"Transgender servicemembers will no longer be subject to the possibility of discharge or separation on the basis of gender identity," the White House said.
There were 8,980 active duty transgender troops in 2019, according to Department of Defence data analysed by the Palm Center, a non-profit group.
"President Biden believes that gender identity should not be a bar to military service, and that America's strength is found in its diversity," the White House statement added.
New Defence Secretary Lloyd Austin, a retired army general, said in a statement: "The Department will immediately take appropriate policy action to ensure individuals who identify as transgender are eligible to enter and serve in their self-identified gender."
"The United States Armed Forces are in the business of defending our fellow citizens from our enemies, foreign and domestic. I believe we accomplish that mission more effectively when we represent all our fellow citizens," he added.
Mr Trump announced on Twitter in 2017 that the country would no longer "accept or allow" transgender Americans to serve in the military, citing "tremendous medical costs and disruption".
The ban took effect in April 2019. Trans personnel who were already serving were allowed to continue, but new recruits were locked out.
Jim Mattis, the then defence secretary, refined the policy to limit it to individuals with a history of gender dysphoria, or when a person's biological sex and identity do not match.
President Biden repeatedly said he planned to overturn the ban.
Prior to the inauguration, a memo from Ron Klain, now the White House Chief of Staff, said Mr Biden planned to use his first full week as president "to advance equity and support communities of colour and other underserved communities".
This is the latest example of Mr Biden using executive orders to overturn Trump era policies.
He has already signed orders halting construction of the Mexico border wall, overturning a ban on travellers from several predominantly Muslim countries, and launching an initiative to improve racial equity.