Bennett said that Lapid, a centrist, will take over as prime minister of the caretaker government in line with last year’s power-sharing deal.
“We made the right decision for Israel,” he said.
The move means Lapid is now poised to host US President Joe Biden, who is due to visit Israel in July.
Lapid thanked Bennett for “putting the country before his personal interest”, but said the inability of the coalition to survive indicated that Israel “is in need of serious change”.
West Bank settler law
Bennett, a religious nationalist, is the former head of a lobby group for Jewish settlers in the West Bank, a Palestinian territory occupied by Israel since 1967.
His government faced a 30 June deadline to renew a measure that ensures settlers live under Israeli law. Palestinians in parts of the West Bank are subject only to Israeli military rule.
Two Arab lawmakers within the coalition refused earlier this month to re-certify the measure, leaving the coalition, which only controlled 60 votes in Israel’s 120-seat parliament, handcuffed.
Bennett, an unswerving supporter of West Bank settlements considered illegal under international law, said he could not allow the measure to lapse.
The law’s expiration would have created “security risks” and “constitutional chaos”, he said.
“I could not allow that.”
Dissolving the government before the measure expires means it is automatically renewed until a new government is formed.
Israel’s Haaretz newspaper reported new elections would be held on 25 October.
Netanyahu, who is on trial over corruption charges that he denies, hailed the end of “the worst government in Israel’s history”.
The veteran right-winger pledged to form “a strong and stable government” of right-wingers.
But Netanyahu has no obvious solution to the political challenges that plagued him through four previous votes since April 2019 in which he failed to secure a governing coalition.
Many on the right still distrust him personally and have ruled out serving in any government he leads, including former ally and coalition member Gideon Saar, currently Israel’s justice minister.
“The goal in the near elections is clear: preventing the return of Netanyahu to the premiership, and enslaving the state to his personal interests,” Saar tweeted.
Political analyst and polling expert Dahlia Scheindlin told AFP earlier this week that while surveys continue to show Netanyahu’s Likud party remains Israel’s most popular, there is no certainty that fresh polls will give him a governing majority.
“In all the surveys in the last two months, only one survey gave (Netanyahu and his allies) 61 seats and that one was a few weeks ago, so it is not like there is a trend (of Likud rising),” she said.
Yohanan Plesner, president of the Israel Democracy Institute think-tank, said the move by Bennett and Lapid highlighted that Israeli governance remains in crisis.
“The decision by Prime Minister Bennett to disperse the Knesset... is a clear indication that Israel’s worst political crisis did not end when this government was sworn into office, but rather merely receded only to return when this coalition failed to find a way to continue moving forward.”
“While this government was one of Israel’s shortest to hold office, it played an historical role by including an Arab party in the coalition and in the decisions made by the national leadership, and therefore paving the way for the possibility of more inclusion by the Arab minority in the political process,” Plesner added.