The bill will now be sent to parliament for debate and likely receive swift final approval, Chief Cabinet Secretary Yoshihide Suga said after Prime Minister Shinzo Abe's cabinet signed off on the legislation.
Abdication must take place within three years of the bill becoming law.
Earlier this year reports suggested that 83-year-old Akihito could step down at the end of December 2018 and be replaced by Crown Prince Naruhito on January 1, 2019.
Reports of his desire to retire surprised Japan when they emerged last July.
In August he publicly cited age and declining health, which was interpreted as his wish to hand the crown to his eldest son.
But current Japanese law has no provision for abdication, thus requiring politicians to craft legislation to make it possible.
The status of the emperor is highly sensitive in Japan given its 20th century history of war waged in the name of Akihito's father Hirohito, who died in 1989.