Starmer expressed an intent to eventually reach three percent, a rise of 0.7 percent from current spending that would mark the biggest increase since the end of the Cold War.
"The great lesson or our history is that tyrants like Putin only respond to strength," he said.
His announcement comes ahead of key talks on Ukraine with Trump in Washington on Thursday.
It is seen as an attempt to appease the US president who has demanded that European powers pay more for their own security.
Starmer revealed that he would host fellow leaders for talks focused on Ukraine and European security this weekend, after returning from the White House.
The UK spent 2.3 percent of gross domestic product (GDP) on defence in 2023/24.
Starmer's Labour government had previously committed to increasing defence spending to 2.5 percent, but had not set a timeline.
Trump has demanded that NATO allies more than double their defence spending targets to five percent of economic output, although the US currently spends around 3.3 percent on defence.
When he meets Trump, Starmer faces a difficult balancing act between backing Ukraine while not distancing himself from the US leader.
He has indicated he will reaffirm support for Ukraine and President Volodymyr Zelensky and insist that Kyiv is at the heart of negotiations for a truce with Russia.
Trump has opened discussions with Moscow to bring an end to the war.
Starmer admitted that the US president's moves in recent weeks had influenced his decision to set out a timeline for 2.5 percent.
"The last few weeks have accelerated my thinking on when we needed to make this announcement," Starmer told reporters.
US defence secretary Pete Hegseth welcomed the move as a "strong step from an enduring partner".
- 'Short-sighted' -
Starmer will hope that his announcement helps to convince Trump to provide security guarantees for any European peacekeepers sent to Ukraine to monitor any ceasefire that is agreed.
The UK premier and France's President Emmanuel Macron have said they are willing to send British and French troops to Ukraine, but they would require a US backup.
Security guarantees would likely take the form of air cover, intelligence and logistics.
"This investment means that the UK will strengthen its position as a leader in NATO and in the collective defence of our continent, and we should welcome that role," said Starmer.
The PM later told reporters said he would be "hosting a number of countries at the weekend for us to continue to discuss how we go forward together as allies in light of the situation that we face".
Polish Prime Minister Donald Tusk said he would be in London on Sunday to talk with a "group of leaders" about "joint defence plans".
Starmer added he hopes to hike spending to three percent of GDP in the next parliament, which would fall during a five-year period after elections expected in 2029.
The initial rise of 0.2 percent would cost the government GBP 13.4 billion ($16.9 billion) more every year from 2027, said Starmer.
That will mean some "extremely difficult and painful choices", he told lawmakers, but added it would contribute to the "biggest sustained increase in defence spending since the end of the Cold War".
The prime minister told parliament the increase would be funded by cutting overseas development aid from 0.5 percent of gross national income (GNI) to 0.3 percent.
Starmer said he "did not want" to cut aid but insisted Britain would still "play a key humanitarian role in war-torn countries like Sudan, Ukraine and Gaza".
Aid agencies reacted with anger to his announcement.
Romilly Greenhill, chief executive of Bond, the umbrella organisation for international development and humanitarian assistance groups, called it a "short-sighted and appalling move".
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