"Now we're finishing the job we've started," Obama told reporters at the White House Rose Garden. "We have now been in Afghanistan longer than many Americans expected."
He said the current 32,000-strong US deployment in Afghanistan will be reduced to around 9,800 by the start of 2015. The number would be further halved by the end of 2015 before eventually being scaled back to a normal embassy presence with a security assistance component by the end of 2016.
"At the beginning of 2015, we will have approximately 9,800 US service members in different parts of the country, together with our NATO allies and other partners," Obama said.
"By the end of 2015, we will have reduced that presence by roughly half. One year later, our military will draw down to a normal embassy presence in Kabul, with a security assistance component, just as we've done in Iraq," he said.
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His announcement came a day after his unannounced trip to Afghanistan on the eve of the memorial day, as he said "future of Afghanistan must be decided by Afghans themselves".
The US and NATO plan to withdraw most of their forces ahead of a year-end deadline. Obama wants to keep a small number of US troops in Afghanistan after 2014 to train Afghan security forces and support counterterrorism missions that started 13 years ago after the attack on the World Trade Centre.
Afghan President Hamid Karzai has refused to authorise the BSA, that should be signed by Karzai's successor to become effective.
"So I'm hopeful we can get this done," Obama said.
The decision means Obama will demit office in 2017 having brought back troops from Afghanistan in the longest war in US history. In 2011, he also ended Washington's combat presence in Iraq.