The former South Africa captain suffered a fractured knee in May that cut short his season at Surrey, where he was also skipper.
Smith had 12 months remaining on the three-year contract that started in 2013, but Surrey confirmed on Sunday that the 33-year-old will not return to The Oval in 2015 as speculation mounts that he is poised to retire.
A statement on Surrey's official website said: "Following his recent knee surgery, the medical experts have strongly advised that his body will not enable him to fulfil the day to day duties of a full county season. Therefore, the sensible decision for both Graeme and Surrey was for him not to return to play next season."
Alec Stewart, Surrey director of cricket, added: "On behalf of the club, and particularly the dressing room, I would like to thank Graeme for the impact he has had in the time that he was with us over the last two years.
"As a person and leader his qualities have helped lay the foundations for the progress that we all want for the club.
"We wish Graeme the very best in the next stage of his career and he will always be welcomed at The Oval."