The Premier League club's board signalled the 50-year-old's departure when it approved a pay-off, reported by British media to be around 3.0 million pounds, despite agreeing a five-year contract in March last year.
According to the terms of that deal Benitez would have been entitled to a severance package of around 16.0 million pounds but Liverpool, burdened by debt and financially impoverished, would have struggled to pay him off in full.
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Benitez could have remained in his job knowing that the board did not want him there. But a compromise was reached, paving the way for a possible move into the Inter Milan job vacated by Jose Mourinho after winning the Champions Le'ague with Inter last month.
"Rafa will forever be part of Liverpool folklore after bringing home the Champions League following the epic final in Istanbul but after a disappointing season both parties felt a fresh start would be best for all concerned," Liverpool chairman Martin Broughton said in a statement on the club website.
Benitez added: "It is very sad for me to announce that I will no longer be manager of Liverpool FC. I would like to thank all of the staff and players for their efforts.
Inter Milan president Massimo Moratti, who said earlier in the week he rated Benitez but could nothing because the Spaniard was with Liverpool, told reporters: "There is no news."
Benitez's departure, after a hugely successful start at Liverpool in 2004/05 when they won the Champions League, comes as little surprise after they finished seventh in the Premier League in the season just ended, their lowest position since 1999.
