They will also keep Frogmore Cottage, but will pay back Sovereign Grant money used to upgrade the property.
Harry and Meghan will spend more of their time in North America and will not carry out duties from the Spring.
Prince Charles will continue to pay the couple money from the Duchy of Cornwall, although it is not clear how much they will receive.
The Prince and his wife will be free to seek employment, but have pledged to uphold the values of the Queen in any commercial ventures.
"Following many months of conversations and more recent discussions, I am pleased that together we have found a constructive and supportive way forward for my grandson and his family," The Queen wrote in a statement released at 6.30pm on Saturday.
"Harry, Meghan and Archie will always be much loved members of my family.
"I recognise the challenges they have experienced as a result of intense scrutiny over the last two years and support their wish for a more independent life.
"I want to thank them for all their dedicated work across this country, the Commonwealth and beyond, and am particularly proud of how Meghan has so quickly become one of the family.
"It is my whole family's hope that today's agreement allows them to start building a happy and peaceful new life."
A statement from Buckingham Palace added: "The Duke and Duchess of Sussex are grateful to Her Majesty and the Royal Family for their ongoing support as they embark on the next chapter of their lives.
"As agreed in this new arrangement, they understand that they are required to step back from their Royal duties, including official military appointments.
"They will no longer receive funding for Royal duties.
"With the Queen's blessing, the Sussexes will continue to maintain their private patronages and associations.
"While they can no longer formally represent The Queen, the Sussexes have made clear that everything they do will continue to uphold the values of Her Majesty."
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