Business Secretary Vince Cable said employees would be given 10% of shares as part of a stock market flotation.
He described it as “the biggest employee share scheme for nearly 30 years”.
Unions have reacted angrily to the plans and have threatened to ballot for strike action.
The Communication Workers Union (CWU) said the sale of Royal Mail was “unwanted by public, customers and the workers”.
The government has opted to float the company on the London Stock Exchange rather than sell it to a private buyer.
Members of the public will be able to buy shares, alongside larger institutional investors.
But 10% of shares are being set aside for eligible members of Royal Mail staff, which they will get for nothing.
“Now the time has come for government to step back from Royal Mail, allow its management to focus wholeheartedly on growing the business and planning for the future,” Mr Cable told MPs.
“It’s now time for employees to hold a stake in the company and share in its success.
Dave Ward, CWU: “If you bring in private owners to Royal Mail, they will change the priorities of the company”
“This government will give Royal Mail the real commercial freedom it’s needed for a long time.”
The sale is likely to value the business at £2bn-£3bn, suggesting up to 150,000 staff will receive £200m-£300m in shares.
The government says the sale is necessary in order to give Royal Mail the access to private capital it needs to grow and remain competitive.
It is currently revamping its business to focus less on the delivery of letters and more on parcels, in order to benefit from the rapid growth of internet shopping.
A boom in parcel delivery helped Royal Mail to more than double its profits last year, after many years of losses.
Mr Cable also said privatisation was necessary to ensure that universal service, which guarantees delivery to all parts of the UK on six days of the week, can continue.
But both Labour and the unions argued the move made no sense.
“Having nationalised the organisation’s debts by taking on its pension liabilities, they now want to privatise the profit at the very time it is making money. How on earth does that make any sense?” said Labour’s Chuka Umunna.
Dave Ward, deputy general secretary of the CWU, said the flotation announcement had “ignored the views of the workforce and the British public”.
“The workforce agreed a modernisation programme with Royal Mail three years ago and it didn’t include privatisation,” he said.
“They have worked hard to modernise the company and deliver the profitable organisation Royal Mail is today. They have recently voted in big numbers against the sale and they will be angered by today’s announcement.”
He said the union would continue to fight the sale and warned that, without a legally binding agreement on terms and conditions, strike action was “inevitable”.
The CWU represents about two-thirds of Royal Mail staff. Earlier this year, its members voted overwhelmingly against privatisation.
The threat of strikes means it is possible that the share sale, set to take place towards the end of the year, could take place under industrial action.
Speaking later to the BBC, Mr Cable described the share offer and a recent pay offer by Royal Mail as “attractive” and said he hoped strike action would not ensue.
“I think when they look at this in the cold light of day, I think they will see that it is in their interests not to disrupt it,” he said.
The flotation is likely to be one of the biggest since large utility companies such as British Gas were privatised in the 1980s.
It will not include the Post Office, which is a now a separate company.
The government said it planned to invest in the network of post offices and potentially set it up as a mutual business.