"I feel the time is coming when my other commitments deserve more of my time and energy," McGrath, 59, said in a statement.
More than a fifth of Prudential shareholders voted against re-appointing McGrath at the insurer's investor meeting in May in protest over the botched AIA deal, which left the company to pick up 377 million pounds ($586 million) in costs and fees.
The unusually large dissenting vote showed McGrath had become the main focus of investor resentment over the AIA debacle rather than chief executive Tidjane Thiam, who had initially been seen as equally culpable.
McGrath, who needed a simple majority of votes to keep his job, said at the time he had no intention of stepping down.
"If you look at the AGM result this year, it was clear the chairman was going to go at some point," said one analyst who asked not to be named.
"It was just a matter of timing before the announcement came out."
McGrath will leave in 2012 once a successor has been found, Prudential said. There has been speculation he could be replaced by Howard Davies, a former chairman of the Financial Services Authority who joined the insurer as a non-executive director in October last year.
Prudential, Britain's biggest insurer, was forced to pull its $35.5bn AIA bid after shareholders baulked at the price, and AIA's parent, U.S. insurer AIG, rejected a cheaper offer.
Buying AIA, Prudential's main foreign rival in its key south-east Asian markets, would have given the insurer a commanding presence in a region where demand for financial services is booming as strong economic growth nurtures an emerging middle class.
Prudential has since sworn off big acquisitions, hiked its dividend and set itself ambitious financial targets in a largely successful effort to mend relations with its shareholders.
McGrath, who has chaired Prudential since January 2009, said he aimed to pursue his interests in the "public, educational and philanthropic sectors."