring from the Senate following 25 years in the upper chamber of parliament, where he was the senior government representative.
Commentators said Senator Hill had fallen from favor in government due to his lukewarm support for Australia's involvement in the US-led invasion of Iraq and unease at Australia's response to scandals surrounding the treatment of Iraqi inmates at US-run prisons in Baghdad.
But Senator Hill said it was his decision to retire and he was not pushed into it by Prime Minister Howard.
"I initiated the process by telling him I believe that I should retire some time and we've had some discussion obviously flowing from that but is my decision and there's been no commitment beyond that," he said.
He is expected to be replaced by another senior Howard minister, with Finance Minister Nick Minchin and Health Minister Tony Abbott among those tipped for the job.
Senator Hill's departure has long been rumored in Canberra and he reportedly turned down offers last year to be Australia's ambassador to London or Washington.
New UN Ambassador
The 59 year old is expected to be named as Australia's next ambassador to the United Nations.
But Senator Hill declined to comment on such speculation during a hastily arranged press conference, saying, "I haven't been the source of any of that speculation and I am not intending to contribute to it now."
He said he had been involved with the UN for a long time, but added that it was in need of reform.
"I'm pleased that Australia is supporting many of their peacekeeping operations around the world," Senator Hill said.
"But I was also obviously very disappointed that the Security Council failed to meet its international responsibility in what ultimately led up to the war in Iraq, so I think it is an institution that is badly in need of reform.
"That has started, they've made some progress in the human rights areas last year, but I still think it has got a long way to go.”
Senator Hill said he had not been offered any other jobs post-politics but he did say he had been involved in talks about possible options.
"I've had discussions about options, and if it was to be a government position that would be something that the government would obviously consider in due course, it would be a decision for the prime minister and for cabinet," he said.
Australia's current ambassador to the UN is due to return home in February.
UN job aimed at denting Costello support
Labor says the plan to appoint Senator Hill as Australia's next ambassador to the UN was designed to dent Treasurer Peter Costello's leadership ambitions.
Opposition foreign spokesman Kevin Rudd criticised the possible appointment, saying such a complex and sensitive job should go to a more experienced diplomat.
Mr Rudd said there were at least a dozen people in the Australian foreign service with the skills and experience to do the UN ambassador's job.
"John Howard can't advance the case that no other comparable talents are available, that's simply not the case," Mr Rudd told reporters in Sydney.
He said Mr Howard wanted the South Australian senator to leave parliament because that would reduce support for Mr Costello's ambitions for the top job.
"What John Howard is doing, in fact, is trying to solve a problem of the Liberal Party in South Australia and using the Australian foreign service as his employment agency to do that.
"By taking Senator Hill out of South Australia, that removes a strong potential supporter of the Costello base in South Australia.
Mr Rudd also questioned the timing of the senator's departure from parliament amid the Iraq kickbacks scandal involving wheat exporter AWB and government officials.
"In the midst of Australia's worst corruption scandal ever, what does the Howard government do? It decides to give jobs to the boys to another one of its favoured mates," Mr Rudd said.
Mr Rudd said Labor was not concerned about the principle of using political appointments to overseas diplomatic posts, but was worried about how often the government was making such appointments.
He said that in the past decade the government had made 19 political appointments to diplomatic posts, compared to the 10 made by Labor during its 13 years in power.