The 7ft 6in (2.3m) giant's career with the Rockets had been plagued by an assortment of injuries, most recently a stress fracture in his left leg.
Yao's injuries forced him to miss the entire 2009-2010 season.
The 30-year-old is considered the NBA's first renowned player from Asia.
Yao officially informed the NBA of his decision sometime during the past two days, Yahoo! Sports reported on its website on Friday.
The Shanghai native averaged 19.0 points and 9.3 rebounds in 486 NBA games during his career and was an eight-time All-Star player, a title given to the most successful contenders in the league.
He was selected first overall by the Rockets in the 2002 NBA draft, following a career with the Chinese national team and the Shanghai Sharks.
But Yao later suffered broken bones in his left foot, which kept him from playing in the 2009-2010 season, as well as a stress fracture in his left leg, forcing him to sit out all but five games during this past season.
Yao's career with the Rockets had been plagued by an assortment of injuriesAnalysts say Yao had a large international impact on the game and was a driving force behind the NBA establishing a China venture in 2007.
Basketball legend Shaquille O'Neal posted a video on his Twitter account, congratulating him on his career.
"You are one of the greatest players ever to come out of China, one of the greatest players period," O'Neal said.
"Let's go on vacation, bro, me and you," he added.
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