Having taken up the post in September 2009, Mr Baggott will not renew his contract which runs out in September.
An email sent by Mr Baggott to his colleagues in the PSNI read: "I wanted to let you know that I have notified the Policing Board this morning of my intention to retire from the PSNI later this year. As such I will not be seeking an extension to my contract which ends in September 2014. I felt it important that you should hear about this first from me.
"My time as Chief Constable of the Police Service of Northern Ireland has been the greatest privilege of my policing service. I am deeply proud to have had the opportunity to work alongside the most courageous, committed and professional people in the world. You have made enormous progress and I am deeply grateful for your constant support and encouragement.
"In my remaining months my priorities will be to ensure the PSNI has the resources to deal effectively with the many challenges ahead and that our very personal, professional and protective service goes from strength to strength."
Mr Baggott, 55, spent the first 20 years of his service in the Metropolitan Police and, throughout his career, has been a strong advocate of neighbourhood policing.
On his first day in the job in Northern Ireland, he spoke of the importance of the role that communities would play in addressing the threat still posed by violent extremists - something which he said should not be underplayed.
The father-of-three assumed command of the PSNI at a time when the force faced balancing multimillion-pound funding cuts with growing public demands for more officers on the beat.
He also took the reins ahead of the politically sensitive transfer of security responsibilities from Westminster to the devolved administration at Stormont, replacing Sir Hugh Orde.
Matt Baggott has made an outstanding contribution to keeping the people of Northern Ireland safe and secure.
Theresa Villiers, Secretary of State
Secretary of State Theresa Villiers, thanked the Chief Constable for his service.
She said: "I would like to offer sincere gratitude to the Chief Constable for the commitment he has demonstrated in delivering effective community policing across Northern Ireland and tackling the threat from terrorism.
"During his time as Chief Constable, Matt Baggott has also been responsible for the successful policing of a number of key events including the Olympic Torch Relay, World Police and Fire Games and the G8 Summit.
"I wish him well for his remaining time as Chief Constable and for the future. I thank him for his dedicated service to Northern Ireland."
The Police Federation for Northern Ireland, which represents the force's rank and file officers, also paid tribute.
Chairman Terry Spence, said: "We are grateful that he is ensuring that there will be no leadership void and therefore essential continuity will be maintained before his successor is recruited.
"On behalf of the federation I wish him and his family well in whatever direction his career may take."
Mr Baggott has been a chief officer of the utmost integrity who has displayed loyalty to his colleagues in the most challenging policing environment in the western world
Terry Spence, Police Federation
Chief Superintendent Nigel Grimshaw, President of the Superintendent's Association for Northern Ireland added: "I wish Mr Baggott every success for the future as he prepares to retire from the PSNI, which is without doubt one of the most demanding roles in policing anywhere."
"This year will be a very important and significant year for the PSNI given it now looks forward to the appointment of both a new Chief Constable and Deputy Chief Constable.
"The challenges facing policing in Northern Ireland remain very significant, and I therefore wish the Policing Board well with their responsibilities in appointing the right people for what are such critical roles."
Recalling Mr Baggott's 2009 appointment, UTV's Political Editor Ken Reid said: "It was quite a difficult job for somebody who came from an English constabulary. And he was faced with really a financial task first of all, which was that the numbers of the force had to go down. There are fewer than 7,000 in the PSNI now.
"He then had the obvious threat from the dissident republicans, the loyalist street protests and it has been quite a challenging job for somebody particularly coming in from the outside.
"There's been much speculation recently that he wouldn't go to renew his contract," he said.
"Significantly one of his deputies, the Deputy Chief Constable Judith Gillespie revealed quite recently that she will leave the force.
"So it's going to be a complete change at the top of the leadership of the PSNI in the Autumn.
He added: "Potential replacements include people like George Hamilton who has been very impressive in dealing with difficult situations and Mark Hamilton, who was the north Belfast commander, and others.
"And of course, when it goes to open competition there could be applicants from the south and parts of England.
"Interestingly, I had talked to Sir Hugh Orde on this matter last year and he didn't think there would be much interest among senior officers in England in the job."
The slow, at times timid, response to the street protests which brought our towns and cities to a standstill in recent years dealt significant damage to community confidence in the police.
Dolores Kelly, SDLP MLA
Jonathan Craig MLA, the DUP's group leader on the Northern Ireland Policing Board, said: "Matt Baggott has served as Chief Constable during some very challenging times.
"He carried out his duties with sincerity and warmth and whilst we did not always agree with some of the decisions he made, I and my colleagues always found him willing to listen and take our views on board.
"The Chief Constable's job is one of the most difficult in Northern Ireland and Mr Baggott tried his best to serve our community and make our society a safer, better place. We wish him well in his retirement", said the DUP MLA.
SDLP Policing Board member Dolores Kelly MLA also commended Mr Baggott for his work, however she said his tenure as head of the organisation, was "not without disappointment".
She said: "It's important that we recognise the Chief Constable's five-year commitment to leading the PSNI through difficult times and unique challenges, both financially and operationally as the security threat remains high across Northern Ireland.
"Matt Baggott's strong focus on community policing and track record of making the most of limited resources made him the best person to take the helm of the organisation in a turbulent time.
"The focus now must shift to restoring strong, stable leadership to the PSNI in the wake of both the Chief Constable and the Deputy Chief Constable's announcements that they will be leaving the organisation."
During his tenure he saw officers killed in the execution of their duty and I know this had a great impact on him.
Ross Hussey, UUP MLA
Ulster Unionist Policing Board member Ross Hussey MLA also added his thanks to the retiring Chief Constable and wished him well in the future.
He said: "I have always found Matt Baggott to be professional in all dealings I have had with him.
"He came to Northern Ireland with a remit to transform the PSNI into a community-based service and although he made great strides in this direction, unfortunately the increased terrorist threat reduced the ability of the Chief and his officers to deliver to the extent they would have wanted."
Sinn Féin member of the Policing Board Pat Sheehan said: "There were many areas that Sinn Féin disagreed with Matt Baggott among them his treatment of the Ombudsman's report into the McGurks Bar and his initial failure to deal with the flag protestors.
"Come September we will wish him well but at the minute there is still a job to do."
The appointment of Mr Baggott's successor will be made by the Northern Ireland Policing Board and is subject to the approval of Justice Minister David Ford.
Mr Ford said: "Matt Baggott has served as Chief Constable of our Police Service during a very difficult period in our history. We have seen police officers come under attack from terrorists and from street protestors and the Chief Constable has been constant in his support for his officers."