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The 38-year-old made his debut in the German top flight 18 years ago and has had three separate spells at Werder and two stints at Bayern.
"Due to the big competition in attack and the young talent we have, whose development we don't want to hinder, we decided to not extend Claudio's contract," said Werder sporting director Frank Baumann.
Pizarro is Bremen's all-time top scorer in the Bundesliga with 104 goals. He is also the all-time leading foreign goal-scorer in the Bundesliga.
"It was always a huge honour for me to wear the SV Werder Bremen shirt. The club, the city and the fans will always have a special place in my heart," said Pizarro, who also had a spell at Chelsea between 2007 and 2009.
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"I would have liked to carry on playing for Werder, but I accept the club's decision."
He won six Bundesliga titles and five German Cups with Bayern as well as the Cup with Bremen in 2009.