Announcing his decision to pass on the reins of the party to a trusted ally Franz Muentefering, Schroeder - much riled for his bitter economic reforms - said, however, he would stay on as the German Chancellor.
"I am committed to this process of reform. I am convinced it is necessary," Schroeder told journalists announcing his surprise move on Friday.
Schroeder's decision is largely seen as a desperate bid to regain the party's backing for his unpopular economic reform programme. His chosen successor, Muentefering is the party's popular parliamentary floor leader.
The German Chancellor said he was committed to carrying on Germany's biggest overhaul of the welfare state since World War Two and wanted to free himself to implement it.
Muentefering, 64, is far better liked that Schroeder in the centre-left party. He could act as a lightning rod for inner-party criticism of Schroeder's policies.
Schroeder's SPD fell to all-time lows of about 25% support in opinion polls in 2003 and has failed to recover since then, alarming its officials ahead of a marathon of more than 10 state and local elections this year.
"I am committed to this process of reform. I am convinced it is necessary."
The growing view that Schroeder's reforms are targeted at the less well-off and betray the party's Socialist roots has triggered an exodus of members, with 43,000 members quitting last year.
Muentefering has backed Schroeder's reforms so far and said he would convince the party they were essential to keeping the welfare system intact.
"You will write into history books that the Social Democrats managed to reform Germany," he said.
But the change in party leadership cast a question mark on Schroeder's ability to keep up the pace of reform.
"It shows they are afraid about the next elections and that the popularity ratings from the opinion polls have got to them," said Adolf Rosenstock, an economist at Nomura International in Frankfurt.